-----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, RQqTqLQ3j07PnVusg76i3jEuu1EEI8aKvShWbvsyJWdil0RO9UGsFx2J/YpP6H8x 0IqOYtAYRfYbvmbEK1zsGw== 0000950144-00-003244.txt : 20000317 0000950144-00-003244.hdr.sgml : 20000317 ACCESSION NUMBER: 0000950144-00-003244 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 20000102 FILED AS OF DATE: 20000316 FILER: COMPANY DATA: COMPANY CONFORMED NAME: SERVICE MERCHANDISE CO INC CENTRAL INDEX KEY: 0000089107 STANDARD INDUSTRIAL CLASSIFICATION: RETAIL-MISC GENERAL MERCHANDISE STORES [5399] IRS NUMBER: 620816060 STATE OF INCORPORATION: TN FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 001-09223 FILM NUMBER: 570915 BUSINESS ADDRESS: STREET 1: 7100 SERVICE MERCHANDISE DR CITY: BRENTWOOD STATE: TN ZIP: 37027 BUSINESS PHONE: 6156606000 MAIL ADDRESS: STREET 1: PO BOX 24600 CITY: NASHVILLE STATE: TN ZIP: 37202 10-K405 1 SERVICE MERCHANDISE COMPANY, INC 1 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------ FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED JANUARY 2, 2000. COMMISSION FILE NO. 1-9223 SERVICE MERCHANDISE COMPANY, INC. (DEBTORS-IN-POSSESSION AS OF MARCH 27, 1999) (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) TENNESSEE 62-0816060 (STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.) P.O. BOX 24600, NASHVILLE, TN (MAILING ADDRESS) 37202-4600 7100 SERVICE MERCHANDISE DRIVE, BRENTWOOD, TN (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER INCLUDING AREA CODE: (615) 660-6000 SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: NONE SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: COMMON STOCK ($.50 PAR VALUE) SERIES A JUNIOR PREFERRED STOCK PURCHASE RIGHTS 9% SENIOR SUBORDINATED DEBENTURES 8 3/8% SENIOR NOTES Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ]. Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] As of February 27, 2000, there were outstanding 99,976,123 shares of the Registrant's common stock, $.50 par value (the "Common Stock"). The aggregate market value of the Common Stock held by non-affiliates on February 27, 2000 (based upon the average of the high and low sales prices of such stock as of such date) was $13,250,644. This calculation assumes that all shares of Common Stock beneficially held by officers and members of the Board of Directors of the Registrant are owned by "affiliates," a status which each of the officers and directors may individually disclaim. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 2 TABLE OF CONTENTS
PAGE NO. ---- PART I...................................................................... 2 Item 1. Business.................................................... 2 Item 2. Properties.................................................. 7 Item 3. Legal Proceedings........................................... 10 Item 4. Submission of Matters to a Vote of Security Holders......... 11 PART II..................................................................... 11 Item 5. Market for the Registrant's Common Stock and Related Stockholder Matters....................................... 11 Item 6. Selected Financial Data..................................... 12 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations................................. 13 Item 7A. Quantitative and Qualitative Disclosures about Market Risk...................................................... 28 Item 8. Financial Statements and Supplementary Data................. 29 Item 9. Changes in and Disagreements With Independent Auditors on Accounting and Financial Disclosure....................... 63 PART III.................................................................... 63 Item 10. Directors and Executive Officers of the Registrant.......... 63 Item 11. Executive Compensation...................................... 65 Item 12. Security Ownership of Certain Beneficial Owners and Management................................................ 71 Item 13. Certain Relationships and Related Transactions.............. 73 PART IV..................................................................... 73 Item 14. Exhibits, Financial Statement Schedule, and Reports on Form 8-K....................................................... 73
1 3 PART I Except where the context indicates otherwise, the "Company" means Service Merchandise Company, Inc. and its subsidiaries and the "Registrant" means Service Merchandise Company, Inc. without reference to its subsidiaries. ITEM 1. BUSINESS The Company, with 223 stores in 32 states at January 2, 2000, is one of the nation's largest retailers of jewelry and offers a selection of brand-name hard goods and other product lines. During the year ended January 2, 2000 ("fiscal 1999"), the Company repositioned its product offerings to focus on value pricing and a broad selection of jewelry and hard good products. These remerchandising efforts were based on perceived customer expectations of entry level price points and a large selection within each product assortment. The Company also revised its media strategy during fiscal 1999 to employ TV, radio and print (including a seasonal sourcebook) campaigns in a coordinated effort to build awareness, prospect for new customers and drive customer traffic. On February 21, 2000, the Company's Board of Directors approved its 2000 Business Plan. Key components of the 2000 Business Plan include exiting certain unprofitable hardlines categories, including toys, juvenile, sporting goods, most consumer electronics and most indoor furniture. As part of the 2000 Business Plan, the Company plans to eliminate between 5,000 and 6,000 positions in stages during 2000 and 2001, including approximately 350 distribution center and 200 corporate positions. The Company announced an initiative to reformat its existing stores as part of the 2000 Business Plan, which would result in excess store space becoming available for subleasing or other real estate transactions. Another important element to the Company's strategy is the convergence of the Internet and store selling environments. Each store will feature Internet kiosks that will provide immediate access to the Company's web site, www.servicemerchandise.com, its bridal and gift registry, and its store directory. The Company also stated that the plan or plans of reorganization currently being considered involve a debt conversion of the Company's prepetition unsecured claims into new common equity of the reorganized Company. Under such circumstances the existing common stock of the Company would be cancelled and would result in existing holders of the common stock receiving no value for their interests. The Company believes the value of the common stock is highly speculative since it is highly probable that it will be cancelled, and therefore, worthless if the expected plan of reorganization is consummated. As a result of the Company's decreased net sales in the fourth quarter of fiscal 1998 and the resulting negative cash flows from operations, in January 1999 the Company began an effort to effect an out-of-court restructuring plan. As part of this out-of-court restructuring plan, on January 20, 1999, the Company entered into a new credit facility with Citibank N.A. (the "Second Amended and Restated Credit Facility"). The Company also developed a plan to close up to 132 stores, up to four distribution centers and to reduce corporate overhead (the "Rationalization Plan"). In March 1999, as part of the Rationalization Plan, the Company announced the closing of the Dallas distribution center and the reduction of its workforce at its Nashville corporate offices by 150 employees. PROCEEDINGS UNDER CHAPTER 11 OF THE BANKRUPTCY CODE Before the Company was able to effect an out-of-court restructuring, on March 15, 1999, five of the Company's vendors filed an involuntary petition for reorganization under Chapter 11 ("Chapter 11") of title 11 of the United States Bankruptcy Code (the "Bankruptcy Code") in the United States Bankruptcy Court for the Middle District of Tennessee (the "Bankruptcy Court") seeking court supervision of the Company's restructuring efforts. On March 27, 1999, the Company and 31 of its subsidiaries (collectively, the "Debtors") filed voluntary petitions with the Bankruptcy Court for reorganization under Chapter 11 under case numbers 399-02649 through 399-02680 (the "Chapter 11 Cases") and orders for relief were entered by the Bankruptcy Court. The Chapter 11 Cases have been consolidated for the purpose of joint administration under Case No. 399-02649. The Debtors are currently operating their businesses as debtors-in-possession pursuant to the Bankruptcy Code. 2 4 Actions to collect pre-petition indebtedness are stayed and other contractual obligations against the Debtors may not be enforced. In addition, under the Bankruptcy Code, the Debtors may assume or reject executory contracts, including lease obligations. Parties affected by these rejections may file claims with the Bankruptcy Court in accordance with the reorganization process. Substantially all pre-petition liabilities are subject to settlement under a plan of reorganization to be voted upon by creditors and equity holders and approved by the Bankruptcy Court. Although the Debtors expect to file a reorganization plan or plans that provide for