-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, LZafwz41YpnWCPysc4AXExivwRKkbJuuPglCdHkho2MGn40dDwq3mUVRjQ5I0CwS 6o7eDzQzjJJpOaL/AzUcPw== 0001193125-03-034323.txt : 20030812 0001193125-03-034323.hdr.sgml : 20030812 20030812162004 ACCESSION NUMBER: 0001193125-03-034323 CONFORMED SUBMISSION TYPE: 8-K PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 20030628 ITEM INFORMATION: Other events ITEM INFORMATION: Financial statements and exhibits FILED AS OF DATE: 20030812 FILER: COMPANY DATA: COMPANY CONFORMED NAME: SPIEGEL INC CENTRAL INDEX KEY: 0000276641 STANDARD INDUSTRIAL CLASSIFICATION: RETAIL-CATALOG & MAIL-ORDER HOUSES [5961] IRS NUMBER: 362593917 STATE OF INCORPORATION: DE FISCAL YEAR END: 0102 FILING VALUES: FORM TYPE: 8-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-16126 FILM NUMBER: 03837828 BUSINESS ADDRESS: STREET 1: 3500 LACEY RD CITY: DOWNERS GROVE STATE: IL ZIP: 60515-5432 BUSINESS PHONE: 7089868800 MAIL ADDRESS: STREET 1: 3500 LACEY ROAD CITY: DOWNERS GROVE STATE: IL ZIP: 60515-5432 8-K 1 d8k.txt FORM 8-K UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 8-K Current Report Pursuant to Section 13 or 15d of the Securities Exchange Act of 1934 Date of Report (Date of earliest event reported): June 28, 2003 SPIEGEL, INC. (Exact name of registrant as specified in its charter) Delaware 0-16126 36-2593917 (State or other (Commission file (I.R.S. Employer jurisdiction of number) Identification No.) incorporation or organization) 3500 Lacey Road Downers Grove, IL 60515-5432 (Address of principal executive offices) (Zip Code) (630) 986-8800 (Registrant's telephone number, including area code) No Change (Former name or Former address, if changed since last report) INTRODUCTORY NOTE As previously reported, on March 7, 2003, the SEC commenced a civil proceeding against the Company in federal court in Chicago alleging, among other things, that the Company's public disclosures violated Sections 10(b) and 13(a) of the Securities Exchange Act of 1934. Simultaneously with the filing of the SEC's complaint, the Company announced that it had entered into a consent and stipulation with the SEC resolving, in part, the claims asserted in the SEC action. Solely for purposes of resolving the SEC action, the Company consented to the entry of a partial final judgment, which was entered against the Company on March 18, 2003, and amended on March 27, 2003. Under the terms of the SEC Judgment, the Company agreed, among other things, to the entry of a permanent injunction enjoining any conduct in violation of Sections 10(b) and 13(a) of the Securities Exchange Act and various rules and regulations thereunder. The Company also consented to the appointment of an independent examiner by the court to review its financial records since January 1, 2000, and to provide a report to the court and other parties within 120 days regarding accounting irregularities. As part of the settlement, the Company neither admitted nor denied the allegations of the SEC's complaint. The SEC reserved its right to petition the court to require the Company to pay disgorgement, prejudgment interest and civil penalties, or to impose other equitable relief. The Company is cooperating fully with the ongoing SEC investigation. Under subsequent orders of the court, the independent examiner's report is presently scheduled to be issued in early September 2003. As a result of the ongoing investigation, the Company's officers are not in a position to certify the Company's financial statements as required by Sections 302 and 906 of the Sarbanes-Oxley Act of 2002. In addition, the Company's outside auditors, KPMG LLP, advised the Company that they would not be able to complete the audit of the Company's 2002 financial statements and reviews of the Company's quarterly financial statements until the Company was able to provide the required officer certifications and KPMG LLP had an opportunity to review and consider the report of the independent examiner appointed under the terms of the SEC Judgment. As a result of the above, the Company notified the SEC that it would not, as a practical matter, be able to file its 2002 Form 10-K and one or more Form 10-Qs in a timely manner as required by the SEC Judgment. On March 31, 2003, the Company filed with the court a motion for clarification of the SEC Judgment in order to request limited relief from the obligation to file reports, subject to certain conditions. On April 10, 2003, the court entered an order on the Company's motion. The order provides that the Company and its officers, directors, employees and agents are not, and will not be in the future, in contempt of the SEC Judgment as a result of the Company's failure to timely file its 2002 Form 10-K and one or more Form 10-Qs with the SEC as required; provided that, among other things, (1) the Company files the financial statements that would have been included in its 2002 Form 10-K and a management's discussion and analysis covering the financial statements on or before May 15, 2003, and (2) the Company files the financial statements that would have been included in any such Form 10-Qs in a timely manner. See "Management's Discussion and Analysis of Financial Condition and Results of Operations-General-SEC Examination and Appointment of an Independent Examiner" for a more detailed discussion of these SEC proceedings. As a result, the Company is filing its financial statements for the second quarter ended June 28, 2003 and related notes in this report. However, the second quarter 2003 financial statements included in this report, and the financial information derived from these financial statements, have not been reviewed in accordance with Statement on Auditing Standards ("SAS") No. 100 and, accordingly, the Company cannot give investors any assurance that the financial information contained herein will not be subject to future adjustment. In addition, any financial information derived from the Company's 2002 fiscal year financial statements have not been audited or reviewed in accordance with SAS No. 100 and may similarly be subject to future adjustment. Specifically, the Company is unable at this time to predict what the independent examiner's report will conclude or whether these conclusions will require any adjustments to the Company's financial statements or disclosures. In addition, the Company's pending bankruptcy case or the formation or consummation of a plan of reorganization may result in the need to adjust the financial statements or disclosures included in this report. Future events may also result in adjustments to the financial statements or disclosures. Item 5. Other Events SPIEGEL, INC. AND SUBSIDIARIES DEBTORS-IN-POSSESSION CONSOLIDATED BALANCE SHEETS ($000s omitted, except share and per share amounts) (unaudited)
June 28, June 29, December 28, 2003 2002 2002 ------------ ---------- ----------- ASSETS Current assets: Cash and cash equivalents $ 122,917 $ 118,558 $ 165,401 Receivables, net 54,355 583,009 90,674 Inventories 342,554 456,823 427,024 Prepaid expenses 67,146 99,660 73,120 Refundable income taxes 1,537 2,516 -- Assets of discontinued operations 77,439 354,441 191,814 ------------ ---------- ----------- Total current assets 665,948 1,615,007 948,033 ------------ ---------- ----------- Property and equipment, net 268,701 327,030 304,124 Intangible assets, net 135,721 135,357 135,721 Other assets 34,850 228,920 97,882 ------------ ---------- ----------- Total assets $ 1,105,220 $2,306,314 $1,485,760 ============ ========== =========== LIABILITIES and STOCKHOLDERS' (DEFICIT) EQUITY Liabilities not subject to compromise Current liabilities: Current portion of long-term debt $ 48,000 $1,140,857 $1,140,857 Related party debt -- 160,000 160,000 Accounts payable and accrued liabilities 301,710 409,345 416,066 Liabilities of discontinued operations 83,808 480,765 258,234 Income taxes payable -- -- 191 ------------ ---------- ----------- Total current liabilities 433,518 2,190,967 1,975,348 ------------ ---------- ----------- Liabilities subject to compromise 1,429,493 -- -- ------------ ---------- ----------- Total liabilities 1,863,011 2,190,967 1,975,348 ------------ ---------- ----------- Stockholders' (deficit) equity: Class A non-voting common stock, $1.00 par value; authorized 16,000,000 shares; 14,945,144 shares issued and outstanding 14,945 14,945 14,945 Class B voting common stock, $1.00 par value; authorized 121,500,000 shares; 117,009,869 shares issued and outstanding 117,010 117,010 117,010 Additional paid-in capital 329,489 329,489 329,489 Accumulated other comprehensive loss (26,309) (9,975) (35,631) Accumulated deficit (1,192,926) (336,122) (915,401) ------------ ---------- ----------- Total stockholders' (deficit) equity (757,791) 115,347 (489,588) ------------ ---------- ----------- Total liabilities and stockholders' (deficit) equity $ 1,105,220 $2,306,314 $1,485,760 ============ ========== ===========
See accompanying notes to consolidated financial statements. 2 SPIEGEL, INC. AND SUBSIDIARIES DEBTORS-IN-POSSESSION CONSOLIDATED STATEMENTS OF OPERATIONS ($000s omitted, except share and per share amounts) (unaudited)
Thirteen Weeks Ended Twenty-six Weeks Ended --------------------------- --------------------------- June 28, June 29, June 28, June 29, 2003 2002 2003 2002 ------------ ------------ ------------ ------------ Net sales and other revenues: Net sales $ 426,613 $ 533,540 $ 840,180 $ 1,070,506 Finance revenue 609 5,158 (30,460) 18,069 Other revenue 45,695 66,948 96,561 134,100 ------------ ------------ ------------ ------------ 472,917 605,646 906,281 1,222,675 Cost of sales and operating expenses: Cost of sales, including buying and occupancy expenses 291,457 325,637 552,732 668,694 Selling, general and administrative expenses 242,403 320,040 513,775 623,472 ------------ ------------ ------------ ------------ 533,860 645,677 1,066,507 1,292,166 Operating loss (60,943) (40,031) (160,226) (69,491) Interest expense (contractual interest for the 13 and 26 weeks ended June 28, 2003 was $23,432 and $44,624, respectively) 1,200 16,067 18,887 29,978 ------------ ------------ ------------ ------------ Loss from operations before reorganization items and minority interest (62,143) (56,098) (179,113) (99,469) Reorganization items, net (84,422) -- (98,412) -- ------------ ------------ ------------ ------------ Loss from operations before minority interest (146,565) (56,098) (277,525) (99,469) Minority interest in (income) loss of consolidated subsidiary -- (6) -- 26 ------------ ------------ ------------ ------------ Net loss $ (146,565) $ (56,104) $ (277,525) $ (99,443) ============ ============ ============ ============ Net loss per common share: Basic and diluted $ (1.11) $ (0.42) $ (2.10) $ (0.75) ============ ============ ============ ============ Weighted average number of common shares outstanding: Basic 131,955,013 131,955,013 131,955,013 131,955,013 ============ ============ ============ ============ Diluted 131,955,013 131,955,013 131,955,013 131,955,013 ============ ============ ============ ============
See accompanying notes to consolidated financial statements. 3 SPIEGEL, INC. AND SUBSIDIARIES DEBTORS-IN-POSSESSION CONSOLIDATED STATEMENTS OF CASH FLOWS ($000s omitted) (unaudited)
Twenty-six Weeks Ended ---------------------- June 28, June 29, 2003 2002 --------- --------- Cash flows from operating activities: Net loss $(277,525) $ (99,443) Adjustments to reconcile net loss to net cash used in operating activities: Reorganization items, net 98,412 -- Depreciation and amortization 29,907 35,425 Net pretax losses on sale of receivables 20,479 4,718 Minority interest in loss of consolidated subsidiary -- (26) Change in assets and liabilities: Decrease in receivables, net 16,340 50,606 Decrease in inventories 86,330 20,724 (Increase) decrease in prepaid expenses 6,130 (11,342) Increase (decrease) in accounts payable and other accrued liabilities 62,538 (67,771) (Increase) decrease in refundable income taxes (1,728) 3,282 --------- --------- Net cash provided by (used in) operating activities before reorganization items 40,883 (63,827) --------- --------- Net cash used for reorganization items (24,173) -- --------- --------- Net cash provided by (used in) operating activities 16,710 (63,827) --------- --------- Cash flows from investing activities: Net additions to property and equipment (255) (2,512) Net reductions (additions) to other assets 1,025 (71,564) --------- --------- Net cash provided by (used in) investing activities 770 (74,076) --------- --------- Cash flows from financing activities: Issuance of debt -- 387,000 Payment of debt -- (138,000) Increase in deferred financing fees -- (1,676) Contribution from minority interest of consolidated subsidiary -- 57 --------- --------- Net cash provided by financing activities -- 247,381 --------- --------- Net cash used in discontinued operations (60,051) (20,548) --------- --------- Effect of exchange rate changes on cash 87 100 --------- --------- Net change in cash and cash equivalents (42,484) 89,030 Cash and cash equivalents at beginning of period 165,401 29,528 --------- --------- Cash and cash equivalents at end of period $ 122,917 $ 118,558 ========= ========= Supplemental cash flow information: Cash paid during the period for: Interest $ 18,725 $ 38,134 ========= ========= Income taxes $ 1,701 $ 517 ========= =========
See accompanying notes to consolidated financial statements. 4 Spiegel, Inc. and Subsidiaries Debtors-in-Possession Notes to Consolidated Financial Statements ($000s omitted, except per share amounts) (unaudited) (1) PROCEEDINGS UNDER CHAPTER 11 OF THE BANKRUPTCY CODE In February 2002, the Company determined, with the lending institutions under its $750 million revolving credit agreement, that a material adverse change had occurred due to the Company's operating performance in the fourth quarter of 2001 and the estimated loss recorded on the expected sale of the bankcard segment. Accordingly, on February 18, 2002, the borrowing capacity on the credit facility was capped at $700,000, which represented the borrowings outstanding on that date. Additionally, for the reporting period ended December 28, 2002, the Company was in default of the financial covenants and other covenants on its other non-affiliate loan agreements. See "-Liquidity and Capital Resources" below for a description of these agreements and defaults. In March 2003, First Consumers National Bank ("FCNB") notified the trustees of its asset backed securitization transactions that a Pay Out Event had occurred on all six series of the Company's asset backed securitizations. See "Management's Discussion & Analysis--Pay Out Events and Cancellation of Credit Cards" below for a description of these events. A principal source of liquidity for the Company had been its ability to securitize substantially all of the credit card receivables that it generated. The Company was unable to secure alternative sources of financing from its existing lenders or other third parties to provide adequate liquidity to fund the Company's operations. As a result, on March 17, 2003, Spiegel, Inc. and 19 of its subsidiaries filed voluntary petitions for reorganization under Chapter 11 of the U.S. Bankruptcy Code in the United States Bankruptcy Court for the Southern District of New York. The reorganization is being jointly administered under the caption "In re: Spiegel, Inc., et al. Case No. 03-11540 (CB)." Spiegel and these subsidiaries are currently operating their business and managing their properties and assets as debtors-in-possession under the Bankruptcy Code. During the bankruptcy process, the Company will continue to operate its business as an ongoing business, but may not engage in transactions outside the ordinary course of business without the approval of the bankruptcy court. The following material subsidiaries were not included in the Chapter 11 case: FCNB, First Consumers Credit Corporation (FCCC), Financial Services Acceptance Corporation (FSAC) and Spiegel Acceptance Corporation (SAC). As a result of the Company's decision in the fourth quarter of fiscal 2001 to sell the bankcard segment, the assets and liabilities of FCNB, FCCC and FSAC, the Company's subsidiaries included in its bankcard segment, were reflected as discontinued operations in the Company's financial statements beginning in the fourth quarter of fiscal 2001. As discussed below, the Company's special purpose bank, FCNB, began a formal liquidation in fiscal 2003 under the terms of a pre-existing disposition plan agreed to with the Office of the Comptroller of the Currency (the "OCC"). The assets of SAC at June 28, 2003 consist primarily of cash and receivables approximating $2 million, which relate to the private-label credit card operation. The primary changes from the first quarter of 2003 to the second quarter of 2003 represent reductions in cash of $9 million for payments made to the trust, reductions in other receivables of $2 million for collections in the second quarter of 2003, and lower prepaid expenses of approximately $5 million principally for prepaid interest which was expensed in the second quarter of 2003. The liabilities of SAC total approximately $20 million at June 28, 2003 and represent primarily accrued expenses. The primary changes from the first quarter of 2003 to the second quarter of 2003 reflect additional liabilities incurred for amounts owed to credit card customers and amounts owed to the trust related to merchandise returns. On March 17, 2003, the bankruptcy court gave interim approval for $150 million of a $400 million senior secured debtor-in-possession financing facility (the "DIP Facility") from Bank of America, N.A., Fleet 5 Retail Finance, Inc. and The CIT Group/Business Credit, Inc. On April 30, 2003, the bankruptcy court granted final approval for the total amount, which was later reduced to $350 million. The DIP Facility will be used to supplement the Company's existing cash flow during the reorganization process. See Note 9. As a result of the Chapter 11 filing, the realization of assets and satisfaction of liabilities, without substantial adjustments and/or changes in ownership, are subject to uncertainty. While operating as debtors-in-possession under the protection of Chapter 11 of the Bankruptcy Code and subject to approval of the bankruptcy court or otherwise as permitted in the ordinary course of business, the Debtors, or some of them, may sell or otherwise dispose of assets and liquidate or settle liabilities for some amounts other than those reflected in the consolidated financial statements. Further, a plan of reorganization could materially change the amounts and classifications in the historical consolidated financial statements. The matters discussed above raise substantial doubt about the Company's ability to continue as a going concern for a reasonable period of time. The Company's consolidated financial statements have been prepared in accordance with generally accepted accounting principles (GAAP) applicable to a going concern, which contemplate, among other things, realization of assets and payment of liabilities in the normal course of business and in accordance with Statement of Position 90-7 ("SOP 90-7"), "Financial Reporting by Entities in Reorganization under the Bankruptcy Code." Accordingly, all pre-petition liabilities subject to compromise have been segregated in the unaudited consolidated balance sheets and classified as liabilities subject to compromise, at the estimated amount of allowable claims. Liabilities not subject to compromise are separately classified as current and non-current. Revenues, expenses, realized gains and losses, and provisions for losses resulting from the reorganization are reported separately as reorganization items, net in the unaudited consolidated statements of operations. Cash used for reorganization items is disclosed separately in the unaudited consolidated statements of cash flows. The eventual outcome of the Chapter 11 case is not presently determinable. As a result, the consolidated financial statements do not give effect to any adjustments relating to the recoverability and classification of assets, the amount and classification of liabilities or the effects on existing stockholders' deficit that may occur as a result of the bankruptcy case. The consolidated financial statements also do not give effect to any adjustments relating to the substantial doubt about the ability of the Company to continue as a going concern. In July 2003, the Company received bankruptcy court approval to implement a Key Employee Retention Plan ("KERP"), which provides cash incentives to certain members of the management team and other employees. The KERP is intended to encourage employees to continue their employment with the Company through the reorganization process. The KERP is being finalized and the Company is in the process of implementing it. The Company's ability to continue as a going concern will depend upon, among other things, the confirmation of a plan of reorganization, its compliance with the provisions of the DIP Facility and its ability to generate cash from operations and obtain financing sufficient to satisfy its future obligations. These challenges are in addition to the operational and competitive challenges the Company's business faces. The Company cannot predict at this time the effect that the Chapter 11 case will have on its operations, particularly its net sales and its access to, and the cost of, goods sold. Included below are the unaudited condensed combined financial statements of the debtor entities. The figures included below are subject to change as discussed in the Introductory Note. 6 Debtors' Condensed Combined Balance Sheet (unaudited) Assets: Current assets $ 586,096 Property and equipment, net 268,701 Intangible assets, net 135,721 Other assets 27,071 ---------- Total assets $1,017,589 ========== Liabilities: Current liabilities $ 333,336 Liabilities subject to compromise 1,429,493 Investments in and advances to non-debtor subsidiaries, net 12,551 ---------- Total liabilities 1,775,380 Stockholders' deficit (757,791) ---------- Total liabilities and stockholders' deficit $1,017,589 ========== Debtors' Condensed Combined Statements of Operations For the thirteen and twenty-six weeks ended June 28, 2003 (unaudited)
Thirteen Weeks Ended Twenty-six Weeks Ended June 28, 2003 June 28, 2003 -------------------- ---------------------- Net sales and other revenue $ 472,882 $ 936,660 Cost of sales and operating expenses (518,544) (1,024,402) Equity in losses of non-debtor subsidiaries (18,833) (84,256) --------- ----------- Operating loss (64,495) (171,998) Interest income (expense) 2,352 (7,115) Reorganization items, net (84,422) (98,412) --------- ----------- Net loss $(146,565) $ (277,525) ========= ===========
7 Debtors' Condensed Combined Statement of Cash Flows For the twenty-six weeks ended June 28, 2003 (unaudited) Net cash used in operating activities $ (13,101) Net cash used for reorganization items (24,173) Net cash provided by investing activities 700 Effect of exchange rate changes on cash 87 --------- Net decrease in cash and cash equivalents (36,487) Cash and cash equivalents at beginning of period 157,796 --------- Cash and cash equivalents at end of period $ 121,309 ========= (2) BASIS OF PRESENTATION The Company has filed, pursuant to the terms of the SEC Judgment (see Introductory Note), its consolidated financial statements for the thirteen and twenty-six weeks ended June 28, 2003 and related notes in this report. However, all 2002 financial information contained in this report is unaudited and 2003 information has not been reviewed in accordance with SAS No. 100 and the Company can give no assurance that the financial information contained herein will not be subject to future adjustment. Specifically, the Company is unable at this time to predict what the independent examiner's report will conclude or whether those conclusions will require any adjustments to the Company's financial statements. In addition, the reorganization process or the formation or consummation of a plan of reorganization may result in the need to adjust the financial statements included in this report. The consolidated financial statements include the accounts of Spiegel, Inc. and its wholly owned subsidiaries. All significant intercompany transactions and accounts have been eliminated in consolidation. As described in Note 10, the Company is in the process of liquidating its bankcard business and has reflected the bankcard business as a discontinued operation. FCNB submitted a liquidation plan to the OCC and has begun its formal liquidation. In addition, in March 2003 the Company also discontinued charging privileges on all of its private-label credit cards. On or about June 25, 2003, Cardholder Management Services ("CMS") a subsidiary of Cardworks, was appointed the successor servicer for the private-label receivables portfolio related to the discontinued private-label cards and has assumed servicing responsibilities. FCNB has been informed that The Bank of New York, as securitization trustee, appointed First National Bank of Omaha as the successor servicer for the bankcard receivables portfolio on or about June 25, 2003. The merchant companies have issued a limited number of private-label credit cards directly rather than through FCNB, which were serviced by FCNB. As a result of the impending liquidation of FCNB, the Company has determined to cease issuing new private-label credit cards internally and has stopped honoring existing cards at its merchant companies. In June 2003, the Company sold these merchant issued credit card receivables, which had a balance of approximately $5 million, for approximately $4 million to First National Bank of Omaha. On April 28, 2003, the Company announced that it had entered into a ten-year agreement with Alliance Data Systems ("Alliance Data"), the terms of which were subsequently approved by the bankruptcy court, to establish a new private-label credit card program for its merchant companies. Services provided by Alliance Data under this agreement include establishing credit criteria for customer acquisition, issuing and activating new cards, extending credit to new cardholders, authorizing purchases made with the new cards, customer care and billing and remittance services. The new Alliance Data credit card program is separate from and has no relation to the Company's existing or prior credit card programs. Alliance Data began issuing cards under this program in May 2003. 8 The Company is charged a customary fee on all credit transactions with Alliance Data . In addition, payments to the Company for customer purchases made with their Alliance Data-issued cards are subject to a 20% "holdback". The holdback currently equals 20% of the principal portion of the receivable balance for Spiegel accounts financed by Alliance Data at each month end. Alliance Data may draw against the holdback for reimbursement of a portion of its operating expenses and principal balance write-offs in connection with customers' failure to pay their credit card accounts under certain circumstances, including cessation of the Company's business or termination of the agreement or its funding arrangement. The agreement also contains certain restrictions limiting the Company's ability to make significant changes to its operations. Upon the Company's emergence from Chapter 11, the holdback will be reduced to 10%, and thereafter would be eliminated if the Company satisfies certain financial criteria. The Company has recorded the holdback, which approximates $1 million as of June 28, 2003, as a receivable in the consolidated balance sheet. As of June 28, 2003, a reserve was not recorded against this receivable as the Company believes that the balance is collectible. The Company will assess the collectability of the receivable balance each period based upon the collection rates on the credit cards and the likelihood that the Company will emerge from Chapter 11 and will be able to meet the financial criteria contained in the agreement. In the event the agreement is terminated under certain circumstances, the Company is required to purchase a substantial portion of the unpaid and outstanding accounts including outstanding finance charges and fees. The consolidated financial statements included herein are unaudited and have been prepared from the books and records of the Company in accordance with accounting principles generally accepted in the United States of America and the rules and regulations of the Securities and Exchange Commission. All adjustments (consisting only of normal recurring accruals) which are, in the opinion of management, necessary for a fair presentation of financial position and operating results for the interim periods are reflected. These consolidated financial statements should be read in conjunction with the unaudited consolidated financial statements and notes thereto included in the Company's 8-K filing, dated May 15, 2003, which includes unaudited consolidated financial statements for the fiscal year ended December 28, 2002. Due to the seasonality of the Company's business, results for interim periods are not necessarily indicative of the results for the year. (3) INTANGIBLE ASSETS Statement of Financial Accounting Standards (SFAS) No. 142, "Goodwill and Other Intangible Assets," which supercedes Accounting Principles Bulletin ("APB") Opinion No. 17, "Intangible Assets," establishes financial accounting and reporting standards for acquired goodwill and other intangible assets. Under SFAS No. 142, goodwill and other intangible assets with indefinite lives are not amortized but rather tested for impairment annually, or more frequently if impairment indicators arise. The Company's intangible assets with indefinite lives principally represent goodwill and trademarks from businesses acquired (principally Eddie Bauer). Effective at the beginning of fiscal 2002, the Company ceased amortization of goodwill and trademarks upon adoption of SFAS No. 142. Upon adoption of SFAS No. 142, a transitional goodwill impairment test was required. In the second quarter of fiscal 2002, the Company completed the transitional goodwill impairment test. The fair value of the reporting unit was estimated using both a discounted cash flow model and a market comparable approach (as prescribed in SFAS No. 142), which resulted in no goodwill impairment. The Company performed its annual impairment test in the fourth quarter of fiscal 2002 and an additional impairment test in the first quarter of fiscal 2003, neither of which resulted in any impairment. However, if additional changes occur during the reorganization process, including the closing of additional Eddie Bauer stores, the Company may be required to write-off any impaired portion of the assets, which could have a material adverse effect on the operating results in the period in which the write-off occurs. 9 The carrying amount for each intangible asset class with an indefinite life is as follows: June 28, June 29, December 28, 2003 2002 2002 -------- -------- ------------ Goodwill $ 76,601 $ 76,601 $ 76,601 Trademarks 58,756 58,756 58,756 -------- -------- -------- $135,357 $135,357 $135,357 ======== ======== ======== In addition to the amounts disclosed above, the Company also has $364 in pension related intangible assets. (4) DERIVATIVES AND HEDGING ACTIVITIES Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative Instruments and Hedging Activities", as amended, establishes accounting and reporting standards for derivative instruments and for hedging activities. All derivative financial instruments, such as interest rate swap agreements and foreign currency forward contracts, are required to be recorded on the balance sheet at fair value. If the derivative is designated as a cash flow hedge, the effective portion of changes in the fair value of the derivative are recorded in other comprehensive loss and are recognized in the income statement when the hedged item affects earnings. Ineffective portions of changes in the fair value of cash flow hedges are recognized in earnings. As described in Note 1, the Company and 19 of its subsidiaries filed voluntary petitions for reorganization under Chapter 11 of the U.S. Bankruptcy Code on March 17, 2003. As a result of this filing, all of the Company's derivative financial instruments were deemed ineffective, and as such, the Company recognized in the first quarter of 2003 in the consolidated statement of operations expenses of approximately $6,960, which have been included in reorganization items, net (see Note 7). Losses related to these cash flow hedges were previously included in accumulated other comprehensive loss in the stockholders' (deficit) equity section of the consolidated balance sheet. As of June 28, 2003, these derivative financial instruments totaling approximately $6,960 are reflected in liabilities subject to compromise and represent the fair value of the derivative financial instruments as of March 17, 2003. USE OF DERIVATIVE FINANCIAL INSTRUMENTS Historically, the Company has used derivative financial instruments principally to manage the risk that changes in interest rates would affect the amount of its future interest payments, and to a lesser extent, to manage risk associated with future cash flows in foreign currencies. The Company did not enter into derivative financial instruments for any purpose other than cash flow hedging purposes. The Company did not use derivative financial instruments for trading or other speculative purposes INTEREST RATE RISK MANAGEMENT Historically, the Company used a mix of fixed- and variable-rate debt to finance its operations. Variable-rate debt obligations exposed the Company to variability in interest payments due to changes in interest rates. To limit the variability of a portion of these interest payments, the Company would enter into receive-variable, pay-fixed interest rate swaps. Under these interest rate swaps, the Company received variable interest rate payments and made fixed interest rate payments; thereby creating fixed-rate debt. The variable-rate of interest received was based on the same terms, including interest rates, notional amounts and payment schedules, as the hedged interest payments on variable-rate debt. These interest rate swaps were determined to be effective; therefore, changes in fair value were reflected in other comprehensive loss and not recognized in earnings until the related interest payments were made. The Company had an interest rate swap agreement to hedge the underlying interest risks on a term loan agreement with Berliner Bank with termination dates from March 1996 to December 2004. The notional 10 amount of the interest swap agreement was $30,000. The fair value of the swap agreement at March 17, 2003 and December 28, 2002 was approximately $(3,459) and $(3,351), respectively, and was estimated by a financial institution and represents the estimated amount the Company would have to pay to terminate the agreement, taking into consideration current interest rates and risks of the transactions. The Company also had an interest rate swap agreement with Bank of America to hedge the underlying interest risks on a portion of the outstanding balance of its revolving credit agreement with a termination date of July 2003. The notional amount of the interest rate swap agreement was $35,000. The fair value of this swap agreement at March 17, 2003 and December 28, 2002 was approximately $(3,501) and $(3,582), respectively, and was estimated by a financial institution and represents the estimated amount the Company would have to pay to terminate the agreement, taking into consideration current interest rates and risks of the transactions. As a result of the Company's Chapter 11 filing, the interest rate swap agreements were determined to be ineffective, which resulted in the Company reclassifying approximately $6,960 from accumulated other comprehensive loss in the stockholders' equity section of the consolidated balance sheet to reorganization items, net in the consolidated statement of operations during the first quarter of 2003. As of June 28, 2003 and December 28, 2002, the cumulative loss in other comprehensive loss related to interest rate swap agreements was $0 and $6,933 (net of tax benefit of $0), respectively. As of June 28, 2003, liabilities subject to compromise and accrued expenses include $6,960 and $0, respectively, related to these interest rate swap agreements. FOREIGN CURRENCY RISK MANAGEMENT The Company is subject to foreign currency exchange rate risk related to its Canadian operations, as well as its joint venture investments in Germany and Japan. Historically, the Company has entered into foreign currency forward contracts to minimize the variability caused by foreign currency risk related to certain forecasted semi-annual transactions with the joint ventures that are denominated in foreign currencies. The principal currency hedged is the Japanese yen. At June 28, 2003, the Company was not party to any foreign currency forward contracts. There were no unrealized gains or losses related to foreign currency forward contracts included in other comprehensive loss as of June 28, 2003 and December 28, 2002. 11 (5) COMPREHENSIVE LOSS AND ACCUMULATED OTHER COMPREHENSIVE LOSS The components of comprehensive loss are as follows:
Thirteen Weeks Ended Twenty-six Weeks Ended -------------------- ---------------------- June 28, June 29, June 28, June 29, 2003 2002 2003 2002 --------- -------- --------- --------- Net loss $(146,565) $(56,104) (277,525) (99,443) Unrealized loss on derivatives (net of tax benefit of $0, $0, $0 and $282, respectively) -- (1,281) -- (797) Reclassification of interest rate hedging losses to net loss -- -- 6,933 -- Foreign currency translation adjustment 1,444 1,090 2,389 984 --------- -------- --------- ------- Comprehensive loss $(145,121) $(56,295) $(268,203) (99,256) ========= ======== ========= =======
The components of accumulated other comprehensive loss are as follows:
June 28, June 29, December 28, 2003 2002 2002 -------- -------- ------------ Accumulated loss on derivative financial instruments (net of tax benefit of $0, $1,610 and $0, respectively) $ -- $(4,018) $ (6,933) Foreign currency translation adjustment (4,043) (5,957) (6,432) Minimum pension liability (22,266) -- (22,266) -------- ------- -------- $(26,309) $(9,975) $(35,631) -------- ------- --------
(6) LIABILITIES SUBJECT TO COMPROMISE Under Chapter 11 of the U.S. Bankruptcy Code, certain claims against the Company in existence prior to the filing of petitions for reorganization are stayed while the Company operates as debtors-in-possession. These pre-petition liabilities are expected to be settled as part of the plan of reorganization and are classified in the June 28, 2003 balance sheet as "liabilities subject to compromise." Liabilities subject to compromise consist of the following: June 28, 2003 ---------- Debt $1,252,857 Trade payables 122,148 Salaries, wages and employee 8,852 Other liabilities 45,636 ---------- Total liabilities subject to compromise $1,429,493 ========== Liabilities subject to compromise represent estimates that will change in future periods as a result of reorganization activity and other events that come to management's attention requiring modification to the above estimates. The primary change from the first quarter of 2003 (which totaled $1,444,627) relates to reclassifications that were recorded to reflect vendor payments that had been prepaid and accordingly, do not represent liabilities subject to compromise. In addition, the reduction in the second quarter of 2003 12 relates to revisions of previously estimated liabilities. Adjustments may result from negotiations, actions of the bankruptcy court, rejection of executory contracts and unexpired leases, the determination as to the value of any collateral securing claims, proofs of claim or other events. It is anticipated that these adjustments, if any, could be material. Payment terms for these amounts will be established in connection with the bankruptcy case. (7) REORGANIZATION ITEMS The net expense resulting from the Company's Chapter 11 filings and subsequent reorganization efforts has been segregated from expenses related to ongoing operations in the consolidated statements of operations and includes the following for the thirteen and twenty-six weeks ended June 28, 2003: Thirteen Weeks Ended Twenty-six Weeks Ended June 28, 2003 June 28, 2003 -------------------- ---------------------- Asset impairments $68,582 $68,582 Professional fees 10,233 11,133 Financing fees 2,519 8,669 Interest rate swaps -- 6,960 Severance 5,263 5,263 Interest income (57) (79) Other (2,118) (2,116) ------- ------- $84,422 $98,412 ======= ======= In April 2003, the Company announced its intent to close all 21 of its Spiegel and Newport News outlet and clearance stores as part of its reorganization efforts. The Company will consider reopening some of these stores in the future to support the inventory liquidation needs of both Spiegel Catalog and Newport News. The Company anticipates the closure of each of the Spiegel outlet stores in the third quarter of 2003. As of the second quarter of 2003, two of the Company's Newport News stores were closed, while the remaining three stores are planned to close in the third quarter of 2003. The store closing plan has received bankruptcy court approval. In April 2003, the Company announced its intent to close 60 under-performing Eddie Bauer stores as a part of its ongoing reorganization process. The store-closing plan has received bankruptcy court approval. The Company will close these stores upon completion of the related store-closing inventory sales. As of June 28, 2003, 14 of these stores have been closed. The Company has announced its intent to close a customer contact center located in Bothell, Washington and one in Rapid City, South Dakota. The Bothell center will be closed in the third quarter of 2003 and the Rapid City facility will be closed by the end of the year. In addition, the Company announced its intent to consolidate its retail distribution facility in Columbus, Ohio with its facility in Groveport, Ohio. Finally, the Company announced its intent to close its distribution facility located in Newport News, Virginia. The facility is scheduled to close at the end of December 2003. Asset impairments were recorded in accordance with SFAS 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." The closure of retail and outlet stores described above resulted in the write-off of approximately $11 million in assets primarily related to leasehold improvements that have no future benefit. Finally, as part of the reorganization process, the Company recorded a write-off of approximately $35 million for a rent leveling asset and other assets associated with a leased building. The impairment was recorded based upon management's decision to terminate the related lease agreement. The Company will record a liability in the future period for the lease rejection cost associated with this lease when the Company formally notifies the landlord or ceases using the facility, whichever is sooner. The expense will likely have a material impact on the consolidated financial statements. The Company abandoned certain capital projects due to capital expenditure restrictions, which led to the write-off of approximately $21 million in assets. 13 Professional fees consist primarily of financial, legal, real estate and other consulting services directly associated with the reorganization process. Financing fees represent payments made to certain banks for the consummation of the new DIP Facility. The interest rate swaps amount is a reclassification from accumulated other comprehensive loss in the consolidated balance sheet to reorganization expense in the statement of operations as a result of the Company's interest rate swap agreements no longer representing an effective hedge due to the Company's Chapter 11 filing. See Notes 4 and 5. In the second quarter, the Company recorded severance costs associated with the termination of employees at various locations due to either the closure of locations or the reduction in force at existing locations. Headcount reductions totaled approximately 600 employees for the store closings and the closure of the Bothell facility described above and the liability remaining at June 28, 2003 related to severance expense totaled approximately $2.5 million. The closure of the Rapid City and Newport News facilities (discussed above) were announced in July 2003 and accordingly, no liability was established as of June 28, 2003 for headcount reductions at these facilities. The Company expects to record severance costs associated with these closures in the third quarter of 2003. Interest income is attributable to the accumulation of cash and short-term investments subsequent to the Chapter 11 filing. Other primarily represents a sub-tenant lease settlement associated with one of the Company's distribution facilities. (8) ACCOUNTS PAYABLE AND ACCRUED LIABILITIES Accounts payable and accrued liabilities consist of the following: June 28, June 29, December 28, 2003 2002 2002 -------- -------- ------------ Trade payables $ 67,736 $143,576 $131,775 Gift certificates and other customer credits 48,487 52,811 58,023 Salaries, wages and employee benefits 32,012 47,206 49,563 General taxes 57,941 67,477 70,948 Allowance for future returns 22,154 19,230 27,994 Other liabilities 73,380 79,045 77,763 -------- -------- -------- Total accounts payable and accrued liabilities $301,710 $409,345 $416,066 ======== ======== ======== 14 (9) DEBT, COMMITMENTS AND CONTINGENCIES Total debt consists of the following:
June 28, June 29, December 28, 2003 2002 2002 -------- ---------- ------------ Revolving credit agreement $ -- $ 700,000 $ 700,000 Otto (GmbH & Co) senior unsecured loan -- 60,000 60,000 Term loan agreements, 6.34% to 8.66% due October 16, 2002 through July 31, 2007 -- 392,857 392,857 Otto-Spiegel Finance G.m.b.H. & Co. KG term loan agreement, 4% due December 31, 2002 -- 100,000 100,000 Secured notes, 7.25% to 7.35% due November 15, 2002 through November 15, 2005 48,000 48,000 48,000 ------- ---------- ---------- Total debt $48,000 $1,300,857 $1,300,857 ======= ========== ==========
For the reporting period ended December 28, 2002 and June 29, 2002, the Company was not in compliance with its financial covenants and certain other covenants contained in its debt agreements and, accordingly, all of the Company's debt was classified as currently due and payable during those periods. In March 2003, FCNB notified the trustees of its asset backed securitization transactions that a Pay Out Event had occurred on all six series of the Company's asset backed securitizations. A principal source of liquidity for the Company had been its ability to securitize substantially all of the credit card receivables that it generated. The Company was unable to secure alternative sources of financing from its existing lenders or other third parties to provide adequate liquidity to fund the Company's operations. As a result, on March 17, 2003, Spiegel, Inc. and 19 of its subsidiaries filed voluntary petitions for reorganization under Chapter 11 of the U.S. Bankruptcy Code in the United States Bankruptcy Court for the Southern District of New York. In addition, on March 17, 2003, the Court gave interim approval for $150 million of a $400 million senior secured debtor-in-possession financing facility (the "DIP facility") from Bank of America, N.A., Fleet Retail Finance, Inc. and The CIT Group/Business Credit, Inc. On April 30, 2003, the bankruptcy court granted final approval for the entire DIP Facility. The DIP Facility is a revolving credit facility under which Spiegel, Inc., Eddie Bauer, Inc., Spiegel Catalog, Inc., Ultimate Outlet Inc. and Newport News, Inc. are the borrowers and, together with the other debtor-in-possession subsidiaries, are guarantors. The DIP Facility has super priority claim status in the Chapter 11 case and is secured by first priority liens on all of the debtors' assets subject to the following: valid and unavoidable pre-petition liens, certain other permitted liens applicable to certain assets, the fees and expenses of any examiner appointed by the court in connection with the SEC Judgment and up to $7 million for professional and administrative fees. Of the DIP Facility, $50 million constituted a Consumer Credit Card Accounts Facility, which permitted the Company to finance consumer receivables generated under credit cards issued directly by the Company's merchant companies. On May 12, 2003, the Consumer Credit Card Account Facility was terminated by the Company and, accordingly, the amount available under the DIP Facility reduced to $350 million. Advances under the DIP Facility may not exceed a borrowing base equal to various percentages of the Company's eligible accounts receivable, eligible inventory and eligible real estate, less specified reserves. 15 Borrowings under the DIP Facility bear interest, at the option of the borrower, at prime plus 1.00% or at LIBOR plus 3.00%. As of June 28, 2003, there were no borrowings drawn under the DIP Facility. However, there were $2.8 million in trade letters of credit outstanding at June 28, 2003. The Company is obligated to pay an unused commitment fee of 0.5% per annum on the unused amount of the maximum committed amount. The DIP Facility is scheduled to terminate on March 17, 2005. The DIP Facility contains customary covenants, including certain reporting requirements and covenants that restrict the ability of the Company and its subsidiaries to incur or create liens, incur indebtedness and guarantees, make dividend payments and investments, sell or dispose of assets, change the nature of its business, enter into affiliated transactions and engage in mergers or consolidations. An event of default would occur under the DIP Facility if the Company or its subsidiaries failed to comply with these covenants, in some cases, after the expiration of a grace period. Upon the occurrence of an event of default, borrowings under the DIP Facility would, upon demand, become due and payable. Under the Bankruptcy Code, actions to collect pre-petition indebtedness, as well as most other pending litigation, are stayed and other contractual obligations against the debtors in the bankruptcy case generally may not be enforced. Absent an order of the bankruptcy court, substantially all of the pre-petition liabilities are subject to settlement under a plan of reorganization to be voted upon by creditors and equity holders and approved by the bankruptcy court. As a result, the Company will defer payments of principal and interest on pre-petition debt until a plan of reorganization has been approved by the bankruptcy court. The ultimate recovery to creditors and equity holders, if any, will not be determined until confirmation of a plan or plans of reorganization. No assurances can be given as to what values, if any, will be ascribed in the bankruptcy proceedings to each of the constituencies. As of the filing date, the Company had secured debt outstanding of $48,000 and unsecured debt outstanding of approximately $1,252,000. The secured debt is reflected as current portion of long-term debt in the consolidated balance sheet. Interest expense has been accrued on the secured debt outstanding and this has been reflected as part of accounts payable and accrued liabilities in the consolidated balance sheet. Prior to the Chapter 11 filing, the Company's credit facilities were as described below. The Company had a $750,000 revolving credit agreement with a group of banks. The commitment was comprised of two components, including a $600,000 long-term agreement that matured in July 2003 and a $150,000 364-day agreement that matured in June 2002. Borrowings under the Company's $600,000 long-term revolving credit agreement were $600,000 at December 28, 2002. Borrowings under the Company's $150,000 364-day revolving credit agreement were $100,000 at December 28, 2002. In February 2002, the Company determined, with its lending institutions, that a material adverse change had occurred due to the operating performance experienced in the fourth quarter of fiscal 2001 and due to the estimated loss recorded on the sale of the bankcard segment. Accordingly, on February 18, 2002 the borrowing capacity under the revolving credit facility was capped at $700,000, which represented the Company's borrowings outstanding on that date. The Company also had term loans with certain banks totaling approximately $441 million as of December 28, 2002. These loans had various maturity dates through July 2007. In addition, two of the loans, totaling $48 million, were secured by certain assets of the Company. The Company's revolving and non-affiliate loan agreements provided for financial and restrictive covenants. For the reporting period December 28, 2002, the Company was in violation of its financial covenants and certain of its other covenants under the agreements. In September 2001, the Company entered into a revolving credit agreement with Otto (GmbH & Co KG). The initial availability under this credit agreement was $75,000, later increased to $100,000, bearing interest at a variable rate based on LIBOR plus a margin, comparable to the Company's other revolving credit agreements. As of February 2002, the balance outstanding under the revolving credit agreement with Otto was $100,000. This obligation was extinguished with the proceeds of new term loans in the aggregate amount of $100,000 from Otto-Spiegel Finance G.m.b.H. & Co. KG, a related party. These term loans had a maturity date of December 31, 2002, and an interest rate of 4% per annum. In March 2002, the Company borrowed an additional $60,000 under a senior unsecured loan from Otto (GmbH & Co KG), which had an 16 interest rate of LIBOR plus a margin. In February 2003, the $60,000 senior unsecured loan from Otto (GmbH & Co KG) was assigned to Otto-Spiegel Finance G.m.b.H & Co KG. As of March 17, 2003, the related party borrowings outstanding consisted of the $100,000 term loans and $60,000 senior unsecured loan from Otto-Spiegel Finance G.m.b.H. & Co. KG. The Company's revolving credit agreement includes fees, which are variable and based on the total commitment of the revolving credit agreement. Borrowings under the Company's revolving credit agreements and loan agreements were an average of $858,601 with a maximum of $974,357 during fiscal 2002. The combined annual interest rate on the revolvers and loan agreements was 4.02 percent in fiscal 2002, excluding the previously mentioned commitment fees. Prior to the Chapter 11 filing, variable-rate debt obligations exposed the Company to variability in interest payments due to changes in interest rates. To limit the variability of a portion of these interest payments, the Company entered into receive-variable, pay-fixed interest rate swaps. Under these interest rate swaps, the Company received variable interest rate payments and made fixed interest rate payments; thereby creating fixed-rate debt. The variable-rate of interest received was based on the same terms, including interest rates, notional amounts and payment schedules, as the hedged interest payments on the variable-rate debt. These interest rate swaps were considered highly effective; therefore, changes in fair value were reflected in other comprehensive loss and not recognized in earnings until the related interest payments were made. In 2002, the fair value of the swap agreements was included in accounts payable and accrued liabilities in the consolidated balance sheets. The Company had an interest rate swap agreement to hedge the underlying interest risks on a term loan agreement with Berliner Bank with termination dates from March 1996 to December 2004. The notional amount of the interest rate swap agreement was $30,000. The Company also had an interest rate swap agreement with Bank of America to hedge the underlying interest risks on a portion of the outstanding balance of the revolving credit agreement with a termination date of July 2003. The notional amount of the interest rate swap