emergence from bankruptcy in 2001, there can be no assurance that a reorganization plan or plans will be proposed by the Debtors or confirmed by the Bankruptcy Court, or that any such plan(s) will be consummated. As provided by the Bankruptcy Code, the Debtors initially had the exclusive right to submit a plan of reorganization for 120 days. On May 25, 1999, the Bankruptcy Court extended the period in which the Company had the exclusive right to file or advance a plan of reorganization to February 29, 2000. On February 2, 2000, the Bankruptcy Court extended the period in which the Company has the exclusive right to file or advance a plan of reorganization to April 30, 2001 and extended the right to solicit acceptance of its plan to June 30, 2001. If the Debtors fail to file a plan of reorganization during such period or if such plan is not accepted by the required number of creditors and equity holders, any party in interest may subsequently file its own plan of reorganization for the Debtors. A plan of reorganization must be confirmed by the Bankruptcy Court, upon certain findings being made by the Bankruptcy Court which are required by the Bankruptcy Code. The Bankruptcy Court may confirm a plan notwithstanding the non-acceptance of the plan by an impaired class of creditors or equity security holders if certain requirements of the Bankruptcy Code are met. The plan or plans currently being considered by the Company involve a debt conversion of the Company's prepetition unsecured claims into new common equity of the reorganized Company. Under such circumstances the existing common stock of the Company would be cancelled and would result in existing holders of the common stock receiving no value for their interests. The Company believes the value of the common stock is highly speculative since it is highly probable that it will be cancelled, and therefore, worthless if the expected plan of reorganization is consummated. At the first day hearing held on March 29, 1999 before Judge George C. Paine, the Bankruptcy Court entered first day orders granting authority to the Debtors, among other things, to pay pre-petition and post-petition employee wages, salaries, benefits and other employee obligations, to pay vendors and other providers in the ordinary course for goods and services received from and after March 15, 1999, and to honor customer service programs, including warranties, returns, layaways and gift certificates. The Company entered into an agreement dated March 29, 1999 with Citicorp USA, Inc., as administrative agent, BankBoston, N.A. as documentation agent and collateral monitoring agent, and Salomon Smith Barney Inc. as sole arranger and book manager, for a debtor-in-possession credit facility (the "DIP Facility") under which the Company may borrow up to $750.0 million, subject to certain limitations, to fund ongoing working capital needs while it prepares a reorganization plan. On April 27, 1999, the Bankruptcy Court approved the DIP Facility. The DIP Facility includes $100.0 million in term loans and a maximum of $650.0 million in revolving loans. The DIP Facility includes a $200.0 million sub-facility for standby and trade letters of credit. Interest rates on the DIP Facility are based on either the Citibank N.A. Alternative Base Rate plus 1.25% for ABR Loans or 2.25% over LIBOR for Eurodollar Loans. The DIP Facility is secured by substantially all of the assets of the Company and its subsidiaries, subject only to valid, enforceable, subsisting and non-voidable liens of record as of the date of commencement of the Chapter 11 Cases and other liens permitted under the DIP Facility. Borrowings under the DIP Facility are limited based on a borrowing base formula which considers eligible inventories, eligible accounts receivable, trade letters of credit and mortgage values on eligible real properties, eligible leasehold interests, available cash equivalents and in-transit cash. Borrowing availability under the DIP Facility continues unless the Company breaches both the minimum EBITDA and minimum availability covenants as defined in the DIP Facility. On June 10, 1999, the Company filed with the Bankruptcy Court schedules and statements of financial affairs setting forth, among other things, the assets and liabilities of the Company as shown by the Company's books and records, subject to the assumptions contained in certain global notes filed in connection therewith. Certain of the schedules were amended on March 6, 2000 and all of the schedules and statements of financial 3 5 affairs are subject to further amendment or modification. Pursuant to order of the Bankruptcy Court, on or about March 15, 2000, the Company will mail notice to all known creditors that the deadline for filing proofs of claim with the Bankruptcy Court is May 15, 2000. Differences between amounts scheduled by the Company and claims by creditors will be investigated and resolved in connection with the Company's claims resolution process. That process will not commence until after the May 15, 2000, bar date 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 is not presently known and, because the settlement terms of such allowed claims is subject to a confirmed plan of reorganization, the ultimate distribution with respect to allowed claims is not presently ascertainable. The Company has filed over 200 motions in the Chapter 11 Cases whereby it was granted authority or approval with respect to various items required by the Bankruptcy Code and/or necessary for the Company's reorganizational efforts. In addition to motions pertaining to real estate disposition matters, the Company has obtained orders providing for, among other things, (i) implementation of employee retention and incentive programs, (ii) termination or suspension of certain employee benefit programs, (iii) adequate protection to certain secured creditors, (iv) implementation of a return to vendor program and other vendor related programs, (v) the sale of the assets of B.A. Pargh., and (vi) the extension of time to assume or reject leases. 2000 BUSINESS PLAN On February 21, 2000, the Company's Board of Directors approved its 2000 Business Plan, which includes the following components: (i) an expansion of jewelry and jewelry related products; (ii) a more targeted selection of those categories that have historically performed well and have an affinity to jewelry, and an exit from certain unprofitable hardlines categories; (iii) the convergence of the Company's in-store and Internet environment; (iv) the reduction of selling and warehouse spaces within the Company's stores to adjust for the new merchandise mix, which allows for the subleasing of excess space; and (v) the rationalization of the Company's overhead structure, logistics network and stores/field organization to generate anticipated cost savings. The execution and success of the 2000 Business Plan is subject to numerous risks and uncertainties. See "Management Discussion and Analysis of Financial Condition and Results of Operations -- Safe Harbor Statement Under the Private Securities Litigation Reform Act of 1995." Pursuant to the 2000 Business Plan, the Company will feature an expanded offering of jewelry and jewelry-related products, with the bulk of the expansion in diamonds. In addition to jewelry, the Company will focus on hardlines categories that have performed well and which generate cross-selling opportunities with jewelry. The Company will exit certain unprofitable categories, including toys, most electronics and sporting goods. As a MULTI-CHANNEL SPECIALTY RETAILER, the Company has included as part of the 2000 Business Plan the planned convergence of the Internet and store selling environments. Each store will feature Internet kiosks that will provide immediate access to the Company's web site, www.servicemerchandise.com, its bridal and gift registry and its store directory. The Company's stores will be reconfigured to feature less overall selling square footage (approximately 18,000 square feet as compared to 27,000 square feet), but increased square footage for jewelry. The excess store space will be available for sub-leasing or other real estate transactions. Seventy stores are scheduled for total refurbishment and upgrade to an expanded jewelry selling area in 2000 while the balance will undergo a more limited capital improvement remodel during 2000. Another 83 stores are scheduled for total refurbishment in 2001. Although the Company plans to continue operating substantially all of its 221 stores, in 2000 it will close its distribution centers in Montgomery, New York and Orlando, Florida. As part of the 2000 Business Plan, the Company will reduce its workforce at its corporate offices, its distribution centers and throughout the stores organization resulting in the elimination of 5,000 to 6,000 positions. To fund the 2000 Business Plan, as well as future operations, and in anticipation of emergence from Chapter 11 in 2001, the Company has obtained a commitment from Fleet Retail Finance Inc. ("Fleet") for a new four year $600.0 million credit facility which includes a commitment for post reorganization financing 4 6 (the "DIP to Exit Facility"). The DIP to Exit Facility, which will be agented by Fleet and fully underwritten by FleetBoston Robertson Stephens, is subject to approval by the Bankruptcy Court and, if approved, is intended to replace the DIP Facility. The commitment provides that the DIP to Exit Facility will be structured as a $600.0 million revolver, although Fleet has reserved the right to allocate up to $85.0 million to a term loan prior to closing. The DIP to Exit Facility commitment also includes a $150.0 million letter of credit subfacility and permits subordinated secured financing in amounts up to an additional $50.0 million on terms reasonably satisfactory to Fleet. The DIP to Exit Facility requires superpriority claim status and a first priority security interest in all assets subject to existing liens, and contains certain other customary priority provisions. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources." At this time, it is not possible to predict the outcome of the Chapter 11 Cases or their effect on the Company's business. Reference is made to Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations," Note B of Notes to Consolidated Financial Statements, and the Report of Independent Auditors included herein which includes an explanatory paragraph concerning a substantial doubt as to the Company's ability to continue as a going concern. GENERAL The Company is one of the nation's largest retailers of jewelry and offers a selection of brand-name hard goods and other product lines. Product offerings are marketed to customers primarily through direct mail flyers, newspaper inserts, radio and television advertising. While customers may purchase products through mail order, telephone order or via the Company's Internet web site, www.servicemerchandise.com, the majority of purchases occur directly in a Company store. The typical store currently consists of approximately 50,000 square feet of total space (approximately 27,000 square feet selling space and 23,000 square feet warehouse space) and is situated on a stand-alone lot or as an anchor in a suburban mall or strip center. The Company operated seven Service Select stores at January 2, 2000, an 11,000 - 14,000 square foot format that carries a full line of jewelry and an edited assortment of hardlines. Two of the Service Select stores were closed in January of 2000. The Company's stores are divided into thematic product categories. In the Fine Jewelry department, merchandise is displayed mostly in showcases. In certain other departments, a sample of the merchandise is displayed, and customers select their purchases via a "pull tag" system. The pull tag is taken to a cashier, the product is paid for and the merchandise is delivered to a pick-up station. In self-service departments, customers select merchandise from a shelf or display and take it to a checkout counter to complete the purchase. In fiscal 1998, the Company transitioned from a showroom retailer to a bulked out, self-service retailer. Except for certain electronics, large fitness equipment and jewelry, almost all product categories may now be shopped on a self-service basis. In 1999, the Company negotiated a contract with Household Retail Services who provided a new private label credit card program. The Bankruptcy Court approved the new credit card program on August 10, 1999. This program was introduced to all stores on September 20, 1999 and all accounts required a new application. None of the previous private label accounts owned by World Financial Network National Bank were converted to the new private label credit card program. The credit card program does not provide the Company any participation in the earnings of the receivables portfolio, but it does provide an additional method of payment for customers and therefore helps generate incremental sales. Virtually every transaction in the store that involves payment, customer information or inventory is recorded and transmitted, on a daily basis, via satellite to a central information system at the Company's corporate offices. In addition, by using the computer, customers may be provided with suggested alternative items, back-order information, online mail orders, gift registry, special orders and layaway information. The Company's computerized daily inventory system tracks the status (on hand, on order, or in transit), location and history of inventory in the retail network. The raw data is used in the Company's inventory replenishment system which tracks inventory positions, sales data and sales forecasts and generates either 5 7 suggested transfers from distribution centers or suggested purchase order quantities. The inventory system also records all sales information to produce daily margin reports with historical comparisons. The Company's information systems track customers' purchases and facilitate tailoring the Company's mailing lists to meet specific objectives. The Company maintains a household database of information on over 24 million households that is updated with each purchase. This database allows the Company to target customers based on specific criteria, including the categories purchased, the frequency of purchases and the value of those purchases. SEASONALITY AND COMPETITION The Company's business is highly seasonal, with the Christmas season being the largest volume-selling period of the year. In preparation for the Christmas season, the Company significantly increases its merchandise inventories, which traditionally have been financed by internally generated funds, short-term borrowings, and terms from vendors. The Company's profitability and cash flows are primarily dependent upon the large sales volume generated during the fourth quarter of its fiscal year. Fourth quarter net sales accounted for 37.4% of total net sales in fiscal 1999. The Company is engaged in a highly competitive business and competes with most nationally known jewelry and general retail merchandisers including department, general merchandise, specialty and discount stores. Many of these competitors are larger and have greater financial resources than the Company. The Company considers quality, value, merchandise mix, service, quality of shopping experience and location to be the most significant competitive factors in its retailing business. SUPPLIERS The Company purchases merchandise from approximately 1,550 suppliers, most of which are manufacturers. Generally, most merchandise is shipped to the Company's regional distribution centers and transported to the stores by commercial contract carriers. In fiscal 1999, the largest vendor accounted for approximately 5.7% of total cash disbursements for inventory items. On January 27, 1999, the Company announced that it had suspended payment on unpaid invoices for goods shipped prior to January 8, 1999, totaling approximately $200.0 million related to trade payables for merchandise from vendors. The Company also announced its intent to pay on a current basis invoices for goods shipped after January 8, 1999. Prior to the filing of the Chapter 11 Cases, the Company's ability to purchase merchandise was adversely affected by its lack of cash reserves and the Company's deteriorating financial performance. Certain vendors refused to ship merchandise to the Company or would only ship on a cash in advance basis. As a result of the Chapter 11 Cases and the DIP Facility, the Company now pays its suppliers for merchandise received post-petition. The Company believes its ability to acquire merchandise from its suppliers is adequate to supply its business needs. As of January 2, 2000, accounts payable totaled $67.3 million, with 62.1% of the Company's $1.45 billion of merchandise orders purchased on terms. The Company's direct import program is responsible for sourcing and repackaging many promotional and seasonal items. Direct import purchases, which totaled approximately $211.8 million in fiscal 1999, allow the Company to reduce many traditional cost factors, thereby lowering the cost of merchandise sold in several product lines. EMPLOYEES The number of persons employed by the Company fluctuates seasonally. During fiscal 1999, the number of active employees varied from approximately 15,000 to approximately 39,000 including part-time, full-time, and temporary employees. As of January 2, 2000, the Company had approximately 26,000 part-time, full-time, and temporary employees, of whom 91.5% were hourly-paid personnel engaged in non-supervisory activities; the balance consisted of administrative, executive, distribution center and store management personnel. In February 2000, the Company began a program to reduce its workforce by 5,000 to 6,000 positions as part of its 2000 Business Plan. See "Business -- 2000 Business Plan." 6 8 None of the Company's employees are covered by a collective bargaining agreement. The Company has never experienced a work stoppage due to a labor disagreement. The Company has experienced a material loss of its workforce primarily due to the uncertainty surrounding the Company's deteriorating financial condition and as a result of the filing of the Chapter 11 Cases. The Company has implemented an employee retention plan, approved by the Bankruptcy Court, which the Company believes has enhanced its ability to retain employees. ITEM 2. PROPERTIES The Company leases and owns retail store facilities, warehouses and office space. The Company has financed a number of its owned facilities out of internally generated funds. Some owned facilities have ground leases on a long-term basis and others are financed by real estate mortgages. The Company's office is located in Brentwood, Tennessee, and is owned by the Company. During 1999, the Company implemented a comprehensive review and analysis of its store operations and determined to close approximately 1/3 of its stores. To assist in the disposition of the real estate interests associated with the closed locations, the Company engaged professional appraisers as well as real estate consultants and brokers. The Company received bids on 77 of the 102 properties offered for sale for an aggregate gross purchase price of approximately $78.8 million. The sale of those properties was approved by the Bankruptcy Court on July 14, 1999. The Company has announced certain strategic real estate initiatives as part of its 2000 Business Plan. See "Business -- 2000 Business Plan." DISTRIBUTION CENTERS The Company operated four distribution centers and one return center (Bowling Green, Kentucky) as of January 2, 2000. These distribution centers are located in Florida, New York, and Tennessee, and contain an aggregate of approximately 2,116,000 square feet as set forth below:
CENTER LOCATION SQ. FEET OWNED/LEASED LEASE TERM - --------------- -------- ------------ --------------------------- Orlando, FL................ 460,000 Leased Primary term extends through 6/30/00 with renewal options through 6/30/22 Montgomery, NY............. 800,000 Owned Primary term extends through 12/31/24 Nashville, TN (1) Owned................ 588,000 Owned Not applicable (2) Owned satellite...... 268,000 Owned Not applicable Bowling Green, KY (Return Center).................. 180,000 Leased Primary term extends through 12/31/00 with renewal options through 12/31/25
The Company has satisfied its obligation under the sale/leaseback for the Montgomery, NY distribution center. The transfer of this property from the industrial development authority to the Company is currently pending. As part of its 2000 Business Plan, the Company intends to close its Montgomery, New York, and Orlando, Florida distribution centers and to consolidate its logistics operations in its Nashville, Tennessee regional distribution center. 7 9 RETAIL STORES As of January 2, 2000, the Company operated 223 retail stores (typically consisting of approximately 50,000 square feet) as follows:
NUMBER OF STORES --------- Owned land and building..................................... 71 Long-term ground lease with an owned building............... 29 Leased...................................................... 148 Stores which have been subleased............................ (1) Properties available for sale............................... (24) --- Total....................................................... 223 ===
Most of the leases contain renewal or purchase options. See Note I of Notes to Consolidated Financial Statements for information concerning the Company's lease commitments. As part of its 2000 Business Plan, the Company intends to reformat certain of its stores and to sublease certain excess space in certain of its reformatted stores. See "Business -- 2000 Business Plan." 8 10 SERVICE MERCHANDISE COMPANY, INC. STORE LOCATIONS The numbers in parentheses show the number of stores per state and where there is more than one store in any city, the number of stores in such city as of fiscal year-end. As of January 2, 2000 the Company operated 223 stores in 32 states. As of February 27, 2000, the Company operates 221 stores in 32 states: ALABAMA (6) Birmingham (2) Huntsville Mobile Montgomery Tuscaloosa ARIZONA (3) Glendale Mesa (2) ARKANSAS (1) Little Rock CALIFORNIA (2) San Francisco San Jose CONNECTICUT (5) Danbury Derby Manchester Newington Orange DELAWARE (3) Dover Wilmington (2) FLORIDA (42) Altamonte Springs Boca Raton Boynton Beach Bradenton Brandon Casselberry Coral Springs Daytona Beach Fort Myers Hollywood Jacksonville (2) Kissimmee Lakeland Largo Leesburg Miami (2) N. Clearwater N. Miami Naples Ocala Orange Park Orlando (3) Pembroke Pines Pensacola Pompano Beach Port Charlotte Port Richie Sanford Sarasota Spring Hill St. Petersburg Stuart Sunrise Tallahassee Tampa (2) W. Melbourne W. Palm Beach GEORGIA (12) Alpharetta Augusta Columbus Decatur Douglasville Duluth Kennesaw Macon Morrow Savannah Smyrna Tucker ILLINOIS (18) Arlington Heights Berwyn Bloomingdale Burbank Crystal Lake Downers Grove (2) Joliet Lansing Matteson Naperville Niles Norridge Oaklawn Orland Park Schaumburg Skokie Waukegan INDIANA (10) Castleton Clarksville Evansville Fort Wayne Greenwood Indianapolis (2) Lake Merrillville Mishawaka KANSAS (1) Overland Park KENTUCKY (6) Florence Lexington Louisville (2) Owensboro Paducah LOUISIANA (9) Baton Rouge Bossier City Harvey Houma Lafayette Metarie Monroe Shreveport Slidell MAINE (2) Augusta S. Portland MARYLAND (2) Baltimore Columbia MASSACHUSETTS (6) Auburn Burlington Natick Saugus Stoughton Swansea MICHIGAN (6) Novi Roseville Southgate Sterling Heights Troy Westland MISSISSIPPI (3) Gulfport Hattiesburg Jackson MISSOURI (4) Crestwood Florissant Springfield St. Peters NEVADA (1) Las Vegas NEW HAMPSHIRE (5) Dover Manchester Nashua Plaistow Salem NEW JERSEY (3) Hazlet Paramus Wayne NEW YORK (6) Hartsdale Lake Grove Middletown Patchoque Poughkeepsie Woodhaven NORTH CAROLINA (7) Cary Charlotte Fayetteville Gastonia Greensboro Pineville Raleigh OHIO (4) Cincinnati (3) Springdale OKLAHOMA (3) Oklahoma City Tulsa Warr Acres PENNSYLVANIA (6) Allentown Greensburg Harrisburg Lancaster Reading Wilkes-Barre SOUTH CAROLINA (3) Columbia Greenville N. Charleston TENNESSEE (10) Antioch Chattanooga Cookeville Franklin Jackson Johnson City Knoxville Madison Memphis (2) TEXAS (26) Arlington Austin Baytown Beaumont Dallas Fort Worth Harlingen Houston (7) Lake Jackson Laredo Lewisville Longview McAllen Mesquite N. Richland Hills Plano Richardson San Antonio Sugar Land Tyler VERMONT (1) Burlington VIRGINIA (5) Chantilly Chesapeake Fredericksburg Glen Allen Midlothian 9 11 ITEM 3. LEGAL PROCEEDINGS On March 15, 1999, five of the Company's vendors filed an involuntary petition for reorganization under Chapter 11 in the Bankruptcy Court seeking court supervision of the Company's restructuring efforts. On March 27, 1999, the Company and 31 of its subsidiaries filed voluntary petitions with the Bankruptcy Court for reorganization under Chapter 11 of the Bankruptcy Code. The Debtors are currently operating their businesses as debtors-in-possession. The Chapter 11 Cases have been consolidated for the purpose of joint administration under Case No. 399-02649. On January 28, 1997, the Company and Service Credit Corp. (the "Subsidiary"), a wholly-owned subsidiary, entered into an agreement with World Financial Network National Bank ("WFNNB") for the purpose of providing a private label credit card to the Company's customers. The contract requires the Subsidiary to maintain a 3.0% credit risk reserve for the outstanding balances, which are owned by WFNNB. The purpose of this reserve is to offset future potential negative spreads and portfolio losses. The negative spreads or losses may result from potential increased reimbursable contractual program costs. The 3.0% credit risk reserve is held by the Subsidiary, which is not in Chapter 11, in the form of cash and cash-equivalents. On April 28, 1999, WFNNB advised the Company that WFNNB has projected that such portfolio losses and negative spreads will be at least approximately $9.0 million. The Company does not have in its possession sufficient information to determine the accuracy or validity of WFNNB's projection. Pending confirmation of the accuracy of WFNNB's projection and a resolution of the Company's rights and remedies, the Company has made provision for such potential liability during fiscal 1999 by maintaining an allowance on the 3.0% credit risk reserve of $9.0 million. On July 16, 1999, the Company filed a complaint against WFNNB in the Bankruptcy Court alleging, among other things, breach of contract and violation of the automatic stay provisions of the Bankruptcy Code by WFNNB with respect to and in connection with the January 1997 private label credit card program agreement between the Company, the Subsidiary and WFNNB (the "World Financial Agreement"). Under the World Financial Agreement, a program was established pursuant to which, among other things, WFNNB agreed to issue credit cards to qualifying Company customers for the purchase of goods and services from the Company. While the ultimate result of this litigation cannot be determined or predicted with any accuracy at this time, the Company intends to pursue available remedies against WFNNB. On August 20, 1999, over the objection of WFNNB, the Bankruptcy Court authorized the Company to enter into an agreement with Household Bank (SB), N.A. ("Household") for the purpose of offering new private label credit cards to those customers of the Company who meet Household's credit standards. The Company's prior private label credit card program with WFNNB was suspended in March of 1999, and the rights and liabilities