agreement was $35,000. As a result of the Company's bankruptcy filing, the fair value of swap agreements, which approximated $6,960 as of March 2003, is reflected as a liability subject to compromise in the consolidated balance sheet. In addition, the Company reclassified approximately $6,960 from accumulated other comprehensive loss in the consolidated balance sheet to reorganization expense in the statement of operations for the first quarter of 2003 as a result of the Company's interest rate swap agreements no longer representing an effective hedge. In March 2002, the Company entered into a Vendor Payment Services Agreement with Otto International Hong Kong (OIHK), a related party, in order to permit the Company to obtain inventory in Asia. The duration of the agreement was for one year, automatically continuing unless terminated by either party with three months' written notice. Under the terms of the agreement, the Company has open account terms with various vendors in certain countries in Asia. OIHK pays these vendors the purchase price for goods, less a fee, within seven days of the purchase order receipt. Since the bankruptcy filing, the Company prepays OIHK for 100% of the purchase order value for goods purchased by Spiegel, Newport News and Eddie Bauer. Prior to the bankruptcy filing, the Company had terms ranging from 21 to 60 days to remit cash to OIHK. OIHK has asserted that, under the terms of the agreement, it has a lien over certain goods supplied to the Company. The Company and its creditors have reserved the right to contest the validity and amount of the OIHK liens in the Chapter 11 proceeding. A substantial amount of the Company's inventory purchases have been financed under the agreement (approximately $92,336 and $53,883 as of June 28, 2003 and June 29, 2002, respectively). If the agreement is terminated by OIHK, the Company would be required to find alternative methods for financing inventory purchases in Asia. This would likely result in an increase in letters of credit required to finance the Company's inventory purchases. This could result in disruption to the existing operations and, if alternative financing were not obtained, the Company's operations would be materially adversely affected. In May 2002, Spiegel Holdings, Inc. ("SHI"), the Company's majority owner, provided, as required by the OCC, among other things, $120 million of escrow deposits to secure payments of certificates and secured 17 credit card deposits. The amount of the required escrow deposits was reduced to $30 million as the certificates of deposit and secured credit card deposits were paid by FCNB. In addition, SHI provided a $78 million letter of credit facility to FCNB in order to secure payment of amounts that could become due against FCNB in the event of the occurrence of certain contingencies. The Company provided an indemnification to SHI on the facility in case the facility was utilized by FCNB. As of June 28, 2003, FCNB had borrowed approximately $15,000 on the facility and, as a result, SHI issued a demand of payment notice to the Company. This demand note is reflected as a liability subject to compromise in the consolidated balance sheets as of June 28, 2003. At June 28, 2003, the Company had outstanding a lease guaranty bond, issued by an insurance carrier in 1999, in the amount of approximately $10,000. This bond provides a guarantee to the mortgage holder for payment of any rent differential if the Company does not meet its performance obligations under an existing lease agreement. The mortgage holder will utilize this bond if the Company rejects the lease as part of its reorganization plans. If this occurs, the Company will record a reorganization expense for the estimated amount of the lease rejection claim after taking the guaranty bond into consideration. At June 28, 2003, the Company also has outstanding certain guarantees for the payment of import fees to customs agents for the importing of goods into the United States. Certain insurance carriers have issued customs bonds, which may be drawn upon by third parties if the Company does not pay duties for importing goods for sale in the United States. The Company continues to pay duties for importing goods as required and records a liability for any unpaid amounts. The Company does not consider it probable that these customs bonds will be utilized. LITIGATION On March 7, 2003, the SEC commenced a civil proceeding against the Company in federal court in Chicago alleging, among other things, that the Company's public disclosures violated Sections 10(b) and 13(a) of the Securities Exchange Act of 1934. Simultaneously with the filing of the SEC's complaint, the Company announced that it has entered into a consent and stipulation with the SEC resolving, in part, the claims asserted in the SEC action. Solely for purposes of resolving the SEC action, on March 7, 2003, the Company consented to the entry of a partial final judgment (the "SEC Judgment"), which was entered against the Company on March 18, 2003, and amended on March 27, 2003. Under the terms of the SEC Judgment, the Company agreed, among other things, to the entry of a permanent injunction enjoining any conduct in violation of Sections 10(b) and 13(a) of the Securities Exchange Act of 1934 and various rules and regulations promulgated thereunder. The Company also consented to the appointment of an independent examiner by the court to review its financial records since January 1, 2000, and to provide a report to the court and other parties within 120 days, which has been extended by an additional 60 days, regarding any accounting irregularities. As part of the settlement, the Company neither admitted nor denied the allegations of the SEC's complaint. The SEC reserved its right to petition the court to require the Company to pay disgorgement, prejudgment interest and civil penalties, or to impose other equitable relief. The Company is cooperating fully with the ongoing SEC investigation. As previously disclosed, the Company's outside auditors, KPMG LLP, advised the Company that they would not be able to complete the audit of the Company's 2002 financial statements and reviews of the Company's quarterly financial statements until the Company was able to provide the required officer certifications and KPMG LLP had an opportunity to review and consider the report of the independent examiner appointed under the terms of the SEC Judgment. See the Introductory Note on page 1 for further discussion. As a result, the Company notified the SEC that it would not, as a practical matter, be able to file its 2002 Form 10-K and one or more Form 10-Qs that complied with the SEC's rules and regulations in a timely manner as required by the SEC Judgment. On March 31, 2003, the Company filed with the court a motion for clarification of the SEC Judgment in order to request limited relief from the obligation to file reports, subject to certain conditions. On April 10, 2003, the court entered an order on the Company's motion. The 18 order provides that the Company and its officers, directors, employees and agents are not, and will not be in the future, in contempt of the SEC Judgment as a result of the Company's inability to timely file its 2002 Form 10-K and one or more Form 10-Qs provided that: . the Company files its 2002 Form 10-K and any past due Form 10-Q with the SEC as soon as possible and not later than 90 days after the filing of the independent examiner's report; . on or before May 15, 2003, the Company files under Item 5 of Form 8-K its financial statements (including the notes thereto) that would have been included in its 2002 Form 10-K, on an unaudited basis, and a management's discussion and analysis covering the unaudited financial statements; . the Company also files any quarterly financial statements that would have been included in a Form 10-Q and a management's discussion and analysis covering these financial statements; . until such time as the Company files its past due Form 10-K and any past due Form 10-Qs, the Company files reports with the Commission on Form 8-K for the following: . monthly sales reports, along with any accompanying press releases; . any monthly financial statements that are filed by the Company with the bankruptcy court; and . any material development concerning the Company, along with any accompanying press release. The Company has complied and intends to continue to comply with the SEC Judgment, as so clarified. On May 15, 2002, FCNB entered into an agreement with the OCC. The agreement calls for FCNB to comply with certain requirements and, among other things: . contains restrictions on transactions between the bank and its affiliates, and requires the bank to review all existing agreements with affiliated companies and make necessary and appropriate changes; . requires the bank to obtain an aggregate of $198,000 in guarantees, which guarantees were provided through the Company's majority shareholder; . restricts the bank's ability to accept, renew or rollover deposits; . requires the bank to maintain sufficient assets to meet daily liquidity requirements; . establishes minimum capital levels for the bank; . provides for increased oversight by and reporting to the OCC; and . provides for the maintenance of certain asset growth restrictions. On November 27, 2002, the OCC approved a disposition plan for the bank. Under the terms of this plan, if FCNB did not receive an acceptable offer to buy the bankcard portfolio by January 2003, it was required to implement plans to liquidate its bankcard portfolio. On February 14, 2003, the Company received a letter from the OCC requiring FCNB to immediately begin the process of liquidating the bankcard receivables portfolio and indicating the steps it must take to do so. The OCC letter required FCNB to, among other things: . notify the trustee for each series of the Company's bankcard receivable securitizations that FCNB will take steps to resign as servicer; . cease all credit card solicitations for its bankcards; . cease accepting new bankcard applications and offering credit line increases to any existing bankcard account; and . cease accepting new charges on existing bankcard accounts on or before April 1, 2003. The Company has complied with the OCC requirements set forth in its letter of February 14, 2003. On March 7, 2003, FCNB discontinued charging privileges on all MasterCard and Visa bankcards issued by FCNB to its customers and has begun the liquidation process required by the OCC. 19 On March 14, 2003, the OCC commenced a cease and desist proceeding against FCNB and issued a temporary cease and desist order indicating, among other things, that FCNB should cease performing its duties as servicer of the bankcard and private-label receivables securitizations as soon as practicable. In response to the temporary OCC order, MBIA Insurance Corporation, the insurer for two of the three private-label series of securitizations, filed an action in the United States District Court for the District of Oregon against FCNB for violation of the existing securitization agreements. On April 11, 2003, FCNB entered into a settlement agreement with MBIA. The terms of the settlement are consistent with the OCC consent order described below. The suit brought by MBIA was dismissed with prejudice. On April 15, 2003, FCNB executed a stipulation and consent to the issuance of a permanent consent order, which was accepted by the OCC. The terms of the stipulation and consent will supercede and terminate the temporary cease and desist order. The agreement entered into with the OCC on May 15, 2002 remains in effect, as does the disposition plan, although the disposition plan was superceded by the liquidation plan described below. The terms of the consent order, dated April 15, 2003, require FCNB to: . cease performing its duties as servicer of the bankcard and private-label securitization trusts upon the appointment of a successor servicer for each trust no later than June 30, 2003; . perform the duties and responsibilities of servicer under the relevant servicing agreements until a successor servicer is appointed, in accordance with the terms of the consent order; . withhold, on a daily basis, its servicing fee, calculated in accordance with the terms of the consent order, from the funds it collects; . deposit its servicing fee in a segregated account designated for this purpose; and . submit, on a weekly basis, a written progress report from its board of directors to the OCC detailing the actions taken to comply with the terms of the consent order and the results of those actions. FCNB has complied with the provisions of the consent order discussed above. In addition, the trustee of each securitization trust appointed a successor servicer for the securitizations. CMS was appointed the successor servicer for the private-label receivables portfolio and assumed servicing responsibilities on or about June 25, 2003. FCNB has been informed that The Bank of New York, as securitization trustee, appointed First National Bank of Omaha the successor servicer for the bankcard receivables portfolio on or about June 25, 2003. As required by the consent order, FCNB submitted a liquidation plan to the OCC, which supercedes the previous disposition plan approved in November 2002. The terms of the plan require FCNB to cease its credit card servicing and all other operating activities on or before June 30, 2003 and to proceed to final liquidation of its assets and final satisfaction of its liabilities beginning in July 2003. Further, the liquidation plan provides for the appointment of the President of FCNB as liquidating agent, who will assume responsibility for carrying out the plan of liquidation. A formal liquidation notice was issued providing that all claims need to be received by the liquidating agent by September 14, 2003. Due to the uncertain nature of many of the potential claims against FCNB, the Company is unable to predict the magnitude of such claims with any degree of certainty. In addition, although the Company believes that its loss reserve established for the discontinuance of the bankcard segment is adequate, based upon existing facts, the ultimate cost to liquidate FCNB is not known with certainty. In December 2002 and January 2003, four lawsuits were filed in the United States District Court for the Northern District of Illinois, Eastern Division, against the Company and certain current and former officers alleging violations of Section 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder. The plaintiffs purport to represent shareholders who purchased the Company's common stock between April 24, 2001 and April 19, 2002. The lawsuit was subsequently amended to add certain directors of the Company as defendants and the Company is no longer a named defendant. The Company is routinely involved in a number of other legal proceedings and claims, which cover a wide range of matters. In the opinion of management, these other legal matters are not expected to have any material adverse effect on the consolidated financial position or results of operations of the Company. 20 (10) DISCONTINUED OPERATIONS In the fourth quarter of fiscal 2001, the Company formalized a plan to sell the bankcard segment. The disposition of the bankcard segment is accounted for in accordance with APB No. 30, "Reporting the Results of Operations-Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions." Accordingly, results of this business have been classified as discontinued operations for all periods presented. Interest expense was allocated to discontinued operations based upon debt that could be specifically attributed to the bankcard segment. As a result of the Company's plan to liquidate the bankcard segment, the remaining business segment is the merchandising segment, which includes the private-label credit card operation related to the sale of the Company's merchandise. The merchandising segment is reflected in the Company's consolidated statements of operations as continuing operations. In the first quarter of 2003, the Company began the liquidation of the bankcard segment, as required under the disposition plan it agreed to with the OCC. In light of the liquidation, the Company reviewed its estimated loss on disposal accrual at June 28, 2003 and determined that the remaining estimated loss on disposal accrual is sufficient to account for the liquidation of the bankcard segment. This estimate is subject to change in future periods based upon any new facts and circumstances that may occur as a result of the liquidation. Losses for the bankcard segment for the 13 and 26-week periods ending June 28, 2003,totaled $94,865 and $114,599, respectively and $7,637 and $11,741, for the 13 and 26-week periods ended June 29, 2002, respectively. These losses have been recorded against the Company's loss on disposal accrual. Assets and liabilities of the discontinued operations are as follows: June 28, June 29, December 28, 2003 2002 2002 -------- --------- ------------ Current assets of discontinued operations $58,475 $ 289,093 $163,479 Long-term assets 18,964 65,348 28,335 ------- --------- -------- Assets of discontinued operations 77,439 354,441 191,814 ------- --------- -------- Current liabilities (including estimated loss on disposal) 71,281 480,765 245,707 Long-term liabilities 12,527 -- 12,527 ------- --------- -------- Liabilities of discontinued operations 83,808 480,765 258,234 ------- --------- -------- Total net liabilities of discontinued operations $(6,369) $(126,324) $(66,420) ======= ========= ======== As of June 28, 2003, current assets consist primarily of cash, trade accounts receivable and deferred income tax assets. Long-term assets consist primarily of other assets such as investments in government and municipal securities. Current liabilities consist primarily of the estimated loss on disposal, and a liability associated with the termination of certain contracts. The loss on disposal reserve at the end of June 28, 2003 relates primarily to the expected costs associated with the liquidation of FCNB. The balance in long-term liabilities reflects deferred income tax liabilities of FCNB. (11) SUBSEQUENT EVENTS In July 2003, the Company continued to streamline its operations and announced its plans to close by the end of December 2003 a customer contact center located in Rapid City, S.D., which employs approximately 240 associates. In addition, the Company will close at the end of December 2003 its 21 distribution facility in Newport News, VA, which supports the Company's Newport News division. The facility employs approximately 400 associates. The Company anticipates that the closure of these facilities will result in reorganization costs in future periods that will have a material impact on the consolidated financial statements of the Company. As part of its ongoing reorganization process, the Company will continue to evaluate its operations and organizational structure. As a result, the Company may make additional changes in its workforce and its operations. The reorganization process will result in additional liabilities for severance and closing costs, write-downs of certain impaired assets (that become impaired as a result of the reorganization plan), and other costs associated with the reorganization process. These costs, in general, will be recorded in the period that the operational changes are approved by management. The Company anticipates that these changes will have a material impact on the consolidated financial statements in future periods. (12) RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS In December 2002, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 148, "Accounting for Stock-Based Compensation-Transition and Disclosure an amendment of FASB Statement No. 123", which provides transition guidance for a voluntary change to the fair value method of accounting (intrinsic value method) for stock option awards. The Statement also amends the disclosure requirements of SFAS No. 123, "Accounting for Stock-Based Compensation". The disclosure requirements apply to annual as well as interim disclosures, and are applicable whether APB No. 25 or SFAS No. 123 is used to account for stock-based awards. The Company has elected to continue to apply the provisions of APB No. 25 (intrinsic value) in accounting for stock-based awards, therefore the transition provisions will have no impact on the Company. The following table illustrates the effect on net earnings (loss) and net earnings (loss) per share as if the Company had applied the fair value recognition provisions of SFAS No. 123, as required by the disclosure provisions of SFAS No. 148.
Thirteen Weeks Ended Twenty-Six Weeks Ended -------------------- ---------------------- June 28, June 29, June 28, June 29, 2003 2002 2003 2002 --------- -------- --------- -------- Net loss as reported $(146,565) $(56,104) $(277,525) $(99,443) Less: Compensation expense determined by the estimated fair value of the options at the grant date as prescribed by SFAS No. 123 (net of related tax effect) 38 51 76 102 --------- -------- --------- -------- Pro forma net loss $(146,603) $(56,155) $(277,601) $(99,545) ========= ======== ========= ======== Net loss per share: Basic and diluted - as reported $ (1.11) $ (0.42) $ (2.10) $ (0.75) ========= ======== ========= ======== Basic and diluted - pro forma $ (1.11) $ (0.42) $ (2.10) $ (0.75) ========= ======== ========= ========
In November 2002, the Emerging Issues Task Force (EITF) reached a final consensus on EITF 02-16,which addresses how a reseller of a vendor's product should account for cash consideration received from vendor. The EITF issued guidance on the following two issues, as follows: (1) cash consideration received from a vendor should be recognized as a reduction of cost of sales in the reseller's income statement, unless the consideration is reimbursement for selling costs or payment for assets or services delivered to the vendor, and (2) performance-driven vendor rebates or refunds (e.g., minimum purchase or sales volumes) should be recognized only if the payment is considered probable, and the method of 22 allocating such payments in the financial statements should be systematic and rational based on the reseller's progress in achieving the underlying performance targets. The Company will monitor prospectively the impact of this EITF on its existing and future agreements with its vendors and does not expect the future results of operations or cash flows to be materially effected by the provisions of this EITF. 23 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS ($000S OMITTED, EXCEPT PER SHARE AMOUNTS) GENERAL The Spiegel Group is a leading international specialty retailer that offers merchandise through catalogs, e-commerce sites and retail stores under its merchant divisions Eddie Bauer, Spiegel and Newport News. Prior to March 2003, the Spiegel Group also offered credit services to qualified customers of its merchant divisions. Historically, the Spiegel Group reported operating results for two segments: merchandising and bankcard. The merchandising segment included an aggregation of the three merchant divisions and the private-label credit card operation. The bankcard segment included primarily the bankcard operations of First Consumers National Bank (FCNB), the Company's special-purpose bank, and Financial Services Acceptance Corporation (FSAC). In the fourth quarter of fiscal 2001, the Company formalized a plan to sell the bankcard segment. Accordingly, the information included in this report reflects the bankcard segment as a discontinued operation for all periods presented. Chapter 11 Filing In February 2002, the Company, together with the lending institutions under its $750 million revolving credit agreement, determined that a material adverse change had occurred due to the Company's operating performance in the fourth quarter of 2001 and the estimated loss recorded on the sale of the bankcard segment. Accordingly, on February 18, 2002, the borrowing capacity on the credit facility was capped at $700,000, which represented the borrowings outstanding on that date. Additionally, for the reporting period ended December 28, 2002, as well as prior periods dating back to December 29, 2001, the Company was in default on the financial covenants and other covenants under its other non-affiliate loan agreements. See "-Liquidity and Capital Resources" below for a description of these agreements and defaults. In March 2003, FCNB notified the trustees of its asset backed securitization transactions that a Pay Out Event had occurred on all six series of the Company's asset backed securitizations. See "-Cancellation of Credit Cards" below for a description of these events. A principal source of liquidity for the Company had been its ability to securitize substantially all of the credit card receivables that it generated. The Company was unable to secure alternative sources of financing from its existing lenders or other third parties to provide adequate liquidity to fund the Company's operations. On March 17, 2003, Spiegel, Inc. and 19 of its direct and indirect subsidiaries filed voluntary petitions for reorganization under Chapter 11 of the U.S. Bankruptcy Code in the United States Bankruptcy Court for the Southern District of New York. The reorganization is being jointly administered under the caption "In re: Spiegel, Inc., et al., Case No. 03-11540 (CB)," referred to collectively as the Chapter 11 case. Spiegel and its Chapter 11 debtor subsidiaries are currently operating their business and managing their properties and assets as debtors-in-possession under the Bankruptcy Code. During the pendency of the Chapter 11 case, the Company and its Chapter 11 debtor subsidiaries will continue to operate its business in the ordinary course, however, the Company and its Chapter 11 debtor subsidiaries may not engage in transactions outside the ordinary course of their businesses without the approval of the bankruptcy court. The following material subsidiaries were not included in the Chapter 11 case: FCNB, First Consumers Credit Corporation (FCCC), Financial Services Acceptance Corporation (FSAC) and Spiegel Acceptance Corporation (SAC). As discussed below, FCNB began a formal liquidation in fiscal 2003 under the terms of a pre-existing disposition plan with the Office of the Comptroller of the Currency (the "OCC"). As a result, the assets and liabilities of FCNB, FCCC and FSAC are reflected as discontinued operations in the Company's financial statements. The assets of SAC at June 28, 2003, consist primarily of cash and other receivables approximating $2 million, which relate to the private-label credit card operation The primary changes from the first quarter of 2003 to the second quarter of 2003 represent reductions in cash of $9 million for payments made to the trust, reductions in other receivables of $2 million for collections in the 24 second quarter of 2003, and lower prepaid expenses of approximately $5 million principally for prepaid interest which was expensed in the second quarter of 2003. The liabilities of SAC total approximately $20 million at June 28, 2003 and represent primarily accrued expenses. The primary changes from the first quarter of 2003 to the second quarter of 2003 reflect additional liabilities incurred for amounts owed to credit card customers and amounts owed to the trust related to merchandise returns. On March 17, 2003, the bankruptcy court gave interim approval for $150 million of a $400 million senior secured debtor-in-possession financing facility (the "DIP Facility") from Bank of America, N.A., Fleet Retail Finance, Inc., and The CIT Group/Business Credit, Inc. On April 30, 2003, the bankruptcy court granted final approval for the entire DIP Facility, which was later reduced to $350 million. The DIP Facility will be used to supplement the Company's existing cash flow during the reorganization process. A description of the DIP Facility appears below under "--Liquidity and Capital Resources." On March 17 and 18, 2003, the bankruptcy court approved other "first day" motions permitting the Company to, among other things: . continue payments for associate wages, salaries and certain other benefits; . honor customer programs and other obligations, such as gift certificates, returns and exchanges; . maintain its cash management system; . pay pre-petition claims of a number of critical vendors; . pay specified pre-petition customs duties and shipping charges; . maintain pre-petition investment practices; . pay pre-petition obligations necessary to maintain current insurance coverage; . pay specified non-property taxes; . reject some of its executory contracts; . retain legal, financial and other professionals on an interim basis pending a final hearing; and . extend the time to file a schedule of assets and liabilities and statements of financial affairs. The matters discussed above raise substantial doubt about the Company's ability to continue as a going concern for a reasonable period of time. The Company's consolidated financial statements have been prepared in accordance with generally accepted accounting principles (GAAP) applicable to a going concern, which contemplate, among other things, realization of assets and payment of liabilities in the normal course of business. The financial statements do not provide for any of the future consequences of the ongoing Chapter 11 case. The eventual outcome of the Chapter 11 case is not presently determinable. As a result, the consolidated financial statements do not give effect to adjustments relating to the recoverability and classification of asset carrying amounts, the amount and classification of liabilities or the effects on existing stockholders' deficit that may occur in future periods as a result of the bankruptcy case. The consolidated financial statements also do not give effect to any adjustments relating to the substantial doubt about the Company's ability to continue as a going concern. The Company's ability to continue as a going concern will depend upon, among other things, the ability of the Company and its Chapter 11 debtor subsidiaries to comply with the provisions of the DIP Facility and to generate cash from operations and obtain financing sufficient to satisfy their future obligations. These challenges are in addition to the operational and competitive challenges the Company's business faces in general. The Company cannot predict at this time the effect that the Chapter 11 case will have on its operations, particularly its net sales and its access to, and the cost of, goods sold. See "-Forward Looking Statements" for a discussion of these and other factors that pose risks to the Company's business. The Company has incurred, and will continue to incur, significant costs associated with the reorganization and cannot predict with certainty how these costs will impact its ability to continue as a going concern. 