of WFNNB, the Company and the Subsidiary are the subject of the litigation referred to in the preceding paragraph. On September 23, 1999, WFNNB filed a motion to dismiss the Company's complaint and a separate motion seeking to have the complaint litigated in the United States District Court for the Middle District of Tennessee (the "District Court"), rather than the Bankruptcy Court. The Company filed timely oppositions to both motions, and, on October 27, 1999, the District Court denied WFNNB's motion to have the complaint litigated in the District Court. The Bankruptcy Court scheduled a hearing on December 6, 1999, to consider WFNNB's motion to dismiss and the Company's opposition thereto. On December 6, 1999, the Bankruptcy Court entered an order dismissing the Company's complaint. On December 16, 1999, the Company filed a motion asking the Court to clarify the order issued on December 6, 1999, and to grant the Company leave to file an amended complaint (the "Company's Motion"). On January 11, 2000, WFNNB responded with an objection to the Company's Motion. On February 22, 2000 the Bankruptcy Court entered an order granting the Company's Motion and the Company filed the amended complaint. At this time, it is not possible to predict the outcome of the Chapter 11 Cases or their effect on the Company's business. Additional information regarding the Chapter 11 Cases is set forth in Item 1. "Business -- Proceedings Under Chapter 11 of the Bankruptcy Code", Item 7. "Management's Discussion 10 12 and Analysis of Financial Condition and Results of Operations," Note B of Notes to Consolidated Financial Statements, and the Report of Independent Auditors included herein which includes an explanatory paragraph concerning a substantial doubt as to the Company's ability to continue as a going concern. If it is determined that the liabilities subject to compromise in the Chapter 11 Cases exceed the fair value of the assets, unsecured claims may be satisfied at less than 100 percent of their face value and the equity interests of the Company's shareholders may have no value. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of security holders during the fourth quarter of fiscal 1999. PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS During fiscal 1999 and 1998, the Common Stock traded on the New York Stock Exchange (the "NYSE") under the symbol "SME." On March 17, 1999, the NYSE notified the Company that it was reviewing the listing status of the Company's listed securities, including the Common Stock. On December 2, 1999, the NYSE announced that trading in the Common Stock was suspended effective on that date and that the NYSE would apply with the SEC for delisting of the Common Stock. The Common Stock was delisted from the NYSE on January 31, 2000. Subsequent to December 2, 1999, the Common Stock has been traded on the National Quotation Bureau, LLC Pink Sheets (the "Pink Sheets") and on the OTC Bulletin Board under the symbol "SVCDQ". The high and low sales prices for the Common Stock as reported by the NYSE until December 2, 1999, and the high and low bid prices on the OTC Bulletin Board and in the Pink Sheets thereafter were as follows:
1999 HIGH LOW - ---- ----- ----- First Quarter............................................... $1.13 $0.19 Second Quarter.............................................. $0.47 $0.25 Third Quarter............................................... $0.38 $0.25 Fourth Quarter.............................................. $0.31 $0.08
1998 HIGH LOW - ---- ----- ----- First Quarter............................................... $2.44 $1.63 Second Quarter.............................................. $2.25 $1.63 Third Quarter............................................... $1.94 $1.50 Fourth Quarter.............................................. $1.69 $0.28
As of February 27, 2000, the closing bid price reported on the OTC Bulletin Board was $0.14 and the approximate number of holders of the Common Stock was 5,724. The Company has not declared any cash dividends to shareholders for fiscal 1999 or 1998. The DIP Facility contains certain restrictive covenants, including a prohibition on the payment of cash dividends. On February 22, 2000, the Company announced that the plan or plans of reorganization presently being considered by the Company involve a debt conversion of the Company's prepetition unsecured claims into new common equity of the reorganized Company. Under such circumstances, the Common Stock would be cancelled and would result in existing shareholders of Common Stock receiving no value for their interests. The Company believes that the value of the Common Stock is highly speculative since it is highly likely that it will be cancelled, and therefore, be worthless if the expected plan of reorganization is consummated. 11 13 ITEM 6. SELECTED FINANCIAL DATA
FISCAL YEAR -------------------------------------------------------------- 1999 1998 1997 1996 1995 ---------- ---------- ---------- ---------- ---------- (IN THOUSANDS, EXCEPT PER SHARE, STORE, RATIO AND RATE DATA) RESULTS OF OPERATIONS Net sales(a)............................. $2,230,500 $3,169,525 $3,662,778 $3,955,016 $4,018,525 Earnings (loss) before interest and income taxes(a)........................ (165,294) (27,145) (63,801) 138,564 162,078 Interest expense -- debt and capitalized leases................................. 64,835 83,255 78,531 75,636 80,908 Earnings (loss) before extraordinary loss and cumulative effect of change in accounting principle(a)................ (229,255) (110,307) (88,957) 39,330 50,325 Net earnings (loss)(a)................... (243,672) (110,307) (91,600) 39,330 50,325 RATIOS & RATES Gross margin to net sales................ 22.2% 23.8% 23.2% 24.2% 24.3% Selling, general and administrative expenses to net sales(a)............... 26.0% 22.4% 19.8% 19.2% 18.7% Effective tax rate....................... 0.4% 0.1% 37.5% 37.5% 38.0% Earnings (loss) before extraordinary loss and cumulative effect of change in accounting principle to net sales(a)... (10.3)% (3.5)% (2.4)% 1.0% 1.3% Net earnings (loss) to net sales(a)...... (10.9)% (3.5)% (2.5)% 1.0% 1.3% PER COMMON SHARE -- BASIC AND DILUTED(b) Earnings (loss) per share before extraordinary loss and cumulative effect of change in accounting principle -- Basic..................... $ (2.30) $ (1.11) $ (0.89) $ 0.39 $ 0.50 Earnings (loss) per share before extraordinary loss and cumulative effect of change in accounting principle -- Assuming dilution......... (2.30) (1.11) (0.89) 0.39 0.50 Net earnings (loss) per share -- Basic... (2.45) (1.11) (0.92) 0.39 0.50 Net earnings (loss) per share -- Assuming dilution............................... (2.45) (1.11) (0.92) 0.39 0.50 Weighted -- average common shares: Basic.................................. 99,721 99,703 99,930 99,209 99,059 Diluted................................ 99,721 99,703 99,930 100,326 100,357 FINANCIAL POSITION Inventories.............................. $ 642,997 $ 896,303 $ 929,818 $1,052,969 $1,034,467 Notes payable............................ 42,977 156,000 -- -- -- Accounts payable......................... 67,318 228,373 482,235 639,887 679,107 Working capital.......................... 424,878 255,980 586,501 489,597 365,025 Total assets(a).......................... 1,161,944 1,626,895 1,951,461 2,087,452 1,999,008 Long-term obligations(c)................. 101,014 508,385 761,522 682,156 623,286 Shareholders' (deficit) equity........... (17,061) 225,895 336,505 427,094 386,742 RATIOS Inventory turnover....................... 2.3x 2.6x 2.8x 2.9x 3.0x Current ratio(a)......................... 2.3x 1.3x 1.7x 1.5x 1.4x Long-term debt to long-term debt + equity................................. 120.3% 69.2% 69.4% 61.5% 61.7% OTHER INFORMATION Total net sales increase (decrease)...................... (29.6)% (13.5)% (7.4)% (1.6)% (0.8)% Comparable store net sales increase (decrease)(d).......................... (7.8)% (8.9)% (3.1)% (1.9)% (3.3)% Number of stores......................... 223 350 361 401 410 ADJUSTED EBITDA DATA Adjusted EBITDA(e)....................... $ (122,867) $ 73,637 $ (4,561) $ 199,189 $ 224,816 Adjusted EBITDA to net sales............. (5.5)% 2.3% (0.1)% 5.0% 5.6%
12 14
FISCAL YEAR -------------------------------------------------------------- 1999 1998 1997 1996 1995 ---------- ---------- ---------- ---------- ---------- (IN THOUSANDS, EXCEPT PER SHARE, STORE, RATIO AND RATE DATA) CASH FLOW DATA Cash flow from operating activities...... $ 192,639 $ (291,351) $ (21,443) $ 65,737 $ 72,829 Cash flow from investing activities...... 39,838 (36,189) (23,270) (29,926) (47,778) Cash flow from financing activities...... (304,635) 97,120 78,879 58,431 (8,095)
- --------------- (a) See Note D to Consolidated Financial Statements for a discussion of the cumulative effect of a change in accounting principle. (b) Restated to reflect the adoption of Statement of Financial Accounting Standards ("SFAS") No. 128. (c) Includes both long-term debt and long-term portion of capitalized lease obligations. (d) Adjusted to reflect a comparable number of selling days. (e) Adjusted EBITDA consists of net earnings before interest, income taxes, depreciation and amortization. Also included in Adjusted EBITDA is other amortization classified as selling, general and administrative expenses in the following amounts: 1999 -- ($136); 1998 -- $630; 1997 -- $992; 1996 -- $966; 1995 -- $964. Certain amounts have been reclassified from selling, general and administrative expenses to interest expense for both current and prior periods. Adjusted EBITDA does not reflect restructuring charges or SFAS No. 121 charges. Adjusted EBITDA is not intended to represent net earnings, cash flow or any other measure of performance in accordance with generally accepted accounting principles, but is included because management believes certain investors find it to be a useful tool for measuring operating performance. While Adjusted EBITDA and similar variations thereof are frequently used as a measure of operations and the ability to meet debt service requirements, these terms are not necessarily comparable to other similarly titled captions of other companies due to the potential inconsistencies in the method of calculation. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 This report includes certain forward-looking statements (statements other than with respect to historical fact, including statements relating to the Company's 2000 Business Plan, its expected plan of reorganization and its expected DIP to Exit Facility) based upon management's beliefs, as well as assumptions made by and data currently available to management. This information has been, or in the future may be, included in reliance on the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are based on a variety of assumptions that may not be realized and are subject to significant business, economic, judicial and competitive uncertainties and potential contingencies, including those set forth below, many of which are beyond the Company's control. Actual results may differ materially from those anticipated in any such forward-looking statements. The Company undertakes no obligation to update or revise any such forward-looking statements. The forward-looking statements and the Company's liquidity, capital resources and results of operations are subject to a number of risks and uncertainties including, but not limited to, the following: approval of plans and activities by the Bankruptcy Court, including the proposed DIP to Exit Facility, proposed enhancements to the Company's existing employee retention program including the proposed enhanced severance program, and the Company's proposed strategic real estate initiatives; the ability of the Company to continue as a going concern; the ability of the Company to operate pursuant to the terms of the present DIP Facility and to consummate and operate pursuant to the terms of the DIP to Exit Facility; the ability of the Company to conduct successful clearance sales in connection with the 2000 Business Plan; the ability of the Company to sublease successfully portions of its real estate in connection with the 2000 Business Plan; the ability of the Company to complete its store refurbishment program within cost and time expectations; the successful implementation of the consolidation of its distribution centers; risks associated with third parties seeking and obtaining Court action to terminate or shorten the exclusivity period, the time for the Company to accept or reject executory contracts including its store leases, and for appointment of a Chapter 11 operation trustee or 13 15 to convert the Company's reorganization cases to liquidations cases; the ability of the Company to operate successfully under a Chapter 11 proceeding, achieve planned sales and margin, and create and have approved a reorganization plan in the Chapter 11 Cases; potential adverse developments with respect to the Company's liquidity or results of operations; the ability of the Company to obtain shipments, negotiate and maintain terms with vendors and service providers for current orders; the ability to fund and execute the 2000 Business Plan; the ability of the Company to achieve cost-savings; the ability of the Company to enter into satisfactory arrangements with third parties with respect to real estate and internet related strategies; the ability of the Company to attract, retain and compensate key executives and associates; competitive pressures from other retailers, including specialty retailers and discount stores, which may affect the nature and viability of the Company's business strategy; trends in the economy as a whole which may affect consumer confidence and consumer demand for the types of goods sold by the Company; the seasonal nature of the Company's business and the ability of the Company to predict consumer demand as a whole, as well as demand for specific goods; the ability of the Company to attract and retain customers; potential adverse publicity; real estate occupancy and development costs, including the substantial fixed investment costs associated with opening, maintaining or closing a Company store; uncertainties with respect to continued public trading in the Company's securities; the ability to effect conversions to new technological systems; and the ability to develop, prosecute, confirm and consummate one or more plans of reorganization with respect to the Chapter 11 cases. OVERVIEW The Notes to Consolidated Financial Statements are an integral part of Management's Discussion and Analysis of Financial Condition and Results of Operations and should be read in conjunction herewith. Proceedings Under Chapter 11 of the Bankruptcy Code On March 15, 1999, five of the Company's vendors filed an involuntary petition for reorganization under Chapter 11 of the Bankruptcy Code in the United States Bankruptcy Court for the Middle District of Tennessee seeking court supervision of the Company's restructuring efforts. On March 27, 1999, the Company and 31 of its subsidiaries filed voluntary petitions with the Bankruptcy Court for reorganization under Chapter 11 and orders for relief were entered by the Bankruptcy Court. The Chapter 11 Cases have been consolidated for the purpose of joint administration under Case No. 399-02649. The Debtors are currently operating their businesses as debtors-in-possession pursuant to the Bankruptcy Code. Actions to collect pre-petition indebtedness are stayed and other contractual obligations against the Debtors may not be enforced. In addition, under the Bankruptcy Code, the Debtors may assume or reject executory contracts, including lease obligations. Parties affected by these rejections may file claims with the Bankruptcy Court in accordance with the reorganization process. Substantially all pre-petition liabilities are subject to settlement under a plan of reorganization to be voted upon by creditors and equity holders and approved by the Bankruptcy Court. Although the Debtors expect to file a reorganization plan or plans that provide for emergence from bankruptcy in 2001, there can be no assurance that a reorganization plan or plans will be proposed by the Debtors or confirmed by the Bankruptcy Court, or that any such plan(s) will be consummated. As provided by the Bankruptcy Code, the Debtors initially had the exclusive right to submit a plan of reorganization for 120 days. On May 25, 1999, the Bankruptcy Court extended the period in which the Company had the exclusive right to file or advance a plan of reorganization to February 29, 2000. On February 2, 2000, the Bankruptcy Court extended the period in which the Company has the exclusive right to file or advance a plan of reorganization to April 30, 2001 and extended the right to solicit acceptance of its plan to June 30, 2001. If the Debtors fail to file a plan of reorganization during such period or if such plan is not accepted by the required number of creditors and equity holders, any party in interest may subsequently file its own plan of reorganization for the Debtors. A plan of reorganization must be confirmed by the Bankruptcy Court, upon certain findings being made by the Bankruptcy Court which are required by the Bankruptcy Code. The Bankruptcy Court may confirm a plan notwithstanding the non-acceptance of the plan by an impaired class of creditors or equity security holders if certain requirements of the Bankruptcy Code are met. The plan or plans currently being considered by the Company involve a debt conversion of the Company's prepetition on secured claims into new common equity of the reorganized Company. Under such circum- 14 16 stances the existing common stock of the Company would be cancelled and would result in existing holders of the common stock receiving no value for their interests. The value of the common stock is highly speculative since it is highly probable that it will be cancelled, and therefore, worthless if the expected plan of reorganization is consummated. At the first day hearing held on March 29, 1999 before Judge George C. Paine, the Bankruptcy Court entered first day orders granting authority to the Debtors, among other things, to pay pre-petition and post-petition employee wages, salaries, benefits and other employee obligations, and to pay vendors and other providers in the ordinary course for goods and services received from March 15, 1999, and to honor customer service programs, including warranties, returns, layaways and