25 Pursuant to the "automatic stay" in effect during the pendency of the Chapter 11 case, actions to collect prepetition indebtedness, as well as most other pending litigation, are stayed against the Company and its Chapter 11 debtor subsidiaries. In addition, other prepetition claims against the Company and its Chapter 11 debtor subsidiaries generally may not be enforced during the Chapter 11 case. However, substantially all prepetition liabilities of the Company and its Chapter 11 debtor subsidiaries are, absent a separate order of the bankruptcy court, subject to compromise and settlement under a confirmed plan of reorganization. As a result, the Company and its Chapter 11 debtor subsidiaries will defer payments of principal and interest on prepetition debt and will compromise such amounts pursuant to a confirmed plan of reorganization. As of the filing date, the Company had outstanding secured debt obligations totaling $48,000 and unsecured debt obligations totaling approximately $1,252,000. Under the Bankruptcy Code and applicable rules of bankruptcy procedure, the Company and its Chapter 11 debtor subsidiaries must file schedules of its assets and liabilities and statements of its financial affairs with the bankruptcy court, setting forth, among other things, the assets and liabilities of the Company as shown by their books and records, subject to the assumptions contained in certain notes filed in connection therewith. All of the schedules are subject to further amendment or modification and may differ materially from the Company's consolidated financial statements. The Company has filed the required schedules of its assets and liabilities and statements of its financial affairs with the bankruptcy court accordingly. Differences between amounts scheduled by the Company and claims made by creditors will be investigated and resolved in connection with the Chapter 11 claims resolution process, and may be significant. That process will not commence until October 1, 2003, the date by which creditors must file prepetition claims against the Company and its Chapter 11 debtor subsidiaries and, in light of the number of creditors of the Company, may take considerable time to complete. Accordingly, the ultimate number and amount of allowed claims are not presently known nor is the ultimate distribution with respect to allowed claims presently ascertainable. The Company would expect therefore to incur additional liabilities, which will be subject to compromise pursuant to a confirmed plan of reorganization, from the determination of the bankruptcy court (or agreement of parties in interest) of allowed claims for items that the Company and its Chapter 11 debtor subsidiaries may claim as contingent or disputed. The final plan of reorganization will ultimately determine the distributions to holders of allowed claims. In addition, the formation of a plan of reorganization is likely to cause other potential adjustments to asset values or accrual of liabilities, for example, as a result of potential asset sales or liquidation of liabilities at amounts different than the carrying amounts presently reflected in the financial statements. Due to the uncertain nature of many of the potential claims against the Company and its Chapter 11 debtor subsidiaries, the Company is currently unable to project the magnitude of such claims with any degree of certainty. The consummation of a confirmed plan of reorganization could also materially alter the amounts reported in the Company's consolidated financial statements. At the present time, the Company cannot predict the ultimate effect that the consummation of a confirmed plan of reorganization may have on the Company's assets and liabilities nor can it predict the various adjustments that may occur to the Company's assets or liabilities during the reorganization process in general. However, the Company believes that the future reorganization activities will have a material impact on the assets and liabilities of the Company. Furthermore, the Company has incurred, and will continue to incur, significant costs associated with the reorganization. See Note 7 to the Consolidated Financial Statements. In addition, under the Bankruptcy Code, the Company and its Chapter 11 debtor subsidiaries must, subject to bankruptcy court approval and satisfaction of other requirements, assume or reject executory contracts and unexpired leases to which they are party, including their retail store leases. Under the Bankruptcy Code, a debtor has 60 days after it files its Chapter 11 case to assume or reject unexpired leases of nonresidential real property. On May 14, 2003, the bankruptcy court granted an interim extension of this time and approved the Company's motion for an extension until January 31, 2004, for the Company to assume or reject its unexpired leases of nonresidential real property with certain limited conditions. There is no deadline by which the Company must assume or reject other unexpired leases or executory contracts. In the event that the Company or one of its Chapter 11 debtor subsidiaries reject an executory contract or unexpired lease, affected parties may file claims against the applicable counterparty in respect of amounts owing, subject to certain caps and other limitations under applicable sections of the Bankruptcy Code. On the other hand, if the Company or one of its Chapter 11 debtor subsidiaries assumes an executory contract or unexpired lease, the Company is generally required to cure all prior defaults, including all prepetition 26 liabilities, which may be significant. As a result, during the Chapter 11 case, the Company expects to record adjustments to its liabilities. Specifically, the Company would expect to incur additional liabilities, which will be subject to compromise pursuant to a confirmed plan of reorganization, as a result of rejecting executory contracts and/or unexpired leases. Conversely, the Company's assumption of executory contracts and/or unexpired leases will convert liabilities subject to compromise under a confirmed plan of reorganization into postpetition liabilities that are not subject to compromise. In order to emerge from Chapter 11, the bankruptcy court must confirm a plan of reorganization and the Company and its Chapter 11 debtor subsidiaries must consummate such a plan. Although the Company and its Chapter 11 debtor subsidiaries expect to file a plan or plans of reorganization providing for emergence from Chapter 11, they cannot assure investors that any plan of reorganization will be proposed, confirmed or ultimately consummated. The Company and its Chapter 11 debtor subsidiaries initially have the exclusive right to file a plan of reorganization for 120 days after filing the Chapter 11 case. On June 25, 2003, the Company obtained an extension to file a plan of reorganization until November 12, 2003. If the Company and its Chapter 11 debtor subsidiaries fail to file a plan of reorganization during this time, or if the plan is not approved by creditors and/or equity holders, any party-in-interest may subsequently file its own plan of reorganization. The United States Trustee has appointed an official committee of unsecured creditors. The creditors' committee and its legal representatives often take positions on matters that come before the bankruptcy court. As a result, it is the most likely entity with which the Company will negotiate the terms of a plan of reorganization. The creditors' committee may not support the Company's positions in the bankruptcy case or the plan of reorganization. Furthermore, disagreements between the Company and the creditors' committee could protract the bankruptcy case, negatively impact the ability of the Company to operate during the Chapter 11 case and delay its emergence from Chapter 11. In order for a plan of reorganization to be confirmed under the Bankruptcy Code, among other things, the requisite number of creditors and/or equity holders entitled to vote must approve the plan. However, under certain circumstances set forth in the Bankruptcy Code, a bankruptcy court may confirm a plan of reorganization notwithstanding its rejection by an impaired class of creditors or equity holders. In addition, under the priority scheme set forth in the Bankruptcy Code, certain post-petition liabilities and pre-petition liabilities need to be satisfied before equity holders are entitled to receive any distributions. The Company cannot predict what values, if any, will be ascribed to any of the constituencies in the Chapter 11 case. Accordingly, holders of Spiegel common stock could receive no distribution in respect of their equity interests and their interests could be cancelled, under a confirmed plan of reorganization. Holders of Spiegel common stock should therefore assume that they could receive little or no value as part of a plan of reorganization. In light of the foregoing, the Company considers the value of its common stock to be highly speculative and cautions equity holders that the stock may ultimately be determined to have no value. Accordingly, the Company urges that appropriate caution be exercised with respect to existing and future investments in its common stock or in any claims related to pre-petition liabilities and/or other securities issued by the Company. Notwithstanding the Company's plan to file a plan of reorganization, it is not possible to predict the effect of the Chapter 11 case on the Company's business, various creditors and equity holders or when the Company will be able to exit Chapter 11. The Company's future results are dependent upon the Company confirming and consummating, on a timely basis, a plan of reorganization. Cancellation of Credit Cards Liquidation of FCNB. On May 15, 2002, FCNB entered into an agreement with the OCC. The agreement calls for FCNB to comply with certain requirements and restrictions regarding its bankcard business and on November 27, 2002, the OCC approved a disposition plan for the bank. Under the terms of this plan, if FCNB did not receive an acceptable offer to buy the bankcard portfolio by January 2003, it was required to implement plans to liquidate its bankcard portfolio. On February 14, 2003, the Company received a letter from the OCC requiring FCNB to immediately begin the process of liquidating the bankcard receivables portfolio and indicating the steps it must take to do so. On March 7, 2003, FCNB discontinued charging privileges on all MasterCard and Visa bankcards issued by FCNB to its customers and has begun the liquidation process required by the OCC. 27 On March 14, 2003, the OCC commenced a cease and desist proceeding against FCNB and issued a temporary cease and desist order indicating, among other things, that FCNB should cease performing its duties as servicer of the bankcard and private-label receivables securitizations as soon as practicable. In response to the temporary OCC order, MBIA Insurance Corporation, the insurer for two of the three private-label series of securitizations, filed an action in the United States District Court for the District of Oregon against FCNB for violation of the existing securitization agreements. On April 11, 2003, FCNB entered into a settlement agreement with MBIA. The terms of the settlement are consistent with the OCC consent order described below. The suit brought by MBIA was dismissed with prejudice. On April 15, 2003, FCNB executed a stipulation and consent to the issuance of a permanent consent order, accepted by the OCC, the terms of which are to supercede and terminate the temporary cease and desist order. The terms of the consent order, dated April 15, 2003, require FCNB to: . cease performing its duties as servicer of the bankcard and private-label securitization trusts upon the appointment of a successor servicer for each trust no later than June 30, 2003; . perform the duties and responsibilities of servicer under the relevant servicing agreements until a successor servicer is appointed, in accordance with the terms of the consent order; . withhold, on a daily basis, its servicing fee, calculated in accordance with the terms of the consent order, from the funds it collects; . deposit its servicing fee in a segregated account designated for this purpose; and . submit, on a weekly basis, a written progress report from its board of directors to the OCC detailing the actions taken to comply with the terms of the consent order and the results of those actions. FCNB has complied with the provisions of the consent order discussed above. In addition, the trustee of each securitization trust appointed a successor servicer for the securitizations. Cardholder Management Services ("CMS"), a subsidiary of Cardworks, was appointed the successor servicer for the private-label receivables portfolio and assumed servicing responsibilities on or about June 25, 2003. FCNB has been informed that The Bank of New York, as securitization trustee, appointed First National Bank of Omaha the successor servicer for the bankcard receivables portfolio on or about June 25, 2003. As required by the consent order, FCNB submitted a liquidation plan to the OCC, which supercedes the previous disposition plan approved in November 2002. The terms of the plan require FCNB to cease its credit card servicing and all other operating activities on or before June 30, 2003 and to proceed to final liquidation of its assets and final satisfaction of its liabilities beginning in July 2003. Further, the liquidation plan provides for the appointment of the President of FCNB as liquidating agent, who will assume responsibility for carrying out the plan of liquidation. A formal liquidation notice was issued providing that all claims need to be received by the liquidating agent by September 14, 2003. Due to the uncertain nature of many of the potential claims against FCNB, the Company is unable to predict the magnitude of such claims with any degree of certainty. In addition, although the Company believes that its loss reserve established for the discontinuance of the bankcard segment is adequate, based upon existing facts, the ultimate cost to liquidate FCNB is not known with certainty. Pay-out Events. FCNB, in addition to its own bankcard operations, has issued substantially all of the Company's private-label credit cards and continued to service the related receivables through June 25, 2003, including securitized receivables. In March 2003, FCNB notified the trustees for all six of its asset backed securitization transactions that a Pay Out Event, or an early amortization event, had occurred on each series. Pay Out Events on the First Consumers Master Trust Series 1999-A, the First Consumers Credit Card Master Note Trust Series 2001-A and the Spiegel Credit Card Master Note Trust Series 2000-A occurred because each of these series failed to meet certain minimum performance requirements for the reporting period ended February 28, 2003. This failure was due to the securitized receivables generating insufficient returns to meet the obligation under the securitization documents (or the failure to meet what is commonly referred to as the excess spread test). The failure to meet the excess spread test resulted from significant 28 declines in the performance and credit quality of the securitized receivables due to higher charge-off rates and lower net sales. The Pay Out Events on the two First Consumers series caused, through cross-default provisions, a Pay Out Event on the First Consumers Credit Card Master Note Trust Series 2001-VFN. The Pay Out Event on the Spiegel 2000-A Series caused, through cross-default provisions, a Pay Out Event on the Spiegel Credit Card Master Note Trust Series 2001-VFN. In addition, MBIA has also declared a Pay Out Event on the Spiegel 2001-A Series. See "-Results of Operations-Finance Revenue" for a discussion of the effect on our financial statements of these Pay Out Events. Cancellation of Private Label Cards. As a result of these Pay Out Events, substantially all monthly excess cash flow from securitized receivables remaining after the payment of debt service and other expenses is diverted to repay principal to investors on an accelerated basis, rather than to pay the cash to the Company upon deposit of new receivables. On March 11, 2003, the Company's merchant companies ceased honoring the private-label credit cards issued to their customers by FCNB in response to these events. On March 17, 2003, the Company and its Chapter 11 debtor subsidiaries filed a motion with the bankruptcy court to reject their private-label credit card agreements with FCNB. This motion was approved by the bankruptcy court on March 18, 2003. The merchant companies have issued a limited number of private-label credit cards directly rather than through FCNB, which were serviced by FCNB. As a result of the impending liquidation of FCNB, the Company has decided to cease issuing new private-label credit cards internally and has stopped honoring existing cards at its merchant companies. In June 2003, the Company sold these merchant issued credit card receivables, which had a balance of approximately $5 million, for approximately $4 million to First National Bank of Omaha. However, on April 28, 2003, the Company announced that it had entered into a ten-year agreement with Alliance Data Systems ("Alliance Data"), the terms of which were subsequently approved by the bankruptcy court, to establish a new private-label credit card program for its merchant companies. Services provided by Alliance Data under this agreement include establishing credit criteria for customer acquisition, issuing and activating new cards, extending credit to new cardholders, authorizing purchases made with the new cards, customer care and billing and remittance services. The new Alliance Data credit card program is separate from and has no relation to the Company's existing or prior credit card programs. Alliance Data began issuing cards under this program in May 2003. The Company is charged a customary fee on all credit transactions with Alliance Data Systems ("Alliance Data"). In addition, payments to the Company for customer purchases made with their Alliance Data-issued cards are subject to a 20% "holdback". The holdback currently equals 20% of the principal portion of the receivable balance for Spiegel accounts financed by Alliance Data at each month end. Alliance Data may draw against the holdback for reimbursement of a portion of its operating expenses and principal balance write-offs in connection with customers' failure to pay their credit card accounts under certain circumstances, including cessation of the Company's business or termination of the agreement or its funding arrangement. The agreement also contains certain restrictions limiting the Company's ability to make significant changes to its operations. Upon the Company's emergence from Chapter 11, the holdback will be reduced to 10%, and thereafter would be eliminated if the Company satisfies certain financial criteria. The Company has recorded the holdback, which approximates $1 million as of June 28, 2003, as a receivable in the consolidated balance sheet. As of June 28, 2003, a reserve was not recorded against this receivable as the Company believes that the balance is collectible. The Company will re-assess the collectability of the receivable balance each period based upon the collection rates on the credit cards and the likelihood that the Company will emerge from Chapter 11 and will be able to meet the financial criteria contained in the agreement. In the event the agreement is terminated under certain circumstances, the Company is required to purchase a substantial portion of the unpaid and outstanding accounts including outstanding finance charges and fees. 29 Unaudited Financial Statements The Company has filed, pursuant to the terms of the SEC Judgment discussed in the "Introductory Note" to this report, its unaudited consolidated financial statements for the quarter ended June 28, 2003 and related notes in this report. These financial statements and notes have not been reviewed in accordance with Statement on Auditing Standards ("SAS") No. 100 and may be subject to future adjustment. In addition, any financial information derived from the Company's 2002 fiscal year financial statements has not been audited and 2003 information has not been reviewed in accordance with SAS No. 100 and may similarly be subject to future adjustment. The Company is unable at this time to predict what the report of the independent examiner appointed by the SEC will conclude or whether these conclusions will require any adjustments to the Company's consolidated financial statements. In addition, the reorganization process or the formation or consummation of a plan of reorganization may result in the need to modify or update the financial statement disclosures included in the Company's final Form 10-Q for the period ended June 28, 2003. Future events may also result in adjustments to the consolidated financial statements or disclosures. Because the independent audit for fiscal 2002 and the review for the first and second quarters of fiscal 2003 have not been completed, the financial information contained herein may be subject to further adjustment for the Pay Out Events on the Company's receivables securitizations or other events that may occur after the date of this filing but are required under generally accepted accounting principles to be reflected in prior periods. The Company expects any independent auditors' report issued to contain an explanatory paragraph indicating that there is substantial doubt about the Company's ability to continue as a going concern. Store Closures and Asset Impairments In April 2003, the Company announced its intent to close all 21 of its Spiegel and Newport News outlet and clearance stores as part of its reorganization efforts. The Company will consider reopening some of these stores in the future to support the inventory liquidation needs of both Spiegel Catalog and Newport News. The Company anticipates the closure of each of the Spiegel outlet stores in the third quarter of 2003. As of the second quarter of 2003, two of the Company's Newport News stores were closed, while the remaining three stores are planned to close in the third quarter of 2003. The store closing plan has received bankruptcy court approval. In April 2003, the Company announced its intent to close 60 under-performing Eddie Bauer stores as a part of its ongoing reorganization process. The store-closing plan has received bankruptcy court approval. The Company will close these stores upon completion of the related store-closing inventory sales. As of June 28, 2003, 14 of these stores have been closed. The Company has announced its intent to close a customer contact center located in Bothell, Washington and one in Rapid City, South Dakota. The Bothell center will be closed in the third quarter of 2003 and the Rapid City facility will be closed by the end of the year. In addition, the Company announced its intent to consolidate its retail distribution facility in Columbus, Ohio with its facility in Groveport, Ohio. Finally, the Company announced its intent to close its distribution facility located in Newport News, Virginia. The facility is scheduled to close at the end of December 2003. Asset impairments were recorded in accordance with SFAS 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." The closure of retail and outlet stores described above resulted in the write-off of approximately $11 million in assets primarily related to leasehold improvements that have no future benefit. Finally, as part of the reorganization process, the Company recorded a write-off of approximately $35 million for a rent leveling asset and other assets associated with a leased building. The impairment was recorded based upon management's decision to terminate the related lease agreement. The Company will record a liability in the future period for the lease rejection cost associated with this lease when the Company formally notifies the landlord or ceases using the facility, whichever is sooner. The expense will likely have a material impact on the consolidated financial statements. The Company abandoned certain capital projects due to capital expenditure restrictions, which led to the write-off of approximately $21 million in assets. 30 Seasonality The Company's retail and direct businesses experience two distinct selling seasons, spring and fall. The spring season is comprised of the first and second quarters and the fall season is comprised of the third and fourth quarters. Net sales are usually substantially higher in the fall season and selling, general and administrative expenses as a percentage of net sales are usually higher in the spring season. Approximately 32% of annual net sales in fiscal 2002 occurred in the fourth quarter. The Company's working capital requirements also fluctuate throughout the year, increasing substantially in September and October in anticipation of the holiday season inventory requirements. Accordingly, the results for the first two quarters are not necessarily indicative of the results to be expected for the entire year. RESULTS OF OPERATIONS The following table sets forth the statements of operations data for the 13 and 26 weeks ended June 28, 2003 and June 29, 2002.
Thirteen Weeks Ended Twenty-six Weeks Ended -------------------- ---------------------- June 28, June 29, June 28, June 29, ($000's omitted) 2003 2002 2003 2002 - -------------------------------------------- --------- -------- --------- ---------- Net sales $ 426,613 $533,540 $ 840,180 $1,070,506 Finance revenue 609 5,158 (30,460) 18,069 Other revenue 45,695 66,948 96,561 134,100 --------- -------- --------- ---------- Total net sales and other revenues 472,917 605,646 906,281 1,222,675 Cost of sales 291,457 325,637 552,732 668,694 Selling, general and administrative expenses 242,403 320,040 513,775 623,472 --------- -------- --------- ---------- Operating loss (60,943) (40,031) (160,226) (69,491) Interest expense 1,200 16,067 18,887 29,978 Minority interest in (income) loss of consolidated subsidiary -- (6) -- 26 Reorganization items, net 84,422 -- 98,412 -- --------- -------- --------- ---------- Net loss $(146,565) $(56,104) $(277,525) $ (99,443) ========= ======== ========= ========== Other information: Gross profit margin (% of total net sales) 31.7% 39.0% 34.2% 37.5% SG&A expenses (% of total revenue) 51.3% 52.8% 56.7% 51.0%
Comparison of the 13-Weeks Ended June 28, 2003 and June 29, 2002 Net sales: Net sales decreased by $106,927 or 20% to $426,613 for the 13-weeks ended June 28, 2003 from net sales of $533,540 for the 13-weeks ended June 29, 2002. Retail sales consist of all store sales, including discount and clearance stores, and direct sales represent catalog and e-commerce sales. Net sales for the second quarter include approximately $26 million in liquidation sales resulting from the sale and transfer of inventory to an independent liquidator in conjunction with the closing of 81 stores. The liquidator is conducting store-closing inventory sales as part of the plan to close 60 Eddie Bauer retail and outlet stores, 16 Spiegel outlet and clearance stores and five Newport News outlet stores. Excluding liquidation sales, net sales decreased approximately 25% versus the comparable period in the prior year. The decrease in net sales was caused by a 43% decrease in catalog net sales, a 4% decrease in retail net sales (which primarily relates to Eddie Bauer), and a 12% decrease in e-commerce net sales. Eddie Bauer comparable store sales decreased 8% from the prior year. (A store is included in comparable store sales if it has been open at least one fiscal year prior to the beginning of the quarter.) Net sales, particularly in the direct business, declined primarily due to the Company's decision in early March to cease honoring the 31 private-label credit cards issued by First Consumers National Bank to customers of its merchant companies (Eddie Bauer, Newport News and Spiegel Catalog). On April 28, 2003, the Company announced that it had entered into an agreement with Alliance Data Systems, to establish a new private-label credit card program for its merchant companies. The new Alliance Data credit card program is separate from and has no relation to the Company's prior credit card programs. See "-Cancellation of Private Label Cards" above for a further discussion of the agreement with Alliance Data. During the second quarter of 2002, approximately 33% of the Company's net sales were made with the Company's private-label cards. During the second quarter of 2003, less than 5% of the Company's net sales were made with the new private-label credit cards issued by Alliance Data Systems. The discontinuance of the charging privileges on the Company's private label cards and FCNB MasterCard and Visa cards has had and will continue to have a substantial negative impact on the Company's net sales. Also contributing to the decrease in net sales was weak customer demand, as well as a planned decline in catalog circulation for each of the merchants and reduced promotional activity at Eddie Bauer. Finance revenue: Finance revenue decreased $4,549 from $5,158 in the second quarter of 2002 to $609 in the second quarter of 2003. The substantial decrease in finance revenue in 2003 primarily resulted from the Pay Out event and the cancellation of the private label credit cards as described above. Finance revenue in 2003 represents revenue generated from the Company's merchant issued credit card program, which was cancelled in May 2003. Historically, when the Company securitized its private-label credit card receivables, it retained interest-only strips, subordinated investor certificates, receivables, servicing rights and cash reserve accounts, all of which comprise retained interests in the securitized receivables. The Company estimated the present value of estimated future cash flows expected to be received over the liquidation period using certain assumptions, including portfolio yield, charge-offs, liquidation rates, interest rates and discount rates. Using these future cash flow estimates, the Company recognized finance revenue over the liquidation period of the receivables portfolio. Upon a change in the estimated future cash flows of the receivables portfolio, the Company recorded gains or losses as additions or subtractions, respectively, to finance revenue. Any excess cash flows resulting from the Company's receivables securitizations were recorded as finance revenue when earned. Finance revenue also includes finance charges and fees on the Company's unsecuritized private-label credit cards. Other revenue: Other revenue consists primarily of: (1) amounts billed to customers for catalog and e-commerce shipping and handling, (2) royalty revenues related to the use of the Eddie Bauer name, and (3) revenues generated from customer list sales to third-parties. Other revenue decreased by $21,253, or 32%, from $66,948 in 2002 to $45,695 in the second quarter of 2003. The decrease resulted primarily from lower shipping and handling income at the merchant companies caused by lower sales volume. Cost of sales: Cost of sales decreased by $34,180 or 11% to $291,457 for the second quarter of 2003, from $325,637 for the second quarter of 2002. As a percentage of net sales, however, cost of sales increased to 68% for 2003 from 61% in the comparable period of the prior year. The increase as a percentage of net sales was driven by higher liquidation markdowns recorded in the current year based upon the decision in the second quarter to change the merchandise assortment and overall brand strategy at Spiegel Catalog and, to a lesser extent, was also due to the sale of inventory in the second quarter to a liquidator in connection with store closings. Selling, general and administrative expenses ("SG&A"): SG&A expenses decreased $77,637 or 24%, to $242,403 for the second quarter of 2003 from $320,040 for the second quarter of 2002. As a percentage of total revenue, SG&A expenses decreased to 51% for the second quarter of 2003 from 53% in the comparable period of the prior year. This decrease was primarily due to lower overall expenses on the private label credit card operations versus the comparable period of the prior year. Partially offsetting this decrease was lower advertising productivity, which resulted in higher advertising costs as a percentage of net sales. Operating loss: The Company recorded an operating loss of $60,943 for the second quarter of 2003 compared to an operating loss of $40,031 for the comparable period of the prior year. The higher operating loss in the current period was due to lower net sales and shipping and handling income at each of the merchant operations as well as higher liquidation markdowns recorded in the current period based upon the 32 decision in the second quarter to change the merchandise assortment and overall brand strategy at Spiegel Catalog. Interest expense: Interest expense totaled $1,200 and $16,067 for the second quarter of 2003 and 2002, respectively. This decrease was due to the Company's filing under Chapter 11 of the U.S. Bankruptcy Code on March 17, 2003. The Company's contractual interest for the second quarter of 2003 was $23,432. Income tax benefit: The Company has recorded no tax benefits associated with its pretax losses incurred for the second quarter of 2003 and 2002, respectively, due to substantial doubt about the Company's ability to continue as a going concern (see Note 1 to the Consolidated Financial Statements). Management believes that it is more likely than not that such deferred tax benefits will not be realized in the future. The Company assesses its effective tax rate on a continuous basis. Reorganization items, net: Reorganization items, net related to the Company's filing for Chapter 11 under the U.S. Bankruptcy Code totaled $84,422 for the second quarter of 2003 versus $0 in the comparable period of the prior year. Reorganization expenses included $10,233 in professional fees incurred after the Chapter 11 filing date which related directly to the bankruptcy filing, $68,582 in asset impairments recorded as part of the Company's bankruptcy reorganization activities, and $5,263 for severance costs associated with the Company's reorganization activities. The Company expects to record expenses for lease rejection costs and headcount reductions in future periods, which will have a material impact on the consolidated financial statements. See Note 7 to the Consolidated Financial Statements. Comparison of the 26-Weeks Ended June 28, 2003 and June 29, 2002 Net sales: Net sales decreased by $230,326 or 22% to $840,180 for the 26 weeks ended June 28, 2003 from net sales of $1,070,506 for the 26 weeks ended June 29, 2002. Net sales for the first half of 2003 included approximately $26 million in liquidation sales resulting from the sale and transfer of inventory to an independent liquidator in conjunction with the closing of 81 stores. Excluding liquidation sales, net sales decreased approximately 24% versus the comparable period in the prior year. The decrease in net sales was caused by a 41% decrease in catalog net sales, a 7% decrease in retail net sales (which primarily relate to Eddie Bauer), and an 11% decrease in e-commerce net sales. Eddie Bauer comparable store sales decreased 9% from the prior year. Net sales, particularly in the direct business, declined primarily due to the Company's decision in early March to cease honoring the private-label credit cards issued by First Consumers National Bank to customers of its merchant companies (Eddie Bauer, Newport News and Spiegel Catalog). During the first half of 2002, approximately 35% of the Company's net sales were made with the Company's private-label cards. During the first half of 2003, approximately 11% of the Company's net sales were made with the new private-label credit cards issued by Alliance Data Systems. Also contributing to the decrease in net sales was weak customer demand, as well as a planned decline in catalog circulation for each of the merchants and reduced promotional activity at Eddie Bauer. Finance revenue: Finance revenue decreased $48,529 from $18,069 in the first half of 2002 to a loss of $(30,460) in the first half of 2003. The substantial decrease in finance revenue in 2003 primarily resulted from the Pay Out event and the cancellation of the private label credit cards as described above. Other revenue: Other revenue decreased by $37,539, or 28%, from $134,100 in the first half of 2002 to $96,561 in the first half of 2003. The decrease resulted primarily from lower shipping and handling income at the merchant companies caused by lower sales volume. In addition, the decrease resulted from lower commissions generated from third parties to syndicate their catalogs. Cost of sales: Cost of sales decreased by $115,962 or 17% to $552,732 for the first half of 2003, from $668,694 for the first half of 2002. As a percentage of net sales, cost of sales increased to 66% for 2003 from 62% in the comparable period of the prior year. The increase as a percentage of net sales was driven by higher liquidation markdowns recorded in the current year based upon the decision to change the merchandise assortment and overall brand strategy at Spiegel Catalog, and to a lesser extent, was driven by 33 sales of inventory to a liqudator in connection with store closings. This was partially offset by higher product cost savings generated at the Eddie Bauer retail operations. Selling, general and administrative expenses ("SG&A"): SG&A expenses decreased $109,697 or 18% to $513,775 for the first half of 2003 from $623,472 for the first half of 2002. As a percentage of total revenue, SG&A expenses approximated 57% for the first half of 2003 and 51% for the first half of 2002. In 2003, SG&A expenses as a percentage of total revenue increased due to lower finance revenue recorded in the current year versus the prior year period. In addition, lower advertising productivity, which resulted in higher advertising costs as a percentage of net sales contributed to the increase in the current year percentage. Operating loss: The Company recorded an operating loss of $160,226 for the first half of 2003 compared to an operating loss of $69,491 for the comparable period of the prior year. The higher operating loss in the current year was due to lower net sales and lower shipping and handling income recorded in the current year as well as higher liquidation markdowns recorded in the current year. Interest expense: Interest expense totaled $18,887 and $29,978 for the first half of 2003 and the first half of 2002, respectively. This decrease was due to the Company's filing for Chapter 11 under the U.S. Bankruptcy Code on March 17, 2003. The Company's contractual interest for the first half of 2003 was $44,624. Income tax benefit: The Company has recorded no tax benefits associated with its pretax losses incurred for the first half of 2003 and the first half of 2002 due to substantial doubt about the Company's ability to continue as a going concern (see Note 1 to the Consolidated Financial Statements). Management believes that it is more likely than not that such deferred tax benefits will not be realized in the future. The Company assesses its effective tax rate on a continuous basis. Reorganization items, net: Reorganization expenses related to the Company's filing for Chapter 11 under the U.S. Bankruptcy Code totaled $98,412 for the first half of 2003 versus $0 in the comparable period of the prior year. Reorganization expenses included $11,133 in professional fees incurred after the Chapter 11 filing date which related directly to the bankruptcy filing, $68,582 in asset impairments recorded as part of the Company's bankruptcy reorganization activities, $8,669 for financing fees, $6,960 for interest rate swaps and approximately $5,263 for severance costs associated with the Company's reorganization activities. See Note 7 to the Consolidated Financial Statements. LIQUIDITY AND CAPITAL RESOURCES The Company has historically met its operating and cash requirements through funds generated from operations, the securitization of credit card receivables and the issuance of debt and common stock. However, the Company was unable to successfully negotiate a new credit facility with its lending institutions, to obtain an amended settlement agreement with MBIA Insurance Corporation ("MBIA"), and to assure the future achievement of minimum performance requirements under its securitization transactions. Accordingly, on March 17, 2003, Spiegel, Inc. and 19 of its subsidiaries filed voluntary petitions for reorganization under Chapter 11 of the U.S. Bankruptcy Code (as discussed above). These matters raise substantial doubt about the Company's ability to continue as a going concern for a reasonable period of time. Net cash provided by operating activities before reorganization items totaled $40,883 for the 26-week period ended June 28, 2003 compared to cash used in operating activities of $63,827 for the 26-week period ended June 29, 2002. The improvement in the first half of 2003 resulted from lower payments made in 2003 for trade accounts payable versus the comparable period in the prior year. In addition, inventory levels declined $86,330 in the first half of 2003 partially due to liquidation sales resulting in the sale and transfer of inventory to an independent liquidator in conjunction with the closing of 81 stores. Inventory levels were also 25% lower at June 28, 2003 as compared to June 29, 2002 due to effective inventory management. 34 Net cash used for reorganization items totaling $24,173 represents primarily payments made to professionals for services related to reorganization activities under the Chapter 11 bankruptcy filing, as well as payments made to consummate a new DIP facility and severance payments. Net cash provided by investing activities totaled $770 for the first half of 2003 compared to net cash used in investing activities of $74,076 in the same period last year. The prior year period included an increase in the cash reserve requirements for private-label preferred credit card receivable securitizations of $67,670 due to unfavorable private-label preferred credit card portfolio performance driven by higher charge-offs. During the first half of 2003, there was no increase in cash reserve requirements as the maximum cash reserve requirement was outstanding at December 28, 2002. Historically, the Company maintained cash reserve accounts as necessary, representing reserve funds used as credit enhancement for specific classes of investor certificates. Cash reserve requirements were determined based upon the actual performance of the credit card portfolio. The performance of the credit card portfolio was measured based primarily upon actual finance yield and charge-off rates. Debt Obligations As of June 28, 2003, total debt was $48,000 compared to $1,300,857 as of June 29, 2002. The decrease in debt in the first half of 2003 was driven by the Company's filing for reorganization under Chapter 11 of the U.S. Bankruptcy Code. As discussed above under "General," this resulted in the Company reflecting its secured debt outstanding at the time of the filing as a debt obligation. The remaining $1,252,857 of unsecured debt, which was outstanding as of March 17, 2003, was re-classified to liabilities subject to compromise in the consolidated balance sheet at June 28, 2003. In connection with its Chapter 11 filing, the Company secured a $400 million senior secured debtor-in-possession financing facility (the "DIP Facility") from Bank of America, N.A., Fleet Retail Finance Inc. and The CIT Group/Business Credit, Inc. On April 30, 2003, the bankruptcy court granted final approval for the entire DIP Facility. The DIP Facility will be used to supplement the Company's cash flow during the reorganization process. The DIP facility is a revolving credit facility under which Spiegel, Inc., Eddie Bauer, Inc., Spiegel Catalog, Inc., Ultimate Outlet, Inc. and Newport News, Inc. are the borrowers and, together with the other Chapter 11 debtor subsidiaries, are guarantors. The DIP Facility has super priority claim status in the Chapter 11 case and is secured by first priority liens on all of the debtors' assets, subject to the following: valid and unavoidable pre-petition liens, certain other permitted liens applicable to certain assets, the fees and expenses of the independent examiner appointed by the court in connection with the SEC Judgment and up to $7 million for professional and administrative fees. Of the DIP Facility, $50 million constituted a Consumer Credit Card Accounts Facility, which permits the Company to finance consumer receivables generated under credit cards issued directly by the Company's merchant companies. Under the terms of the DIP Facility, the Company at its option terminated the Consumer Credit Card Accounts Facility effective as of May 12, 2003. As a result, on such date the maximum amount available to be borrowed under the DIP Facility was permanently reduced to $350 million. This action was taken primarily because: (i) the private label credit card financing arrangements with Alliance Data had commenced by such date and (ii) earlier termination of the Consumer Credit Card Accounts Facility resulted in less unused DIP Facility line fees payable by the Company. Advances under the DIP Facility may not exceed a borrowing base equal to various percentages of the Company's eligible accounts receivable, eligible inventory and eligible real estate, less specified reserves. Borrowings under the DIP Facility bear interest, at the option of the borrower, at prime plus 1.00% or at LIBOR plus 3.00%. As of June 28, 2003, there were no borrowings drawn under the DIP Facility. However, there were $2.8 million in trade letters of credit outstanding at June 28, 2003. The Company is obligated to pay an unused commitment fee of 0.5% per annum on the unused amount of the maximum committed amount. The DIP Facility is scheduled to terminate on March 17, 2005. 35 The DIP Facility contains customary covenants, including certain reporting requirements and covenants that restrict the ability of the Company and its subsidiaries to incur or create liens, incur indebtedness and guarantees, make dividend payments and investments, sell or dispose of assets, change the nature of its business, enter into affiliated transactions and engage in mergers or consolidations. An event of default would occur under the DIP Facility if the Company or its subsidiaries failed to comply with these covenants, in some cases, after the expiration of a grace period. Upon the occurrence of an event of default, borrowings under the DIP Facility would, upon demand, become due and payable. In March 2002, the Company entered into a Vendor Payment Services Agreement with Otto International Hong Kong (OIHK), a related party, in order to permit the Company to obtain inventory in Asia. The duration of the agreement is for one year, automatically continuing unless terminated by either party with three months' written notice. Under the terms of the agreement, the Company has open account terms with various vendors in certain countries in Asia. OIHK pays these vendors the purchase price for goods, less a fee, within seven days of the purchase order receipt. Since the bankruptcy filing, the Company prepays OIHK for 100% of the purchase order value for goods purchased by Spiegel, Newport News and Eddie Bauer. Prior to the bankruptcy filing, the Company had terms ranging from 21 to 60 days to remit cash to OIHK. OIHK has asserted, that under the terms of the agreement, it has a lien over certain goods supplied to the Company. The Company and its creditors have reserved the right to contest the validity and amount of the OIHK liens in the Chapter 11 proceeding. A substantial amount of the Company's inventory purchases have been obtained under the agreement, (approximately $92,336 and $53,883 for the first half of 2003 and 2002, respectively.) If the agreement is terminated by OIHK, the Company would be required to find alternative methods for obtaining inventory purchases in Asia. This would likely result in an increase in letters of credit required to finance the Company's inventory purchases. This could result in disruption to the existing operations and, if alternative financing was not obtained, the Company's operations would be materially adversely affected. The Company's pre-petition credit facilities prior to the Chapter 11 filing are as described in Note 9 to the Company's Consolidated Financial Statements. The Company's ability to continue as a going concern will depend upon, among other things, the confirmation of a plan of reorganization, its compliance with the provisions of the DIP Facility and its ability to generate cash from operations and obtain financing sufficient to satisfy its future obligations. These challenges are in addition to the operational and competitive challenges the Company's business faces. The Company anticipates that its DIP Facility, together with its current cash reserves and cash flow from its operations, will be sufficient to fund its operations during the reorganization process. However, the Company has no experience operating as a debtor-in-possession. As a result, the assumptions underlying its projected cash requirements during the bankruptcy process may prove to be inaccurate. As of June 28, 2003 the Company's contractual cash obligations excluding liabilities subject to compromise and including leases that have not been rejected as of June 28, 2003 are as follows:
2003 2004 2005 2006 2007 Thereafter -------- ------- ------- ------- -------- ---------- DIP Facility $ -- $ -- $ -- $ -- $ -- $ -- Secured Notes 48,000 -- -- -- -- -- Operating leases 65,110 95,897 82,385 68,937 59,229 180,823 -------- ------- ------- ------- -------- -------- Total cash obligations $113,110 $95,897 $82,385 $68,937 $ 59,229 $180,823 ======== ======= ======= ======= ======== ========
Contractual cash obligations that are subject to compromise have been deferred due to the Chapter 11 filing and therefore are omitted from the table (See Note 6 to the Consolidated Financial Statements). Other commercial commitments outstanding at June 28, 2003, included a lease guaranty bond and certain guarantees for the payment of import fees to customs agents for the importing of goods into the United 36 States. (See Note 9 to the Consolidated Financial Statements). In addition, there were $2.8 million in trade letters of credit outstanding at June 28, 2003. MARKET RISK The Company is exposed to market risk from changes in interest rates and, to a lesser extent, foreign currency exchange rate fluctuations. Prior to the Pay Out Events, which occurred on the Company's receivables securitization transactions in March 2003, the Company was also exposed to market risk on its securitizations. As a result of the Pay Out Events, the Company no longer generates receivables that would be sold to the securitization trusts. In seeking to minimize risk, the Company historically managed exposure through its regular operating and financing activities and, when deemed appropriate, through the use of derivative financial instruments. The Company has not used financial instruments for trading or other speculative purposes and is not party to any leveraged financial instruments. Interest Rates In connection with its filing for bankruptcy protection in March, the Company secured the $350 million DIP Facility described above. As of June 28, 2003, no amounts have been borrowed under this facility. All future borrowings under this facility will bear interest at rates that represent a margin over either the prime rate or LIBOR. As a result, the Company expects to have interest rate exposure to shifts in these reference interest rates, depending on the type of borrowing it makes under the DIP Facility. Prior to its Chapter 11 filing, the Company managed interest rate exposure through a mix of fixed and variable-rate financings. The Company was generally able to meet certain targeted objectives through its direct borrowings. Substantially all of the Company's variable-rate exposure related to changes in the one-month LIBOR rate. If the one-month LIBOR rate had changed by 50 basis points, the Company's interest expense in 2002 would have changed by approximately $3,926. Interest rate swaps were used to minimize interest rate exposure when appropriate, based on market conditions. The notional amounts of the Company's interest rate swap agreements totaled $65,000 at December 28, 2002. See Note 9 to the Consolidated Financial Statements for a description of these swap arrangements. As a result of the Company's Chapter 11 filing, in the first quarter of 2003, the Company's interest rate swap agreements were determined to be ineffective which resulted in the Company reclassifying approximately $6,960 from accumulated other comprehensive loss in the stockholders' (deficit) equity section of the consolidated balance sheet to reorganization items, net in the consolidated statement of operations. The Company is uncertain whether it will enter into swap agreements during the Chapter 11 bankruptcy filing. The Company is subject to foreign currency risk related to its Canadian operations, as well as joint venture investments in Germany and Japan. The Company is party to certain transactions with the Canadian operations and joint ventures that are denominated in foreign currencies. The Company believes that its exposure to foreign exchange rate risk is not material due to the size and nature of the operations. CRITICAL ACCOUNTING POLICIES Management's Discussion and Analysis discusses the Company's Consolidated Financial Statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. 