gift certificates. The Company has entered into the DIP Facility dated March 29, 1999 with Citicorp USA, Inc., as administrative agent, BankBoston, N.A. as documentation agent and collateral monitoring agent, and Salomon Smith Barney Inc. as sole arranger and book manager, for a debtor-in-possession credit facility under which the Company may borrow up to $750.0 million, subject to certain limitations, to fund ongoing working capital needs while it prepares a reorganization plan. The DIP Facility includes $100.0 million in term loans and a maximum of $650.0 million in revolving loans. The DIP Facility includes a $200.0 million sub-facility for standby and trade letters of credit. Interest rates on the DIP Facility are based on either the LIBOR plus 2.25% for LIBOR Loans or prime plus 1.25% for ABR Loans. The DIP Facility is secured by substantially all of the assets of the Company and its subsidiaries, subject only to valid, enforceable, subsisting and non-voidable liens of record as of the date of commencement of the Chapter 11 Cases and other liens permitted under the DIP Facility. On April 27, 1999, the Bankruptcy Court approved the DIP Facility. Borrowings under the DIP Facility are limited based on a borrowing base formula which considers eligible inventories, eligible trade letters of credit, eligible accounts receivable, mortgage values on eligible real properties, eligible leasehold interests, available cash equivalents and in-transit cash. Availability under the DIP Facility continues unless the Company breaches both the minimum EBITDA and minimum availability covenants, as defined in the DIP Facility. The Company believes the DIP Facility should provide it with adequate liquidity to conduct its operations while it prepares a reorganization plan or until the Company obtains a new credit facility. On February 21, 2000, the Company signed a commitment letter for a debtor in possession and exit credit facility. See "Management Discussion and Analysis of Financial Condition and Results of Operations -- DIP and Exit Credit Facility." On February 21, 2000, the Company signed a commitment letter with Fleet Retail Finance Inc. Subject to the expected approval of the Bankruptcy Court and closing, the Company's anticipated four-year, $600.0 million DIP to exit credit facility (the "DIP to Exit Facility") will replace the Company's existing $750.0 million DIP Facility (the "DIP Facility"). The DIP to Exit Facility will be agented by Fleet Retail Finance Inc. ("Fleet"), a co-agent of the DIP Facility, and fully underwritten by FleetBoston Robertson Stephens Inc. The Company believes the DIP to Exit Facility will be structured as a $600.0 million revolver, although Fleet has reserved the right to allocate up to $85.0 million to a term loan prior to closing. The DIP to Exit Facility also is expected to include a letter of credit subfacility of $150.0 million and permits subordinated secured financing in amounts up to an additional $50.0 million on terms reasonably satisfactory to Fleet. The DIP to Exit Facility is expected to require superpriority claim status and a first priority security interest in all assets subject to existing liens, and to contain certain other customary priority provisions. The DIP to Exit Facility is expected to be subject to various customary terms and conditions, and must be closed by the Company no later than May 31, 2000. The DIP to Exit Facility is expected to mature four years from closing but can be converted to exit financing by the Company at any time during the four-year term as long as applicable conditions to conversion are satisfied. The interest rate during the first year of the term is anticipated to be LIBOR plus 250 basis points or prime plus 75 basis points; thereafter, the Company believes the interest rate on the DIP to Exit Facility will be subject to quarterly adjustment pursuant to a pricing grid based on availability and/or EBITDA, as defined in the DIP to Exit Facility, with ranges of 200 to 275 basis points over LIBOR and 25 to 100 basis points over prime. 15 17 The Company believes the DIP to Exit Facility will include various covenants designed to facilitate implementation of the 2000 Business Plan and the Company's anticipated emergence from Chapter 11 in 2001. To fund capital expenditures, including the Company's planned two-year store renovation program, the facility is expected to permit the Company to invest up to $70.0 million of capital expenditures during 2000 (plus certain incremental amounts based on the amount of subleased space completed during the fiscal year). In 2001, the DIP to Exit Facility is expected to permit capital expenditures up to $150.0 million less actual capital expenditures invested during 2000. During 2002 and 2003, the Company anticipates that it may invest up to $50.0 million each year with 100 percent carryover of unexpended amounts from prior years. The DIP to Exit Facility is expected to include a financial covenant test similar to the test in the current DIP Facility. The Company believes it would not breach this financial covenant unless unused borrowing availability falls below $50.0 million and the Company fails to meet specified minimum EBITDA performance (as defined in the DIP to Exit Facility) performance. Expected to be excluded from the EBITDA calculation are revenues and expenses associated with discontinued inventory lines, the Orlando and Montgomery distribution centers and the reduction in force plan (including payroll and severance) except with respect to non-continuing EBITDA amounts in excess of $100.0 million. The Company believes there will be no restrictions in the facility on the Company's ability to sublease and lease store space pursuant to the 2000 Business Plan; lease all or part of the corporate headquarters; sell, pursuant to sale-leasebacks or outright, the corporate headquarters, the Orlando and/or Montgomery distribution centers; and/or implement a credit card receivables securitization program. The Company also believes it will retain the ability to complete intercompany restructurings, intercompany asset transfers and intercompany/third-party real estate transactions. Events of default under the Facility are expected to include customary default provisions as well as key management provisions that would trigger a default in the event that both the current Chief Executive Officer and President ceased to be employed, unless at least one of them is replaced by a person reasonably satisfactory to Fleet within 90 days and/or the acquisition by any one person or entity of 50 percent of the voting stock of the Company. Closing of the facility is subject to customary closing conditions, including at least $155.0 million of availability at close and no material adverse change in the financial condition, operations or assets of the Company at the time of closing. Conversion of the facility to an exit financing is also expected to be based on customary closing conditions, including the Agent's reasonable satisfaction with capital structure, plan of reorganization and any materially revised projections, as well as the achievement by the Company of a specified trailing 12-month EBITDA (which varies depending on time of exit) and certain minimum availability (which varies from $50.0 to $100.0 million) depending on the time of exit. The Company's Consolidated Financial Statements have been prepared on a going concern basis, which contemplates continuity of operations, realization of assets and liquidation of liabilities and commitments in the normal course of business. The filing of the involuntary and voluntary petitions referred to above, the related circumstances and the losses from operations raise substantial doubt with respect to the Company's ability to continue as a going concern. The appropriateness of using the going concern basis is dependent upon, among other things, confirmation of a plan or plans of reorganization, future profitable operations and the ability to generate cash from operations and financing sources sufficient to meet obligations. As a result of the filing of the Chapter 11 Cases and related circumstances, realization of assets and liquidation of liabilities is subject to significant uncertainty. While under the protection of Chapter 11, the Debtors may sell or otherwise dispose of assets, and liquidate or settle liabilities, for amounts other than those reflected in the Consolidated Financial Statements. Further, a plan or plans of reorganization could materially change the amounts reported in the accompanying Consolidated Financial Statements. The Consolidated Financial Statements do not include any adjustments relating to recoverability of the value of recorded asset amounts or the amounts and classification of liabilities that might be necessary as a consequence of a plan of reorganization. At this time, it is not possible to predict the outcome of the Chapter 11 Cases or their effect on the Company's business. Additional information regarding the Chapter 11 Cases is set forth in Item 1. "Business -- Proceedings Under Chapter 11 of the Bankruptcy Code", Note B of Notes to Consolidated Financial Statements and the Report of Independent Auditors included herein which includes an explanatory