37 Management bases its estimates and judgments on historical experience and on various other factors that are believed to be reasonable under the circumstances. Management generally evaluates its estimates and assumptions on an ongoing basis for significant changes or events. Actual results may differ from these estimates under different assumptions or conditions. Estimates are deemed critical when a different estimate could have reasonably been used or where changes in the estimate are reasonably likely to occur from period to period, and would materially impact the Company's financial condition or results of operations. The receivables and reorganization charges accounting policies described below represent new critical accounting policies in the second quarter of 2003. The receivables policy reflects the new agreement with Alliance Data Systems described below. Critical estimates inherent in these accounting policies are discussed in the following paragraphs. Receivables The Company is charged a customary discount fee on all credit transactions with Alliance Data Systems. In addition, payments to the Company for customer purchases made with their Alliance Data-issued cards are subject to a 20% "holdback" fee. The holdback currently equals 20% of the principal portion of the receivable balance financed by Alliance Data at each month end. Alliance Data may draw against the holdback for reimbursement of a portion of its write-offs in connection with customers' failure to pay their credit card accounts under certain circumstances. Upon the Company's emergence from Chapter 11, the holdback will be reduced to 10%, and thereafter would be eliminated if the Company's satisfies certain financial criteria. The Company has recorded the holdback, which approximates $1 million as of June 28, 2003, as a receivable in the consolidated balance sheet. As of June 28, 2003, a reserve was not recorded against this receivable as the Company believes that the balance is collectable. The Company will assess the collectability of the receivable balance each period based upon the historical collection rates on the credit cards, which to date have been limited, and management's determination of the likelihood that the Company will emerge from Chapter 11 and will be able to meet the financial criteria contained in the agreement at that time. Each of these factors is highly uncertain. Future events may have a significant effect on management's estimates or determinations, which may cause the Company to reserve against or write off all or a portion of this holdback. Discontinued Operations In the fourth quarter of 2001, the Company formulated a plan to sell the bankcard segment. Therefore, the assets and liabilities of the bankcard segment are included in discontinued operations. Discontinued operations reflect the assets and liabilities of the bankcard segment based on management's best estimates of the amounts expected to be realized on the sale or liquidation of the bankcard segment. As of June 28, 2003, the Company had not received an acceptable offer for the sale of the bankcard segment and has begun the liquidation of FCNB. On June 25, 2003, FCNB stopped the servicing of its bankcard and private label portfolios and transferred the servicing of the bankcard and private label portfolios to First National Bank of Omaha and Cardholder Management Services, respectively. The Company has determined that its accrual for the estimated loss on disposal is adequate to account for the liquidation of the bankcard segment. The estimated loss on disposal of the bankcard segment is highly sensitive to changes in market conditions, as well as changes in the bankcard receivable portfolio performance. Future events may have a significant effect on the amount of the assets and liabilities recorded for the bankcard segment, including additional liabilities arising from the Pay Out Events and FCNB's servicing of both private label and bankcard receivables. In addition, the settlement of liabilities recorded by FCNB may also result in significant changes to the results of the private-label credit card operation, Spiegel Acceptance Corporation ("SAC"), which is reflected as part of the continuing operations of the Company. This is due to an intercompany agreement between FCNB and SAC. This may have a significant impact on the results of the Company in future periods. These estimates may be revised in subsequent periods as new information becomes available. Inventory Valuation Inventories, principally merchandise available for sale, are stated at the lower of cost or market. Cost is determined primarily by the average cost method or by the first-in, first-out method. The average cost or first-in, first-out method inherently requires management judgment and contains estimates such as the amount of markdowns necessary to clear unproductive or slow-moving inventory, which may impact the 38 ending inventory valuation as well as gross margins. In addition, the Company considers the impact of store closings and the future sale of inventory to liquidators in its assessment of inventory valuation. The Company reviews its provision for excess and obsolete inventory on an on-going basis to ensure that inventory values are reflected at their estimated net realizable value. In the second quarter of 2003, the Company recorded an incremental provision based upon the decision to change the merchandise assortment and overall brand strategy at Spiegel Catalog. This decision will result in a lower net realizable value for the existing inventory on hand as the product will be marked down in order to sell the inventory in advance of the receipt of the new merchandise assortment. Although the Company has seen a significant decline in net sales, the Company has managed its inventory purchases in line with the corresponding net sales declines. Long-Lived Asset Impairment The Company has a significant investment in intangible assets and property and equipment. The carrying value of long-lived assets are periodically reviewed by the Company whenever events or changes in circumstances indicate that a potential impairment has occurred. For long-lived assets held for use, a potential impairment occurs if projected future undiscounted cash flows are less than the carrying value of the assets. The estimate of cash flows includes management's assumptions of cash inflows and outflows directly resulting from the use of that asset in operations. When a potential impairment has occurred, an impairment write-down is recorded if the carrying value of the long-lived asset exceeds its fair value. The Company is in the process of closing 60 Eddie Bauer stores and 21 Spiegel and Newport News clearance and outlet stores in 2003 as part of its reorganization efforts. As a result, the Company has recorded certain write-downs in its property and equipment as described in Note 7 to the Consolidated Financial Statements. Revenue Recognition The Company records revenue at the point of sale for retail stores and at the time of shipment for catalog and e-commerce sales. Membership fee revenue related to discount clubs offered to direct customers is recognized in net sales over the term of the membership, which is 12 months. Amounts billed to customers for catalog and e-commerce shipping and handling are recorded as other revenue at the time of shipment. Advertising Costs Costs incurred for the production and distribution of direct response catalogs are capitalized and amortized over the expected lives of the catalogs, which are less than one year. The amortization expense is recorded in the period that the sales associated with the catalog are expected to be realized. Actual sales may deviate significantly from forecasted sales, which may result in significant changes in the amortization expense recorded in a particular period. All other advertising costs for catalog, e-commerce, retail and credit operations are expensed as incurred. Income Taxes Deferred tax assets and liabilities are determined based on differences between the financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that are expected to be in effect when the differences are expected to reverse. As of June 28, 2003 and December 28, 2002, the Company has recorded a valuation allowance against its total net deferred tax assets due to substantial doubt about the Company's ability to continue as a going concern. The Company performs a review of its deferred tax position on an on-going basis to determine if it is more likely than not that the deferred tax assets recorded by the Company will be realized in future periods. 39 Securitizations Prior to the occurrence of the Pay Out Events described above, the majority of the Company's credit card receivables were transferred to trusts that, in turn, sold certificates and notes representing undivided interests in the trusts to investors. The receivables were sold without recourse. Accordingly, no allowance for doubtful accounts related to the sold receivables was maintained by the Company. When the Company sold receivables in these securitizations, it retained interest-only strips, subordinated certificates, a seller's interest in receivables that are transferred to the trust but are not sold and cash reserve accounts, all of which have been included in retained interests in securitized receivables, with the exception of cash reserve accounts which have been included in other assets. Cash reserve accounts and retained interests in securitized bankcard receivables of FCNB have been included in the Consolidated Balance Sheets in net assets of discontinued operations. For the receivables that were transferred to the trust but were retained by the Company and for receivables that were not transferred to a trust, the Company accounted for these receivables at fair value, which represented the full value of the receivables less an allowance for doubtful accounts. The allowance for doubtful accounts was calculated based on a percentage of the full value of the receivables portfolio. The percentage was determined upon consideration of current delinquency data, historical loss experience and general economic conditions. In addition, for fiscal year 2003 and for fiscal year 2002, management also considered its decision, in March 2003, to cease honoring the private-label and bankcard credit cards issued by FCNB and held in the securitization trusts. These events caused the Company to increase its allowance for doubtful accounts substantially. Future events affecting the Company or relating to its securitization transactions could cause additional changes in the ultimate settlement of these transactions. Recognition of gain or loss on the sale of receivables to the securitization trusts depended in part on the previous carrying amount of the receivables involved in the transfer and the allocation of the carrying amount between the assets sold and the retained interests based on their relative fair value at the date of transfer. The Company recognized gains or losses upon the sale of the receivables based upon the present value of estimated future cash flows that the Company expected to receive over the liquidation period of the receivables. These future cash flows consisted of an estimate of the excess or deficit of finance charges and fees over the sum of the interest paid to certificate holders, contractual servicing fees and charge-offs. For fiscal years prior to 2002, estimated future cash flows also included estimated future finance charges and principal collections related to interests in the credit card receivables retained by the Company. For fiscal years 2002 and 2003, the collections related to the Company's interests in the credit card receivables were not reflected in the fair value calculation due to the occurrence of the Pay Out Events in March 2003 and the required allocation of cash flow from the receivables to pay investors. Estimates of future cash flows were calculated using management estimates and assumptions of, among other things, portfolio yield, charge-offs, liquidation rates, interest rates and discount rates. These estimates were highly sensitive to changes in portfolio performance and inherently required management judgment on future portfolio performance. Cash reserve accounts were maintained as necessary, representing restricted funds used as credit enhancement for specific classes of investor certificates issued in certain securitization transactions. In conjunction with its asset-backed securitizations, the Company has recognized gains or losses to earnings based on the fair value of estimated future cash flows that the Company expects to receive over the liquidation period of the receivables. In fiscal year 2002, as a result of the Pay Out Events and allocation of cash flows to pay investors, the Company wrote down all of its retained interest in the securitized receivables. These future cash flows consist of an estimate of the excess or deficit of finance charges and fees over the sum of the interest paid to certificate holders, contractual servicing fees and charge-offs. For fiscal years prior to 2002, estimated future cash flows also included estimated future finance charges and principal collections related to interests in the credit card receivables retained by the Company. For 2002, the collections related to the Company's interests in the credit card receivables were not reflected in the fair value calculation due to the occurrence of the Pay Out Events in March 2003 and the required allocation of cash flow from the receivables to pay investors. Estimates of future cash flows are calculated using management estimates and assumptions of, among other things, portfolio yield, 40 charge-offs, liquidation rates, interest rates, and discount rates. Changes in interest rates and other assumptions and estimates used in determining the present value of these estimated future cash flows have experienced significant shifts in the past based on changes, among other factors, in the credit portfolio, general economic downturn and lower interest rates. As of June 28, 2003, the Company had written down all of its retained interests in the securitized receivables. After the liquidation of the receivables portfolio is completed, the Company may be entitled to a recovery of a portion of its retained interests. This recovery, which is not likely, would be recorded in the period realized. Reorganization Charges The Company has recorded reorganization charges in fiscal year 2003 related to the following actions taken as a result of the bankruptcy and related reorganization activities: closing of stores, consolidation of distribution and call center operations, abandonment of capital projects for information systems, and restructuring of the overall business while in bankruptcy. These charges require judgments about exit costs to be incurred for employee severance, contract and lease terminations, the future net realizable value of long-lived assets and other liabilities. As a result of the bankruptcy proceedings, certain estimates for store closings are now calculated based on statutory formulas, however, significant judgment is involved in estimating the claims of lessors for items other than rent, including cure costs, taxes, utilities, etc. The ability to obtain agreements with lessors to terminate leases or with other parties to assign leases can also affect the accuracy of current estimates. The Company anticipates that material reorganization charges will continue to be incurred in future periods based upon decisions made as part of the reorganization process. CONTROLS AND PROCEDURES The Company's independent auditors have informed the audit committee of certain internal control deficiencies that constitute reportable conditions. These control deficiencies relate to the Company's wholly owned subsidiary, FCNB. The deficiencies relate to routine transactions and accounting estimates, policies and procedures, and account balance classifications in the financial statements. FCNB has begun a formal liquidation process that has resulted in significant reductions and changes in staff. The Company's management still believes that significant control deficiencies remain at FCNB and continues to work with the management team to adequately assess the accounting transactions recorded by FCNB management. On June 30, 2003, FCNB commenced its formal liquidation as required by the OCC. As a result, the Company no longer has control over the disclosure controls and procedures and the internal controls over financial reporting of FCNB and the other subsidiaries of the Company that are managed by FCNB, including FCCC, FSAC and SAC. At this time, the Company cannot be assured you that the financial and other information regarding these entities that is included in this report is accurate or complete. OTHER RECENT DEVELOPMENTS In July 2003, the Company received bankruptcy court approval to implement a Key Employee Retention Plan ("KERP"), which provides cash incentives to certain members of the management team and other employees. The KERP is intended to encourage employees to continue their employment with the Company through the reorganization process. The KERP is being finalized and the Company is in the process of implementing it. The plan is attached as Exhibit 99.1 hereto. The Company has also entered into an employment contract with Geralynn Madonna, which is attached hereto as Exhibit 99.2. On April 24, 2003, the Board approved the creation of a restructuring committee (the "Restructuring Committee"). The Board intends that the Restructuring Committee will be comprised of at least two independent directors and the Company's Chief Restructuring Officer/Interim Chief Executive Officer as soon as qualified independent directors have been selected. 41 The Restructuring Committee will approve and authorize transactions involving the Company and any director, officer or controlling shareholder of the Company and any family member or affiliate of any of them, and will make recommendations to the full board of directors regarding any other matters relating to or arising out of the restructuring or reorganization of the Company. FORWARD-LOOKING STATEMENTS This report contains statements that are forward-looking within the meaning of applicable federal securities laws and are based upon the Company's current expectations and assumptions. You should not place undue reliance on those statements because they speak only as of the date of this report. Forward-looking statements include information concerning the Company's possible or assumed future financial condition or results of operations. These statements often include words such as "expect," "plan," "believe," "anticipate," "intend," "estimate," or similar expressions. As you read and consider this report, you should understand that these statements are not guarantees of financial condition, performance or results. They involve risks, uncertainties and assumptions. Although the Company believes that these forward-looking statements are based on reasonable assumptions, you should be aware that many factors could affect its actual financial results and actual results could differ materially from the forward-looking statements. These factors include, but are not limited to, uncertainty regarding the Company's ability to continue as a going concern; uncertainty regarding the Company's ability to operate pursuant to the terms of the DIP Facility; uncertainty regarding the Company's ability to develop and consummate one or more plans of reorganization; risks associated with third parties seeking and obtaining court approval to terminate or shorten the exclusivity period for the Company to propose and confirm one or more plans of reorganization, for the appointment of a Chapter 11 trustee or to convert the Chapter 11 case into a Chapter 7 case; the effect on the Company's net sales and cash flow of its decision to stop accepting private-label credit cards at its merchant companies; the effects on the Company of the Pay-Out Events recently experienced by all of the Company's securitization agreements that are backed by the Company's credit card receivables; the ultimate effect on the Company of the pending investigation by the SEC; the uncertainty relating to the outcome of the liquidation of the bankcard segment; the ability of the Company to maintain trade credit and contracts that are important to its operations; the financial strength and performance of the retail and direct marketing industry; changes in consumer spending patterns; risks associated with collections on the Company's credit card portfolio; the success of merchandising, advertising, marketing and promotional campaigns; and various other factors beyond the Company's control. All future written and oral forward-looking statements made by the Company or persons acting on the Company's behalf are expressly qualified in their entirety by the cautionary statements contained or referred to above. Except for the Company's ongoing obligations to disclose material information as required by the federal securities laws, the Company does not have any obligation or intention to release publicly any revisions to any forward-looking statements to reflect events or circumstances in the future or to reflect the occurrence of unanticipated events. Item 7. Exhibits. (C) Exhibits 99.1 Motion and Order pursuant to 11 U.S.C. sec 105(a) and 363(b) authorizing the debtors to implement a Key Employee Retention Plan to pay certain bonuses and to execute and perform under employment agreements with certain key executives 99.2 Employment agreement, dated as of July 25, 2003 by and between Spiegel, Inc. and Geralynn Madonna. 42 SIGNATURE 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. SPIEGEL, INC. Dated: August 12, 2003 /s/ James M. Brewster ------------------------------------------------- James M. Brewster Senior Vice President and Chief Financial Officer (Principal Accounting and Financial Officer) 43 EX-99.1 3 dex991.txt MOTION FOR AN ORDER PURSUANT TO 11 U.S.C. SECTIONS 105(A) AND 363(B) Hearing Date and Time: June 24, 2003 at 10:00 a.m. Objection Deadline: June 20, 2003 at 12:00 p.m. SHEARMAN & STERLING 599 Lexington Avenue New York, New York 10022 Telephone: (212) 848-4000 Facsimile: (212) 848-7179 James L. Garrity, Jr. (JG-8389) Marc B. Hankin (MH-7001) Attorneys for the Debtors and Debtors in Possession UNITED STATES BANKRUPTCY COURT SOUTHERN DISTRICT OF NEW YORK - -----------------------------------------------------X : : Chapter 11 : In re: : Case No. 03 - 11540 (CB) : SPIEGEL, INC., et al., : (Jointly Administered) : Debtors. : : : : - -----------------------------------------------------X MOTION FOR AN ORDER PURSUANT TO 11 U.S.C.(S)(S) 105(a) AND 363(b) AUTHORIZING THE DEBTORS TO IMPLEMENT A KEY EMPLOYEE RETENTION PLAN, TO PAY CERTAIN BONUSES AND TO EXECUTE AND PERFORM UNDER EMPLOYMENT AGREEMENTS WITH CERTAIN KEY EXECUTIVES TO THE HONORABLE CORNELIUS BLACKSHEAR UNITED STATES BANKRUPTCY JUDGE: Spiegel, Inc. ("Spiegel") and certain of its direct and indirect subsidiaries, as debtors and debtors in possession (collectively, the "Debtors" or the "Spiegel Group"), file this motion (this "Motion") for entry of an Order, pursuant to sections 105(a) and 363(b) of title 11 of the United States Code (the "Bankruptcy Code"), authorizing the Debtors to (i) implement a key employee retention plan (the "KERP"), (ii) pay certain bonuses described below, and (iii) execute and perform under Employment Agreements (as defined below) with four key executives. The facts and circumstances supporting this Motion are set forth in the Affidavit of Anne Linsdau, Senior Vice President of Human Resources of Spiegel, in support of the Motion, filed concurrently herewith. In support of this Motion, the Debtors respectfully state as follows: Background 1. On March 17, 2003 (the "Petition Date"), each of the Debtors filed a voluntary petition in this Court for relief under chapter 11 of the Bankruptcy Code. 2. On March 24, 2003, the United States Trustee for the Southern District of New York appointed a statutory committee of unsecured creditors (the "Committee"). As of the date hereof, no request has been made for the appointment of a trustee or examiner in these cases. 3. The Debtors have continued in possession of their respective properties and have continued to operate and manage their businesses as debtors in possession pursuant to sections 1107(a) and 1108 of the Bankruptcy Code. 4. The Spiegel Group is a leading international general merchandise and specialty retailer that offers apparel, home furnishings and other merchandise through catalogs, e-commerce sites and over 500 retail stores. The Spiegel Group's retail businesses operate through its three merchant divisions: Eddie Bauer, Spiegel Catalog, and Newport News (each, a "Merchant Division"). Each Merchant Division is comprised of several entities, all of which are Debtors herein. Jurisdiction 5. This Court has jurisdiction to consider this matter pursuant to 28 U.S.C. (S)(S) 157 and 1334. This is a core proceeding pursuant to 28 U.S.C. (S) 157(b)(2)(A). Venue is proper before this Court pursuant to 28 U.S.C. (S)(S) 1408 and 1409. 2 Relief Requested 6. By this Motion, the Debtors seek authority, under sections 105(a) and 363(b) of the Bankruptcy Code, to implement the KERP, pay certain bonuses described below, and to execute and perform under the Employment Agreements (as defined below). Background 7. As described in greater detail below, the relief requested by this Motion is designed to maximize the value of the Debtors' estates for the benefit of their creditors and other stakeholders by accomplishing the following objectives: . Provide continuity of management responsible for strategic decisions and day-to-day operations to ensure that the Debtors' restructuring initiatives are carried out in an efficient manner. . Provide a sense of security to key employees who may find themselves displaced as a result of their own efforts in carrying out the restructuring plan. . Create and sustain employee morale, loyalty and commitment in the face of difficulties that necessarily attend a complex chapter 11 case. 8. In sum, the relief requested by this Motion is designed to minimize management and other key employee turnover by providing inducements to those employees to continue working for the Debtors, as well as to enhance employee morale and job commitment. The Debtors believe that the implementation of the KERP, paying the bonuses described below and performing under the Employment Agreements (as defined below) are necessary in order to accomplish a successful reorganization and to maximize recoveries for their constituencies. Key Employee Retention Plan A. Critical Need to Implement the KERP 9. The retention of key management and other employees is in the best interests of the Debtors' estate and their creditors as such retention will maximize the value of the Debtors' business and their assets. In contemplation of a successful reorganization, the 3 Debtors are seeking to gain the commitment of their key employees by securing their loyalty with a competitive and fair program by providing incentives comparable to: (i) those provided to employees with similar positions and experience in similar industries; and (ii) similar arrangements that have been approved for employees of similarly-situated companies operating under chapter 11 protection. 10. Since the Petition Date, the Debtors have proceeded expeditiously to implement the first phase of a restructuring program in order to maximize the value of their estates for the benefit of their creditors and other stakeholders. These restructuring initiatives include (i) the liquidation of the Spiegel Catalog and Newport News outlet stores, (ii) the closure of approximately 60 Eddie Bauer retail stores, (iii) the closure of a customer call center located in Bothell, Washington, (iv) the consolidation of Distribution Fulfillment Services, Inc. (DFS) into one facility in Columbus, Ohio, and (v) the restructuring of the Merchant Divisions and Spiegel corporate in order to gain greater organizational and operational efficiencies. 11. In connection with these restructuring initiatives, the Debtors have involuntarily terminated approximately 900 employees during the postpetition period. In addition, approximately 1,250 employees have voluntarily terminated their employment this period. These terminations are adversely affecting the ability of the Debtors to retain critical employees, particularly those in management positions and those at the corporate level. The unfamiliarity of employees with the chapter 11 process exaggerates their concerns regarding job security and the prospects of their employer, thereby contributing to a potentially unstable situation. 12. The continued operation of the Debtors' businesses depends upon the retention of services of its key managers and the maintenance of employee morale. If a key manager is lost, it will be difficult and expensive to attract an equally qualified replacement and 4 would likely hinder the implementation of the Debtors' restructuring directives. The loss of key managers at this critical time would cause substantial disruption to the Debtors' business and would severely impact employee moral and retention. Deterioration in employee moral at this critical time would have an adverse impact on the workforce and the value of the Debtors' assets and business. Given the lack of certainty with respect to the Debtors' prospects that necessarily attend any chapter 11 case, the Debtors must strive to maintain goodwill with and the best possible work environment for all employees. 13. In sum, the Debtors cannot afford to lose their key employees, especially at this critical time in the chapter 11 process. It is essential that the Debtors stem further employee departures by providing incentives and protections that will induce key employees to remain in the Debtors' employ and dedicate themselves to the successful reorganization of the Debtors' businesses. B. KERP Summary 14. Following a thorough review of the Debtors' workforce and operational needs, the Debtors' senior management with the assistance of Watson Wyatt & Company ("Watson Wyatt"), which specializes in compensation and related issues, developed the KERP./1/ The KERP includes the following five components: . A retention plan (the "Retention Plan") structured to encourage key employees to remain with the Debtors during the restructuring period. . A transition bonus plan (the "Transition Bonus Plan") to provide the Debtors flexibility to determine the necessary workforce during the restructuring period and provide incentives to non-Retention Plan employees with uncertain employment periods. . A performance incentive plan (the "Performance Incentive Plan") to provide the necessary incentives for key employees during the restructuring period to meet the Debtors' business goals. - ---------- /1/ The Debtors will seek to retain Watson Wyatt pursuant to a separate application to be filed with this Court. 5 . An enhanced severance plan (the "Enhanced Severance Plan") to provide employees with a sense of financial security due to their necessarily uncertain employment duration during the restructuring period. 15. Debtors have assigned key employees to six organizational levels (each a "Level") that are eligible for the various plans other than the Transition Bonus Plan (collectively, the "Key Employees"): - -------------------------------------------- Level Representative Position # Eligible - -------------------------------------------- 1 President & CEO 2 2 Senior Executives 12 3 Key Executives 19 4 Senior Managers 27 5 Managers 120 6 Key Contributors 45 - -------------------------------------------- Total 225 ============================================ 16. The Debtors anticipate that certain individuals who are promoted or newly hired during these chapter 11 cases may be added to the KERP. The Debtors anticipate that the cost of any such additions will be, at a minimum, offset by workforce attrition. i. The Retention Plan 17. The Retention Plan provides for retention bonuses (each a "Retention Bonus") ranging from 25% to 80% of base salary, payable in three installments beginning September 17, 2003 (six months after the Petition Date) through the Debtors' emergence from chapter 11. The Retention Bonus varies by level of the Key Employee as follows:
- -------------------------------------------------------------------------------------------------- Retention Bonus Payout Schedule Total Retention -------------------------------------------------- Level Employees Base Salary Opportunity Sep-03 Mar-04 Emergence Total - -------------------------------------------------------------------------------------------------- 1 2 $ 1,560,000 65-80% $ 285,750 $ 400,050 $ 457,200 $ 1,143,000 2 12 $ 3,529,014 55-60% $ 494,239 $ 691,935 $ 790,783 $ 1,976,958 3 19 $ 3,579,038 50% $ 447,380 $ 626,332 $ 715,808 $ 1,789,519 4 27 $ 3,966,209 40% $ 396,621 $ 555,269 $ 634,593 $ 1,586,484 5 120 $10,507,699 30% $ 788,077 $1,103,308 $1,260,924 $ 3,152,310 6 45 $ 2,497,985 25% $ 156,124 $ 218,574 $ 249,798 $ 624,496 - -------------------------------------------------------------------------------------------------- Total 225 $25,639,900 $2,568,200 $3,595,500 $4,109,100 $10,272,800 ==================================================================================================
18. The Retention Bonuses are to be paid according to the following payment schedule: 6 . 25% six months after the Petition Date. . 35% twelve months after the Petition Date. . 40% sixty days after the Company's emergence from chapter 11. 19. The Retention Plan includes the following provisions with respect to those employees whose employment is terminated or who are employed by a business unit that is sold during the course of the restructuring: . Key Employees who voluntarily terminate their employment prior to the specified payout date will forfeit any relevant Retention Bonus amounts to the extent such Retention Bonuses remain unpaid at the date of voluntary termination. . Key Employees who are involuntarily terminated (other than for cause) will receive the entire Retention Bonus at the time of termination, as well as an enhanced severance benefit (as described below). . Key Employees who are employed by a divested business unit will have their entire Retention Bonus paid at the time of divestiture or sale of significant business unit operating assets. ii. Transition Bonus Plan 20. The Transition Bonus Plan is for directors, managers, and staff employees who will not participate in the Retention Plan, and therefore provides the Debtors with maximum flexibility to decide on its manpower for the next year. The Transition Bonus Plan will be communicated to the designated employees who will be needed until certain projects are completed and, at the time of termination, would receive their severance benefits and a transition bonus pursuant to the Transition Bonus Plan. Managers have the discretion to decrease the transition bonus if the employee is needed for a shorter period. The table below describes the eligible company levels and opportunity targets of the Transition Bonus Plan, with an expected pool allocation of approximately $1.5 million: 7 - ---------------------------------------------------------- Transition Transition SPGL Average Bonus Bonus Level Employees Base Salary Opportunity Amount - ---------------------------------------------------------- DIR 15 $101,800 35% $ 534,450 MGR 32 $ 69,900 25% $ 559,200 STAFF 54 $ 50,100 15% $ 405,810 ========================================================== Total 101 $1,499,500 ========================================================== iii. Performance Incentive Plan 21. The 14 executives in Levels 1 and 2 of the KERP will participate in the Performance Incentive Plan with a target incentive pool of approximately $5.5 million. At the discretion of Spiegel's Chief Executive Officer (the "CEO"),/2/ upon the Debtors' emergence from chapter 11, the Performance Incentive Plan will payout 100% if the earnings before interest, taxes, depreciation and amortization of the June 2003 Plan (the "EBITDA June 2003 Plan") is fully achieved, and 50% of the incentive pool if 85% of the EBITDA June 2003 Plan is achieved. 22. The 19 executives in Level 3 of the KERP will participate in the Performance Incentive Plan with a target incentive pool of $2 million. At the discretion of the CEO, upon the Debtors' emergence from chapter 11, the Performance Incentive Plan will payout 100% if the EBITDA June 2003 Plan is fully achieved, and 50% of the incentive pool if 85% of the EBITDA June 2003 Plan is achieved. 23. Employees in Levels 4 and 5 of the KERP will participate in the Performance Incentive Plan with a target incentive pool of $1.45 million. Upon the Debtors' emergence from chapter 11, the Performance Incentive Plan will payout 100% if the EBITDA June 2003 Plan is fully achieved, and 50% of the incentive pool if 85% of the EBITDA June 2003 Plan is achieved. - ---------- /2/ William C. Kosturos is presently the Interim Chief Executive Officer and Chief Restructuring Officer of Spiegel. If a permanent Chief Executive Officer is not appointed, then the defined term "CEO" shall refer to the Interim Chief Executive Officer. 8 24. A discretionary pool of $1 million may be used to supplement the Performance Incentive Plan payout of KERP participants. Employees who are not assigned to a level under the KERP will be eligible for their annual incentive opportunities that will be determined in accordance with prepetition practices. 25. As the EBITDA June 2003 Plan has not yet been finalized, the Debtors will establish the applicable benchmarks for the Performance Incentive Plan in consultation with the Committee. In the highly unlikely event that the Debtors are unable to reach agreement with the Committee on such benchmarks, the Debtors will not implement the Performance Incentive Plan pursuant to the relief requested by this Motion. Instead, the Debtors will seek this Court's authority to implement the Performance Incentive Plan pursuant to such benchmarks that the Debtors shall propose. 26. In accordance with prepetition practice, the Debtors will establish an incentive bonus plan for employees who are not eligible to participate in the Performance Incentive Plan (the "Ordinary Course Incentive Plan"). The Debtors intend to allocate up to $5 million for the Ordinary Course Incentive Plan, but expect that, assuming the applicable benchmarks described below are satisfied, only approximately $3.75 million will be paid to employees under such plan due to attrition by certain of such employees. Pursuant to the Ordinary Course Incentive Plan, satisfaction of the benchmarks under the EBITDA June 2003 Plan for corporate employees will be measured on the EBITDA June 2003 Plan. Employees of the Merchant Divisions, Distribution Fulfillment Services, Inc. (DFS), and Spiegel Group Teleservices, Inc. will be measured on their respective division's 2003 earnings before interest and taxes, and on the EBITDA June 2003 Plan. As the Ordinary Course Incentive Plan is consistent with the Debtors' ordinary course prepetition practice, the Debtors are not seeking this 9 Court's authority to implement the Ordinary Course Incentive Plan, and are describing it in this Motion in the interests of full disclosure. iv. Enhanced Severance Plan 27. Pursuant to the proposed Enhanced Severance Plan, Key Employees will be entitled to receive the greater of their regular severance benefit determined in accordance with existing policy, applicable severance agreement or the enhanced severance benefit level as detailed below. The cost differential between current/contractual severance and the enhanced severance is outlined in paragraph 30 below. - ---------------------------------------------------- Enhanced Severance Level Representative Position (% of Salary) - ---------------------------------------------------- 1 President & CEO 200% - ---------------------------------------------------- 2 Senior Executives 65% - ---------------------------------------------------- 3 Key Executives 50% - ---------------------------------------------------- 4 Senior Managers 50% - ---------------------------------------------------- 5 Managers 25% - ---------------------------------------------------- 6 Key Contributors 25% - ---------------------------------------------------- With respect to those employees with existing employment agreements the Debtors seek authority to pay the severance benefits set forth included in such agreement in the event that the applicable employee is terminated without cause during the stated term of the applicable employment agreement. Thereafter, those employees will receive enhanced severance in accordance with the provisions set forth above. By this Motion, the Debtors are not seeking authority to assume or reject any such employment agreements. 28. The Enhanced Severance Plan contains the following provisions regarding an employee's entitlement to enhanced severance upon termination: . Employees who voluntarily terminate employment will not be entitled to severance benefits including any payments under the KERP. . Employees who are involuntarily terminated (other than for cause) will receive their eligible severance benefit payable in a single lump sum at the 10 time of termination, subject to review by the compensation committee of the Board of Directors. v. Program Costs 29. The estimated aggregate maximum cost of the KERP is approximately $26.4 million excluding any severance payments:
Key Employee Retention Program ---------------------------------------------------------- Retention Transition Performance Bonus Bonus Incentive Bonus TOTAL ----------- ---------- --------------- ----------- KERP Employees Levels 1 & 2 $ 3,119,958 -- $ 5,473,000 $ 8,593,000 Level 3 $ 1,789,519 -- $ 2,000,000 $ 3,789,500 Level 4 & 5 $ 4,738,793 -- $ 1,447,000 $ 6,185,800 Level 6 $ 624,496 -- -- $ 624,500 Discretionary $ 1,000,000 $ 1,000,000 $10,272,800 -- $ 9,920,000 $20,192,800 Non-Retention Plan Employees Employees -- $1,500,000/3/ $ 3,750,000/4/ $ 5,250,000 CEO Discretionary Pool -- -- -- $ 1,000,000 TOTAL $10,272,800 $1,500,000 $13,670,000 $26,442,800
30. The potential costs of the Enhanced Severance Plan as compared to the Debtors' current severance benefits are outlined in the table below:
Severance Current Enhanced Level Representative Position Incumbents Benefit Severance Severance Differential - ----- ----------------------- ---------- --------- ----------- ----------- ------------ 1 President & CEO 2 200% $ 3,120,000 $ 3,120,000 $ 0 2 Senior Executives 12 65% $ 2,336,478 $ 2,293,859 -$42,618 3 Key Executives 19 50% $ 1,484,779 $ 1,789,519 $ 304,740 4 Senior Managers 27 50% $ 1,407,313 $ 1,983,105 $ 575,792 5 Managers 120 25% $ 1,988,132 $ 2,626,925 $ 638,793 6 Key Contributors 45 25% $ 282,494 $ 624,496 $ 342,002 TOTAL 225 $10,619,200 $12,437,900 $1,818,708
C. Authorization to Pay Certain Bonuses 31. As noted above, the continued performance of the Debtors' employees is critical to their ability to maximize the value of their estates for the benefit of creditors and other - ---------- /3/ Assumes all eligible employees are paid out full stay bonus opportunity. /4/ $5 million incentive pool with 25% assumed attrition. 11 parties in interest. In connection with developing the KERP, the Debtors have determined that it is in the best interests of their estates to obtain authority to pay the bonuses described below. In each case, the bonuses were either earned entirely during the prepetition period, or were promised to particular key employees (other than the Key Executives, as defined below) during the prepetition period and may be earned by the applicable employee based on services rendered, either in whole or in part, during the post-petition period. Although on the Petition Date the Debtors requested authority to pay certain prepetition amounts owing to employees,/5/ the Debtors did not request authority to pay any of the bonuses described below because the Debtors considered that it would only be appropriate to do so in connection with a global employee retention program (such as the KERP) and after having discussed the same with the Committee. i. 2002 Incentive Bonus 32. During the prepetition period, the Debtors established an employee incentive plan for the 2002 fiscal year that ended on December 31, 2002. The benchmarks for such plan were appropriately set in light of the Debtors' prepetition situation, which included operating in a very competitive retail and direct marketing environment. Prior to the Petition Date, the Debtors determined that approximately 931 employees earned bonuses under such plan (the "2002 Incentive Bonuses"). Such employees received the first half of their 2002 Incentive Bonuses on February 28, 2003. By this Motion, the Debtors request authority to pay the second half of the 2002 Incentive Bonuses (the "Second Half 2002 Incentive Bonuses") to such employees on or about July 18, 2003. The aggregate amount of such bonus payments is approximately $5.53 million. - ---------- /5/ Motion of the Debtors for an Order Pursuant To 11 U.S.C.(S)(S)363(b) and 105(a) Authorizing (I) Payment Of Prepetition Wages, Salaries, Vacation Benefits, Expense Reimbursement, Severance Benefits, Employee Benefit Plans, Policies, Programs and Practices, (II) Continuance of Employee Benefit Plans, Policies, Programs And Practices, and (III) Certain Other Specified Relief, dated March 17, 2003 [Docket No. 38]. 12 ii. Bonuses to Five Key Employees 33. In order to attract and retain five key employees (none of whom are Key Executives) during the prepetition period, the Debtors agreed to provide these employees certain bonuses in the aggregate amount of approximately $183,000 that are payable in 2003 or 2004 (collectively, the "Separate Bonuses"). These separate bonuses include a signing bonus as well as certain bonuses to be paid based on performance or continued service to the Debtors. By this Motion, the Debtors request authority to pay the Separate Bonuses in accordance with their terms. D. Employment Agreements for Key Executives 34. In any organization, certain persons are undeniably critical to that organization's ability to achieve its goals. In this case, the Debtors' goal is to maximize their value for the benefit of their creditors pursuant to a confirmed plan of reorganization. The Debtors have determined, that in order to achieve this goal, it is critical that they continue to receive the services provided by the following four key executives (collectively, the "Key Executives"):/6/ . Fabian Mansson: Fabian Mansson has served as President and Chief Executive Officer of Eddie Bauer, Inc. since July 1, 2002. In this capacity, Mr. Mansson drives the strategic vision for the Eddie Bauer Brand. Mr. Mansson, formerly served as Chief Executive Officer of Hennes & Mauritz ("H&M"), one of Europe's most successful retail chains with more than $4 billion in sales and more than 800 stores located worldwide. While at H&M from 1991 through 2000, Mr. Mansson served in a variety of positions, including Group Merchandising Manager and Division Manager, before assuming the role of Chief Executive. Immediately prior to his employment by Eddie Bauer, Mr. Mansson was an Executive Vice President with Spray Ventures, a Swedish venture capital company, where he was jointly responsible with the chief executive officer for successfully reducing operating costs, improving the company's financial structure and restructuring parts of the business. - ---------- /6/ Each of the Key Executives is a Key Employee. 13 . Geralynn Madonna: Geralynn Madonna has been President and Chief Executive Officer of Spiegel Catalog, Inc. and Newport News, Inc. since March 14, 2003. In this capacity, Ms. Madonna oversees all aspect of operations, including but not limited to financial management, design, manufacturing and merchandising. Ms. Madonna previously held the position of President and Chief Operating Officer of Newport News. Ms. Madonna has been with the Debtors for more than 22 years. In her most recent position as president and chief operating officer of Newport News, she oversaw all company-wide operations, including merchandising, product design and development, and financial management. . Alexander Birken: Alexander Birken serves as Senior Vice President and Chief Operating Officer of Spiegel. In this capacity, Mr. Birken oversees all aspects of the Spiegel Group's information services, corporate real estate, audit and support operations as well as special projects, including critical cost-cutting initiatives. Mr. Birken joined the Spiegel Group in August 2002. He came to the Spiegel Group from the Otto Group where he held various positions for 11 years and most recently served as Senior Vice President. . James Brewster: James M. Brewster was appointed as Senior Vice President and Chief Financial Officer for the Spiegel Group on February 26, 2003. For the 10 years prior to this appointment, Mr. Brewster served as Senior Vice President and Chief Financial Officer for Newport News, Inc. In this capacity, Mr. Brewster has responsibility for the financial plans and policies of the company and for strategic activities in the legal, investor relations, tax and loss prevention functions. Mr. Brewster joined Newport News, Inc. in 1986 as manager of financial systems and moved up through the organization, serving as director of finance, director of inventory control, vice president and treasurer, and vice president and chief financial officer before being promoted to senior vice president and chief financial officer in 1992. 35. By this Motion, the Debtors seek authority to enter into separate employment agreements (collectively, the "Employment Agreements") with the Key Executives in accordance with the terms set forth in the term sheets annexed hereto as Exhibits A through D (collectively, the "Term Sheets"). The Debtors have requested, pursuant to the Ex Parte Emergency Motion of the Debtors for an Order Pursuant to 11 U.S.C. (S) 107(b) and Fed. R. Bankr. P. 9018 Authorizing the Debtors to File Under Seal Employment Agreement Term Sheets Exhibit to Motion for an Order Pursuant to 11 U.S.C.(S)(S) 105(a) and 363(b) Authorizing the Debtors to Implement a Key Employee Retention Plan, Pay Certain Bonuses and to Execute and 14 Perform Under Employment Agreements with Key Executives, that such Term Sheets be filed under seal because they include confidential commercial information. The Term Sheets set forth confidential information regarding the Key Executives' salary, bonus opportunities, benefits, and severance benefits. The Debtors submit that the employment terms set forth in the Term Sheets are reasonable and consistent with market practices. The Debtors have provided copies of the term sheets to the Committee. 36. The Employment Agreements are necessary in order to ensure that the Key Executives will continue working for the Debtors. If a Key Executive is lost, it will be difficult and expensive to attract an equally qualified replacement and would severely hinder the implementation of the Debtors' restructuring directives. Moreover, the Key Executives provide the strategic vision for the Debtors' businesses. The loss of a Key Executive would cause a substantial disruption to the Debtors' businesses and make it difficult for the Debtors to continue as a going concern. Finally, the loss of a Key Executive would severely impact employee moral and retention. Deterioration in employee moral at this critical time would have an adverse impact on the workforce and the value of the Debtors' assets and business. Basis For Relief 37. Section 363(b)(1) of the Bankruptcy Code permits a debtor in possession to use property of the estate "other than in the ordinary course of business" after notice and a hearing. 11 U.S.C (S) 363(b)(1). Additionally, section 105(a) of the Bankruptcy Code allows this Court to "issue any order, process, or judgment that is necessary or appropriate to carry out the provisions of the [Bankruptcy Code]." 11 U.S.C (S) 105(a). See, e.g., In re Casse, 198 F.3d. 327, 336 (2d Cir. 1999) ("11 U.S.C. (S) 105 is an omnibus provision phrased in such general terms as to be the basis for a broad exercise of power in the administration of a bankruptcy case. The basic 15 purpose of section 105 is to assure the bankruptcy courts power to take whatever action is appropriate or necessary in aid of the exercise of their jurisdiction." (internal citations omitted)). 38. The Debtors respectfully submit that the Debtors have demonstrated a sound business justification for authority to implement the KERP, pay the Separate Bonuses and the Second Half 2002 Incentive Bonuses, and to execute and perform under the Employment Agreements. Such relief can be granted outside the ordinary course of business if the Debtors demonstrate a sound business justification for obtaining it. See In re Lionel Corp., 722 F.2d 1063, 1071 (2d Cir. 1983) (business judgment rule requires a finding that a good business reason exists to grant a debtor's application under section 363(b)). 39. Once the Debtors articulate a valid business justification, "[t]he business judgment rule 'is a presumption that in making a business decision the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action was in the best interests of the company.' " In re Integrated Resources, Inc., 147 B.R. 650, 656 (S.D.N.Y. 1992) (quoting Smith v. Van Gorkom, 488 A.2d 858, 872 (Del. 1985)). 40. The business judgment rule has vitality in chapter 11 cases and shields a debtor's management from judicial second-guessing. Id.; In re Johns-Manville Corp., 60 B.R. 612, 615-16 (Bankr. S.D.N.Y. 1986) ("[T]he Code favors the continued operation of a business by a debtor and a presumption of reasonableness attaches to a Debtor's management decisions."). 41. Given the importance of the Debtors' Key Employees to the Debtors' continued operations, this Court should approve the relief requested herein. Courts in this District and others have recognized the needs of chapter 11 debtors to retain their employees in order to assure continued business functions in chapter 11 and therefore have approved retention, incentive, and severance programs under Bankruptcy Code section 363(b)(1) similar to those 16 proposed herein (each program, of course, being tailored to the needs of particular debtors) as a proper exercise of a debtor's business judgment. See, e.g., In re Global Crossing Ltd., et al., Case Nos. 02-40187 (REG) through 02-40241 (REG) (Bankr S.D.N.Y May 24, 2002) (approving multimillion dollar key employee retention program); In re Enron Corp., et al., Case No. 01-16034 (AJG) (Bankr. S.D.N.Y. May 8, 2002) (approving multimillion dollar key employee retention program and authorizing administrative expense priority for indemnification claims arising from postpetition services of directors and officers); See also In re Montgomery Ward, Case No. Civ A. 98-52 (JJF) (D. Del. Nov. 24, 1999) (discussing bankruptcy court record and noting "in every major case that I have ... we have this type of a program [retention and severance] early on in the case because of the free- fall chapter 11 problems that we have, including the public's perception and creditors, vendors, et cetera's perception of this company"). 42. The Debtors have determined that the costs associated with the adoption of the KERP, Separate Bonuses, Second Half 2002 Incentive Bonuses, and the Employment Agreements are more than justified by the benefits that the Debtors expect to realize from them, including boosting morale and discouraging resignations among Key Employees, as well as incentivizing employees to vigorously assist in preserving and enhancing the value of the Debtors' estates. 43. The proposed relief will enable the Debtors to retain the knowledge, experience and loyalty of the Key Employees who are crucial to the Debtors' reorganization efforts. If Key Employees were to leave their current jobs at this critical point in the Debtors' chapter 11 cases, it is likely that the Debtors would not be able to attract replacement employees of comparable quality, experience, knowledge and character. 17 44. Suitable new employees, even if available, would not have in-depth and historical knowledge of the Debtors' businesses. The time and costs incurred, and the learning curve necessarily involved in hiring replacements for key employees, outweighs the potential costs of payments made under the KERP. 45. In sum, the Debtors have determined in the exercise of their business judgment that it is essential that the managers, supervisors and directors continue to focus their efforts on supporting and maintaining the Debtors' reorganization efforts in the coming months. Accordingly, the Debtors believe that granting the relief requested in this Motion is in the best interests of the Debtors' estates, their creditors, and other interested parties. Notice 46. Notice of this Motion has been provided in accordance with the "Order Pursuant to 11 U.S.C. (S)(S) 102 and 105(a) and (d) and Bankruptcy Rule 2002(m), 9006 and 9007 Establishing Certain Notice, Case Management and Administrative Procedures and Scheduling Initial Case Conference in Accordance with Local Bankruptcy Rule 1007-2(e)" entered by this Court on March 21, 2003. The Debtors submit that, under the circumstances, no other or further notice need be provided. Waiver of Memorandum of Law 47. Given that there are no novel issues of law presented herein and that the legal authority for the relief being sought is set forth herein, the Debtors respectfully request that this Court waive the requirement that the Debtors file a memorandum of law in support of this Motion as provided in Rule 9013-1(b) of the Local Bankruptcy Rules for the United States Bankruptcy Court for the Southern District of New York. 18 No Prior Request 48. No prior motion for the relief sought herein has been made by the Debtors to this or any other court. WHEREFORE the Debtors respectfully request entry of an order granting the relief requested herein and such other or further relief as is just. Dated: New York, New York June 11, 2003 By: /s/ James L. Garrity, Jr. ------------------------------- James L. Garrity, Jr. (JG-8389) Marc B. Hankin (MH-7001) SHEARMAN & STERLING 599 Lexington Avenue New York, New York 10022 Telephone: (212) 848-4000 Facsimile: (212) 848-7179 Attorneys for the Debtors and Debtors in Possession 19 UNITED STATES BANKRUPTCY COURT SOUTHERN DISTRICT OF NEW YORK - ------------------------------------------x : : Chapter 11 : In re: : Case No. 03 - 11540 (CB) : SPIEGEL, INC., et al., : (Jointly Administered) : Debtors. : : : : - ------------------------------------------x ORDER PURSUANT TO 11 U.S.C. (S)(S) 105(a) AND 363(b) AUTHORIZING THE DEBTORS TO IMPLEMENT A KEY EMPLOYEE RETENTION PLAN, TO PAY CERTAIN BONUSES AND TO EXECUTE AND PERFORM UNDER EMPLOYMENT AGREEMENTS WITH CERTAIN KEY EXECUTIVES Upon the motion dated June 11, 2003 (Docket No. 455) (the "Motion") /1/ filed by Spiegel, Inc. ("Spiegel") and certain of its direct and indirect subsidiaries, as debtors and debtors in possession in the above-captioned chapter 11 cases (collectively, the "Debtors"), for an Order authorizing the Debtors to (i) implement a key employee retention plan, (ii) pay certain bonuses, and (iii) execute and perform under employment agreements with four key executives, as described in greater detail in the Motion; and upon the Affidavit of Anne Linsdau, Senior Vice President of Human Resources of Spiegel, in support of the Motion; and it appearing that this Court has jurisdiction to consider the Motion pursuant to 28 U.S.C. (S)(S) 157 and 1334; and it appearing that venue of these cases and this Motion in this district is proper pursuant to 28 U.S.C. (S)(S) 1408 and 1409; and it appearing that this matter is a core proceeding pursuant to 28 U.S.C. (S) 157(b); and it appearing that the relief requested in the Motion is in the best interests of the Debtors, their estates and creditors; and it appearing that notice of the Motion has been given - ---------- /1/ Capitalized terms used herein and not otherwise defined herein shall have the meanings set forth in the Motion. as provided in the Motion, and that no other or further notice need be given; and upon the record herein and after due deliberation thereon; and good and sufficient cause appearing therefor, it is ORDERED, that the Debtors be, and hereby are, authorized and empowered to implement and make payments under the KERP as set forth in the Motion and as modified by this Order, provided that the KERP shall include a separate retention bonus that shall be paid to such employees who were entitled to receive the Second Half 2002 Incentive Bonuses on the same terms and conditions as set forth in the Motion with respect to the Second Half 2002 Incentive Bonuses (the "Separate Retention Bonuses"); and it is further ORDERED, that the Debtors shall only implement and make payments under the KERP pursuant to a written plan document (the "KERP Document") that shall be subject to the prior review and reasonable approval of the Official Committee of Unsecured Creditors appointed in these cases (the "Committee"), which KERP Document shall memorialize the KERP as set forth in the Motion and as modified by this Order; and it is further ORDERED, that the KERP Document shall (i) set forth the mechanisms for payment and the business performance targets for the Performance Incentive Plan, (ii) provide that an employee may only receive a Separate Retention Bonus after having released all prepetition claims against the Debtors in connection with any prepetition bonuses, (iii) provide that the Debtors shall only make a payment to an employee pursuant to the KERP Document after having first determined that such employee is in good standing, in light of current and past performance (including, but not limited to, any actions described in any report submitted by the independent examiner appointed pursuant to the Partial Final Judgment and Order or Permanent Injunction and Other Equitable Relief, dated March 11, 2003, entered by the District Court for the Northern District of Illinois in United States Securities and Exchange Commission v. Spiegel, Inc., Case No. 03C 1685 (the "Independent Examiner Report")) as of the date such 2 payment is to be made (each, a "KERP Payment"), and (iv) provide that the Debtors shall have the discretion to delay making a KERP Payment if, as of the date such payment would otherwise be made pursuant to the KERP Document, the Debtors cannot determine at that time that an employee is in good standing; and it is further ORDERED, that in the event the Debtors and the Committee do not reach agreement with respect to any part of the KERP Document, the Debtors may only implement and make payments governed by such part upon further order of this Court; and it is further ORDERED, that the Debtors shall provide the Office of the United States Trustee (the "U.S. Trustee") and the Committee (collectively, the "KERP Notice Parties") fifteen days' prior written notice of any payment under the Retention Plan or the Performance Incentive Plan to any employee, which notice shall set forth the name and title of each employee, as well as the amount of any such payment (each, a "KERP Notice"), and in the event a KERP Notice Party determines that any such payment to a particular employee described in a KERP Notice is inappropriate, such party shall, at least five days before the payment date set forth in the applicable KERP Notice, provide the Debtors and the other KERP Notice Party a written "Notice of Objection to KERP Payment" setting forth the KERP payments that are the subject of the objection and precise nature of the objection; and it is further ORDERED, that if the Debtors receive a Notice of Objection to KERP Payment, the Debtors will withhold payment of the applicable KERP payment pending consensual resolution of the Notice of Objection to KERP Payment or an order of this Court authorizing the Debtors to make such payment; and it is further ORDERED, that in the event the parties are unable to consensually resolve an objection set forth in a Notice of Objection to KERP Payment, the Debtors may request that this Court separately authorize such payment, and this Order is without prejudice to the rights of 3 either the U.S. Trustee or the Committee to raise any objection with respect to a subsequent request by the Debtors to make a KERP Payment that is the subject of a Notice of Objection to KERP Payment; and it is further ORDERED, that the Debtors be, and hereby are, authorized and empowered to pay the Separate Bonuses as set forth in the Motion; and it is further ORDERED, that the Debtors be, and hereby are, authorized and empowered to execute and perform under separate employment agreements with each of the Key Executives that memorialize the terms and conditions set forth in the revised Term Sheets dated July 11, 2003, provided that such agreements shall be subject to the prior review and reasonable approval of the Committee; and it is further ORDERED, that the provision of Bankruptcy Rule 6004(g) staying the effectiveness of this Order for ten days are hereby waived, and this Order shall be effective immediately upon entry thereof; and it is further ORDERED, that the Court shall retain jurisdiction to hear and determine all matters arising from the implementation of this Order; and it is further ORDERED, that the requirement pursuant to Local Rule 9013-1(b) that the Debtors file a memorandum of law in support of the Motion is hereby waived. Dated: New York, New York July 15,2003 /s/ Cornelius Blackshear ------------------------------ HONORABLE CORNELIUS BLACKSHEAR UNITED STATES BANKRUPTCY JUDGE 4 EX-99.2 4 dex992.txt EMPLOYMENT AGREEMENT EMPLOYMENT AGREEMENT The Employment Agreement ("Agreement") is entered into between Spiegel, Inc., a Delaware corporation ("the Company") and Geralynn Madonna (the "Executive"). WHEREAS, the Company wishes to employ the Executive as the President of Spiegel Catalog, Inc. and Newport News, Inc.; and WHEREAS, the Company and the Executive desire to memorialize the terms of their employment relationship as set forth herein; NOW, THEREFORE, in consideration of the promises and the mutual agreements contained herein, the adequacy and sufficiency of which are hereby acknowledged, the Company and the Executive agree as follows: 1. Employment 1.1 Term. Subject to the approval by the Bankruptcy Court for the Southern District of New York (the "Bankruptcy Court"), the Company hereby employs the Executive and the Executive hereby agrees to be employed by the Company upon the terms and subject to the conditions contained in this Agreement. The Executive's term of employment (the "Term") with the Company shall be for the period commencing as of April 1, 2003 (the "Effective Date") and terminating as of March 31, 2005, unless otherwise terminated pursuant to Articles 3 and 4 of this Agreement. In the event that the Company desires to enter into an employment agreement with the Executive for a period after the Term, Company shall provide the Executive with the proposed employment agreement covering the new term of employment at least six (6) months prior to the last day of the Term. 1.2 Position and Duties. The Executive shall hold the position of President of Spiegel Catalog, Inc. and Newport News, Inc. and shall perform such duties and responsibilities and attain such performance objectives established from time to time. The Executive shall report directly to the Interim Chief Executive Officer of Spiegel Inc. or the Chief Executive Officer of Spiegel Inc. as the case may be (the "Spiegel CEO") or such other individual(s) as designated by the Spiegel CEO (including, without limitation, any designee pursuant to Article 4 of this Agreement). The Spiegel CEO may, in his sole discretion, require the Executive to perform duties and responsibilities on behalf of any of the Company's affiliates. In the event that the Executive shall transfer to an affiliate of the Company, then the Company shall thereafter be defined for the purpose of this Agreement as the name of such affiliate. 1.3 Standard of Care. During the Term, the Executive agrees to devote her attention and energies to the Company's business and shall not engage in any other business activity whether or not such business activity is pursued for gain, profit or other pecuniary advantage unless such business activity is approved by the Spiegel CEO or such other individuals as designated by him. However, subject to approval by the Spiegel CEO, the Executive may serve as a Director of other companies, so long as such service does not conflict with the interests of the Company. 2. Compensation. 2.1 Annual Base Salary. The Executive's annual base salary shall be Seven Hundred Thousand Dollars ($700,000) ("Annual Base Salary") payable in accordance with the Company's regular payroll practices. On each January 1 during the Term thereafter, the Executive's Annual Base Salary shall be reviewed by the Spiegel CEO or his designee, and changes, if any, shall be in his sole discretion. Any change in the Executive's Annual Base Salary shall occur in conjunction with the Company's normal merit review schedule for other officers of the Company. 2.2 Guaranteed Bonus. For the fiscal year ending December 31, 2003, the Executive shall receive a portion of the Incentive Bonus (defined below) in the amount of Five Hundred and Twenty Five Thousand Dollars ($525,000) (the "Guaranteed Bonus") payable at the time such bonuses are paid to the Company's employees generally, provided that, except as set forth in Sections 3.1, 3.3 and 4.3 below, the Executive remains employed by the Company as of the last day of such fiscal year. 2.3 Key Employee Retention Program Participation. Subject to approval of the Key Employee Retention Program (the "KERP") by the Bankruptcy Court the Executive shall be a participant in the KERP attached hereto as Exhibit A. Subject to the terms and conditions of each of this Agreement and the KERP, the Executive shall be eligible to receive a retention bonus in the amount of Four Hundred and Fifty Five Thousand Dollars ($455,000) (the "Retention Bonus") and shall be eligible to earn an incentive bonus in the target amount of Eight Hundred Fifty Seven Thousand Five Hundred Dollars ($857,500) (the "Incentive Bonus") which amount includes the Guaranteed Bonus of $525,000 described in Section 2.2. 2.4 Retirement Benefits. During the Term, the Executive shall be entitled to participate in all qualified and non-qualified retirement programs including, without limitation, the Value in Partnership Profit Sharing and 401(k) Savings Plan (the "VIP") and the Supplemental Executive Retirement Program (the "SERP"), offered to peer level Executives at the Company, subject to the terms and eligibility requirements as defined by each plan as in effect from time to time. 2.5 Employee Benefits and Perquisites. During the Term, the Executive shall be entitled to the benefits provided to peer-level executives of the Company, subject to the terms and eligibility requirements for each such program as in effect from time to time. The Executive shall be entitled to five (5) weeks paid vacation annually. The Executive shall also be eligible for three (3) personal days annually. 2.6 Executive Perquisite Allowance. During the Term, the Executive shall receive an annual allowance of Twenty Thousand Dollars ($20,000) payable in equal installments in accordance with the Company's regular payroll practices. 2.7 Special Bonus. The Executive shall receive a bonus (the "Special Bonus") in the amount of One Hundred Thousand Dollars ($100,000) which shall be paid on August 29, 2003. 2 2.8 Right to Change Plans. Notwithstanding anything in the Agreement to the contrary, the Company in its sole discretion may amend, discontinue, terminate, substitute, or maintain any qualified or non-qualified benefit plan or program. 2.9 Execution of a Release and Settlement Agreement. Executive shall be eligible to receive the additional compensation described in Sections 3.1, 3.3, 3.3, 3.4 and 4.3 only if the Company and Executive execute a mutually satisfactory Release and Settlement Agreement. 3. Notice of Termination of Employment In the event of the Executive's termination of employment with the Company prior to the expiration of the Term, the Executive shall be entitled to receive the payments and benefits (the "Severance Benefits") set forth below in this Article 3 or Article 4. Executive agrees that by accepting any of the Severance Benefits set forth in this Agreement, she waives her right to any severance benefits under any Company policy, plan or procedure. Executive further agrees that acceptance of Severance Benefits under any Section of this Agreement waives Executive's rights to Severance Benefits under any other Section of this Agreement. 3.1 Termination Due to Retirement, Death or Incapacity. If, prior to the expiration of the Term, the Executive's employment is terminated by reason of retirement, death or incapacity (as described below), the Company's obligation under this Agreement shall immediately terminate. Notwithstanding the foregoing, the Company shall be obligated for the following through the effective date of such termination (to the extent that such amounts have not been previously paid): (a) any Annual Base Salary accrued through the effective date of such termination; (b) the Special Bonus (c) the pro rata portion of the Guaranteed Bonus and a pro rata portion of the Incentive Bonus, if any, for the fiscal year in which such termination occurs (less the Guaranteed Bonus); (d) any accrued but unused vacation pay; and (e) all other rights and benefits the Executive is vested in pursuant to other plans and programs of the Company. In the event of the Executive's termination of employment due to Executive's death, her date of termination shall be the date of death. In the event the Executive shall be unable to perform all of the Executive's duties hereunder by reason of illnesses, physical or mental disability or other similar incapacity which inability has continued or could reasonably be expected to continue for more than ninety (90) days, the Company has the right to immediately terminate the Executive's employment. The benefits described in Sections 3.1 (a) and (d) shall be paid in cash to the Executive in a single lump sum as soon as practicable following the effective date of termination. All other payments due to the Executive upon termination of employment shall be paid in accordance with the terms of such applicable plans or programs. With the exception of the covenants contained in Article 6 herein 3 (which shall survive such termination), the Company and the Executive thereafter shall have no further obligations under this Agreement. 3.2 Voluntary Termination by the Executive. The Executive may terminate her employment with the Company at any time by giving the Spiegel CEO, written notice of her intent to terminate, delivered at least three (3) months prior to the effective date of termination. The termination automatically shall become effective upon the expiration of the three (3) month notice period. Notwithstanding the foregoing, the Spiegel CEO may waive the three (3) month notice period; however, the Executive shall be entitled to receive the compensation described in Sections 2.1, 2.4, 2.5 and 2.6 for the three (3) month notice period, subject to the eligibility and participation requirements of such plans and programs. The Executive shall also be entitled to receive the Special Bonus in the event it has not been paid as of the date of such voluntary termination. In the event of a voluntary termination the Executive shall be entitled to all her vested amounts in the VIP and SERP plans, as defined by the vesting schedule in effect at the time of termination. 3.3 Involuntary Termination. At all times during the Term, the Spiegel CEO, or such other individuals as designated by him may terminate the Executive's employment for reasons other than death, incapacity, retirement or for Misconduct by providing to the Executive a Notice of Termination, at least three (3) months prior to the effective date of termination (an "Involuntary Termination"). Such notice of Involuntary Termination shall be irrevocable absent express, mutual consent of the parties. Upon the effective date of an Involuntary Termination, following the expiration of the three (3) month notice period, the Company shall pay or provide the following to the Executive. (a) The amounts set forth in either clause (i) or clause (ii) in this Section 3.3(a) which shall be determined based on the effective date of the Involuntary Termination: (i) in the event the effective date of an Involuntary Termination occurs on or prior to the effective date of a plan of reorganization of the Company, an amount equal to two (2) times the Executive's Annual Base Salary established for the fiscal year in which the effective date of an Involuntary Termination occurs; or (ii) in the event the effective date of an Involuntary Termination occurs following the effective date of a plan of reorganization of the Company, an amount equal to the greater of (x) one times the Executive's Annual Base Salary in effect on the date such Involuntary Termination occurs and (y) the balance of the Annual Base Salary that would have been paid to the Executive if she had remained employed through the remainder of the Term; 4 (b) The following amounts, but only to the extent such amounts have not been paid as of the time of the Involuntary Termination: (i) the Guaranteed Bonus, (ii) the Retention Bonus, (iii) the Special Bonus, and (iv) the pro rata portion of the Incentive Bonus, if any, for the fiscal year in which such termination occurs (less the Guaranteed Bonus). (c) Any accrued but unused vacation through the effective date of termination. (d) All other benefits to which the Executive has a vested right at the time according to the provisions of the governing plan or program, through the effective date of termination. All other benefits shall include Company matching and profit sharing allocations contributed on the Executive's behalf to the VIP and the SERP. In the event of an Involuntary Termination the Executive shall be considered 100% vested in all funds in her VIP and SERP Plans as of the date of termination in accordance with the terms of such plans as in effect from time to time. The benefits described in Sections 3.3 (a)(i) or (ii), and (c) shall be paid in cash to the Executive in a single lump sum as soon as practicable following the effective date of the Involuntary Termination. All other payments due to the Executive upon the Involuntary Termination of employment shall be paid in accordance with the terms of such applicable plans or programs. With the exception of the covenants contained in Article 6 herein (which shall survive such termination), the Company and the Executive thereafter shall have no further obligations under this Agreement. 3.4 Offer of Proposed Employment Agreement. Pursuant to Section 1.1, if Company elects to present to Executive a proposed new employment agreement for a new term (the "Proposed Employment Agreement"), it will be provided to Executive at least six (6) months prior to the end of the Term. In the event that prior to the end of the Term the Company fails to offer the Proposed Employment Agreement within twenty (20) days after receiving written notice from Executive detailing such failure, the Company shall pay the Executive, within thirty (30) days following the expiration of the Term, an amount equal to one (1) times the Executive's Annual Base Salary in effect at such time, provided that the Executive is no longer employed by the Company or any of its affiliates. 3.5 Termination for Misconduct. Nothing in this Agreement shall be construed to prevent the Spiegel CEO, or such other individuals as designated by him from terminating the Executive's employment under this Agreement for Misconduct. In the event the Executive's employment under this Agreement is terminated by the Spiegel CEO, or such other individuals as designated by him for Misconduct, the Company shall pay the Executive her Annual Base Salary and accrued vacation pay pro-rated through the effective date of termination, and the Executive shall immediately thereafter forfeit all rights and benefits (other than vested benefits) she would otherwise have been entitled to receive under this 5 Agreement, including, without limitation, any benefits under Section 2.3 of this Agreement. The Company and the Executive thereafter shall have no further obligations under this Agreement with the exception of the covenants contained in Article 6 herein (which shall survive such termination). "Misconduct" shall mean (i) a breach by the Executive of the duties and responsibilities of the Executive under this Agreement or any breach by the Executive of any term of this Agreement and the continued failure of Executive to cure such breach within ten (10) days after written notice of such breach and demand for performance has been given by the Company to the Executive, (ii) the willful engaging by the Executive in conduct that is injurious to the business, reputation, character, or community standing of the Company or its affiliates, (iii) the engaging by the Executive in dishonest, fraudulent, or unethical conduct or in other conduct involving moral turpitude to the extent that in the reasonable judgment of the Spiegel CEO, or such other individuals as designated by him, the Executive's reputation and credibility no longer conform to the standards expected of the Company's executives, (iv) the Executive's admission, confession, plea bargain to or conviction in a court of law of any crime or offense involving misuse, or misappropriation of money or other property, a felony, fraud or moral turpitude, or (v) a violation of any statutory or common law duty to the Company or its affiliates, including, but not limited to, the duty of loyalty. 4. Change in Control 4.1 Employment Termination Within Twenty Four (24) Months Following a Change in Control of the Company. Under certain circumstances set forth below, Executive shall be entitled to receive from the Company Change in Control ("CIC") Severance Benefits ("CIC Severance Benefits") if there has been a CIC of the Company. 4.2 Qualifying CIC Termination. The occurrence of any one or more of the following events ("Qualifying CIC Termination") within twenty four (24) months following the effective date of a CIC of the Company shall trigger the payment of CIC Severance Benefits: (a) An Involuntary Termination of the Executive's employment evidenced by a Notice of Termination delivered to the Executive; or (b) A resignation by the Executive in the event that the Company or any Successor Company, as defined in Section 5.3, materially breaches any provision of this Agreement and does not cure such breach within (30) days of receiving a written notice from the Executive with such notice explaining in reasonable detail the facts and circumstances claimed to provided a basis for the Executive's claim. 4.3 Severance Benefits Paid upon a Qualifying CIC Termination. In the event of a Qualifying CIC Termination, the Company shall pay or provide the following to the Executive. 6 (a) An amount equal to two (2) times the Executive's Annual Base Salary established for the fiscal year in which the effective date of termination occurs. (b) The following amounts, but only to the extent such amounts have not been paid as of the time of the Qualifying CIC Termination: (i) the Guaranteed Bonus, (ii) the Retention Bonus, (iii) the Special Bonus (iv) the pro rata portion of the Incentive Bonus if any, for the fiscal year in which such termination occurs (less the Guaranteed Bonus). (c) Any accrued but unused vacation through the effective date of termination. (d) All other benefits to which the Executive has a vested right at the time according to the provisions of the governing plan or program, through the effective date of termination. All other benefits shall include Company matching and profit sharing allocations contributed on the Executive's behalf to the VIP and the SERP. In the event of a Qualifying CIC Termination the Executive shall be considered 100% vested in all funds in her VIP and SERP Plans as of the date of termination in accordance with the terms of such plans as in effect from time to time. The benefits described in Sections 4.3 (a), and (c) shall be paid in cash to the Executive in a single lump sum as soon as practicable following the effective date of termination. All other payments due to the Executive upon termination of employment shall be paid in accordance with the terms of such applicable plans or programs. With the exception of the covenants contained in Article 6 herein (which shall survive such termination), the Company and the Executive thereafter shall have no further obligations under this Agreement. 4.4 "Change in Control" or CIC" means the consummation of any of the following events: (a) Any merger or consolidation of the Company with or into another entity; provided that as a result thereof, the owners, as of the Effective Date, of the Company cease to own, directly or indirectly, an aggregate of more than fifty percent (50%) of the outstanding equity ownership of the surviving company; (b) The complete liquidation of the Company; (c) The sale to a third party of the equity ownership in the Company provided that as a result thereof, owners of the Company as of the Effective Date cease to own, directly or indirectly, an aggregate of more than fifty percent (50%) of the outstanding equity ownership of the Company. 7 5. Assignment 5.1 Assignment by the Company. This Agreement may and shall be assigned or transferred to, and shall be binding upon and shall inure to the benefit of any Successor Company. Failure of the Company to obtain the agreement of any Successor Company to be bound by the terms of this Agreement prior to the effective date of any such succession shall be a breach of this Agreement, and shall immediately entitle the Executive, upon her resignation to receive benefits from the Company in the same amount and on the same terms as the Executive would be entitled to receive in the event of an Involuntary Termination as provided in Section 3.3 (failure of assignment not related to a Change in Control) or a Qualifying CIC Termination as provided in Section 4.3 (if failure of assignment follows or is in connection with a Change in Control). Except as herein provided, this Agreement may not otherwise be assigned by the Company. 5.2 Assignment by Executive. This Agreement shall inure to the benefit of and be enforceable by the Executive's personal or legal representatives, executors, administrators, successors, heirs, distributees, devisees, and legatees. If the Executive dies and any amount is owed to him pursuant to this Agreement, all such amounts, unless otherwise provided herein, shall be paid to Executive's beneficiary in accordance with the terms of the Agreement. If the Executive has not named a beneficiary, then such amounts shall be paid to the Executives' devisee, legatee, or other designee, or if there is no such designee, to the Executive's estate. 5.3 Definition of Successor Company. "Successor Company" for purposes of this Agreement is an entity who is a successor (whether direct or indirect, by purchase, merger, consolidation or otherwise) to all or substantially all of the business or assets of the Company. Any such Successor Company shall be deemed substituted for all purposes of the "Company" under the terms of this Agreement. 6. Confidentiality 6.1 Disclosure of Information. The Executive recognizes that he has access to and knowledge of confidential and proprietary information of the Company that is essential to the performance of her duties under this Agreement. The information which the Company regards as confidential and proprietary and/or as trade secrets includes all information, including a formula, pattern, compilation, program, device, method, technique, or process that derives independent economic value, actual or potential, from not being generally known to, and not being readily ascertainable by proper means, by other persons who can obtain economic value, actual or potential, from its disclosure or use. The Executive shall not, during or after her employment by the Company, in whole or in part, disclose such information to any person, firm, corporation, association, or other entity for any reason or purpose whatsoever, nor shall he make use of any such information for her own purposes, so long as such information has not otherwise been disclosed to the public or is not otherwise in the public domain except as required by law or pursuant to administrative or legal process. 8 6.2 Covenants Regarding Other Employees. During the Term, and for a period of twelve (12) months following the Executive's termination of employment for any reason, the Executive agrees not to actively solicit directly or indirectly any exempt, supervisory and/or management (as such terms are defined under the Fair Labor Standards Act) employee ("Prohibited Employee") of the Company to terminate his or her employment with the Company or to interfere in a similar manner with the business of the Company. For each breach of this provision by Executive, in addition to the rights and remedies available to the Company as provided in this Agreement, Executive hereby agrees to pay the Company, not as a penalty but as liquidated damages to reimburse the Company for training and recruiting costs incurred in replacing such Prohibited Employee, a sum equal to fifty percent (50%) of the employee's annual salary as of the date of the Prohibited Employee's termination of employment with the Company. 6.3. Non-Competition. During the period beginning on the Effective Date and ending on the first anniversary of the cessation of the employment of the Executive for any reason whatsoever (the "Restricted Period"), the Executive shall not (i) engage, directly or indirectly, in any business anywhere in the world that directly and primarily produces or supplies services or products of the kind produced or supplied by the Company and its subsidiaries and affiliates (collectively, the "Company Group") or (ii) directly or indirectly own an interest in, manage, operate, join or Control (as defined below), lend money or render financial or other assistance to or participate in or be connected with as an officer, employee, partner, shareholder, consultant or otherwise of any person or company that directly and primarily competes with the Company Group in producing or supplying services or products of the kind produced or supplied by the Company Group as of the Date of Termination; provided, however, that, for the purposes of this Section 6.3, ownership of securities having no more than one percent of the outstanding voting power of any competitor, and that are listed on any national securities exchange or traded actively in the national over-the-counter market shall not be deemed to be in violation of this Section 6.3 so long as the Executive has no other connection or relationship with such competitor. For purposes of this Section 6.3, the term "Control," as used with respect to any person or company, means the possession, direct or indirect, of the power to direct or cause the direction of the management and policies of such person or company, whether through the ownership of voting securities, by contract or otherwise. 7. Miscellaneous 7.1 Indemnity Protection. In the event that the Executive is personally named in a lawsuit in connection with the services he provides to the Company under this Agreement, the Company shall indemnify the Executive provided that the Executive cooperates in defense of such matter, and that at all times the Executive acted within the scope of her job responsibilities and authority. Notwithstanding the foregoing, the Executive shall have no right of indemnification should a subsequent discovery or a factual determination disclose that the Executive's actions were inconsistent with the foregoing conditions. 7.2 Payment of Legal Fees. Neither the Company nor the Executive shall pay or seek payment of any of the legal fees or other expenses incurred by the other 9 party as a result of any dispute between the parties regarding the validity, enforceability, or interpretation of this Agreement. 7.3 Notices. Any notice or request required or permitted to be given hereunder shall be sufficient if given in writing and delivered personally or sent by registered mail, return receipt requested, as follows: (a) if to the Executive, to her address as set forth in the records of the Company, and (b) if to the Company, to the attention of the Vice President-Human Resources of the Company with a copy to the General Counsel, Spiegel, Inc. Either party may designate a different address for delivery of notices in accordance with this Section 7.4. Such notice of a different address for delivery of notices shall be deemed to have been given upon the personal delivery or mailing thereof, as the case may be. 7.4 No Further Benefits. In the event the Executive is entitled to receive any Severance Benefits or any CIC Severance Benefits under this Agreement, he shall not be entitled to any payment or benefit under any other severance plan, program, agreement or similar arrangement of the Company or any of its affiliates. 7.5 Entire Agreement. This Agreement and the KERP supersedes any prior agreements or understandings, oral or written, between the parties hereto or between the Executive and the parties hereto, with respect to the subject matter hereof, and constitutes the entire agreement of the parties with respect thereto. 7.6 Modification. This Agreement shall not be varied, altered, modified, canceled, changed, or in any way amended except by mutual agreement of the parties in a written instrument executed by the parties hereto or their legal representatives. 7.7 Severability. In the event that any provision or portion of this Agreement shall be determined to be invalid or unenforceable for any reason, the remaining provisions of this Agreement shall be unaffected thereby and shall remain in full force and effect. 7.8 Counterparts. This Agreement may be executed in two or more counterparts, each of which shall be deemed an original but all of which together shall constitute one and the same instrument. 7.9 Governing Law. To the extent not preempted by federal law, the provisions of the Agreement shall be construed and enforced in accordance with the laws of the State of Illinois. 10 IN WITNESS WHEREOF, this Agreement shall become effective as of the first day of the Term upon receipt and execution by the Company of two originals of this Agreement duly executed by the Executive. Spiegel, Inc. Executive By: /s/ Anne Linsdau /s/ Geralynn Madonna ------------------------- ---------------------------------- Title: SVP Human Resources Geralynn Madonna Date: 7/17/03 Date: 7/25/03 11 -----END PRIVACY-ENHANCED MESSAGE-----