paragraph concerning a substantial doubt as to the Company's ability to continue as a going concern. If it is 16 18 determined that the liabilities subject to compromise in the Chapter 11 Cases exceed the fair value of the assets, unsecured claims may be satisfied at less than 100% of their face value and the equity interests of the Company's shareholders may have no value. The Company believes the DIP Facility or, if consummated the DIP to Exit Facility should provide the Company with adequate liquidity to conduct its business while it prepares a reorganization plan. However, the Company's liquidity, capital resources, results of operations and ability to continue as a going concern are subject to known and unknown risks and uncertainties, including those set forth above under "Safe Harbor Statement Under The Private Securities Litigation Reform Act of 1995." RESULTS OF OPERATIONS Fiscal Year Ended January 2, 2000 Compared to Fiscal Year Ended January 3, 1999 The Company's consolidated statements of operations presentation changed in fiscal 1997 to disclose the financial statement impact of the inventory liquidations associated with the closed facilities as a result of restructuring and remerchandising activities. The line item "Closed facilities" represents activity specifically identifiable to inventory liquidations conducted in conjunction with (1) the Company's restructuring plan adopted on March 25, 1997 ("Restructuring Plan"); (2) the Company's rationalization plan adopted on March 8, 1999 ("Rationalization Plan") and (3) exiting the computer, infant, pet supply and other merchandise categories and certain components of the wireless communication and sporting goods categories as part of a remerchandising program. As of January 2, 2000, primarily all of the aforementioned merchandise categories have been liquidated. All activity for these items is classified in "Closed facilities." Prior year amounts reflect operating results for these same facilities and merchandise classifications. Selling, general and administrative expenses for closed facilities do not include any allocation of corporate overhead. The Company's business is highly seasonal with a significant portion of its sales occurring in the fourth quarter. Fourth quarter net sales accounted for 37.4% and 40.6% of total net sales in fiscal 1999 and 1998, respectively. The Company maintains its books using a 52/53 week year ending on the Sunday closest to the end of the calendar year. There were 52 weeks in the fiscal years ended January 2, 2000 and December 28, 1997. There were 53 weeks in the fiscal year ended January 3, 1999. In the fourth quarter of fiscal 1999, there were 13 reporting weeks. All previous quarters in fiscal years 1999, 1998 and 1997 were also reported on a 13 week basis, other than the fourth quarter of fiscal 1998, which was reported on a 14 week basis. Net Sales Total net sales for the Company were $2.23 billion in fiscal 1999 compared to $3.17 billion in fiscal 1998. The decline in net sales was primarily due to the closure of 127 stores as a result of the restructuring and remerchandising activities and out of stock levels associated with procurement difficulties encountered prior to the Chapter 11 filings. Net sales from operations excluding closed facilities were $2.0 billion for fiscal 1999 compared to $2.3 billion for fiscal 1998, a decrease of $285.0 million or 12.6%. Jewelry comparable store sales increased 1.1%, while hardline comparable store sales decreased 12.0%. Increases in jewelry sales were offset by sales decreases in electronics, toys and kids, and fitness/sports. Net sales from closed facilities were $0.3 billion for fiscal 1999 compared to $0.9 billion for fiscal 1998. Sales from closed facilities decreased primarily due to closing 127 under performing stores in fiscal 1999, as compared to nine under performing stores in fiscal 1998. Gross Margin In fiscal 1999, gross margin was $494.6 million as compared to $754.3 million in fiscal 1998. The decrease in gross margin dollars was primarily due to a decline in sales. 17 19 Gross margin after cost of merchandise sold and buying and occupancy expenses and excluding closed facilities was $493.7 million, or 25.1% of net sales from operations excluding closed facilities for fiscal 1999, compared to $565.5 million, or 25.1% of net sales from operations excluding closed facilities for fiscal 1998. The decline in gross margin was primarily due to out of stock levels associated with procurement difficulties encountered prior to the Chapter 11 filings, which the Company believes adversely affected sales and gross margin. Gross margin for closed facilities, after cost of merchandise sold and buying and occupancy expenses, was $0.8 million, or 0.3% of sales of these facilities in fiscal 1999 as compared to gross margin of $188.8 million or 20.7% in fiscal 1998. The decrease in both gross margin dollars and rate was due to the volume of inventory liquidation and merchandise discounts offered in liquidating inventories at the 127 under performing stores closed in fiscal 1999 as compared to nine stores closed in fiscal 1998. Selling, General and Administrative Expenses Selling, general and administrative expenses declined $128.3 million in fiscal 1999 to $580.8 million from $709.1 million in fiscal 1998. The $128.3 million decline was primarily due to store closures, corporate downsizing and overhead reduction efforts. Selling, general and administrative expenses were $483.9 million, or 24.6% of net sales from operations excluding closed facilities for fiscal 1999 compared to $552.0 million, or 24.6% of net sales from operations excluding closed facilities for fiscal 1998. The decrease was primarily attributable to a $33.0 million decrease in employment costs and a $35.1 million decrease in other selling, general and administrative expenses primarily due to corporate downsizing and overhead reduction efforts. Selling, general and administrative expenses for closed facilities were $96.9 million, or 37.3% of net sales from operations for closed facilities for fiscal 1999 compared to $157.1 million, or 17.2% of net sales from operations for closed facilities for fiscal 1998. The decrease was primarily attributable to a $63.5 million decrease in employment costs offset by a $3.3 million increase in other selling, general and administrative expenses primarily due to store closures. Other Income Other income increased $25.5 million in fiscal 1999 to $38.4 million from $12.9 million in fiscal 1998. The increase was primarily due to gains on the sale of owned and leased properties. Depreciation and Amortization Depreciation and amortization on owned and leased property and equipment was $42.6 million for fiscal 1999 as compared to $57.1 million for fiscal 1998, a decrease of 25.4% primarily due to store closures and lower capital expenditures. Capital expenditures, excluding capitalized leases, decreased to $23.0 million in fiscal 1999 as compared to $50.7 million in fiscal 1998. Reorganization Items Reorganization items represent expenses incurred by the Company resulting from the Chapter 11 Cases specific to the reorganization process. For the fiscal year ended January 2, 2000, the Company recorded net reorganization items (income) of $1.8 million. Reorganization items include expenses of $18.4 million for professional fees, $11.8 million related to store closing costs, $9.8 million associated with the loss on disposal of assets, and other administrative items of $4.2 million, partially offset by income of $46.0 million associated with the reduction of accrued rent for rejected leases. Interest Expense Interest expense on debt and capitalized leases decreased to $64.8 million in fiscal 1999 from $83.3 million in fiscal 1998. As a result of the filing of the Chapter 11 Cases, the Company ceased accruing interest on the 8 3/8% Senior Notes and 9% Senior Subordinated Debentures on March 16, 1999. 18 20 Extraordinary Item An extraordinary loss on the early extinguishment of debt was recorded in the amount of $7.9 million during the first quarter ended April 4, 1999. This charge related to the write-off of deferred financing charges paid in conjunction with the Company's prior Amended and Restated Credit Facility and Second Amended and Restated Credit Facility upon the consummation of the DIP Facility. Cumulative Effect of a Change in Accounting Principle The Company changed its method of accounting for layaway sales during fiscal 1999. The cumulative effect of the change for periods prior to fiscal 1999 is an increase in net loss of $6.6 million or ($0.07) per share. Layaway sales for 1999 have been recognized upon delivery of merchandise to the customer. Layaway sales in prior years were recognized when the initial layaway deposit was received. The Company changed its method of accounting for layaway sales in response to the Securities and Exchange Commission's Staff Accounting Bulletin: No. 101 -- Revenue Recognition In Financial Statements. Income Tax The Company recognized an income tax benefit of $0.9 million for fiscal 1999 compared to $0.1 million for fiscal 1998. The Company has recorded a full valuation allowance on net deferred tax assets because realization of such assets in the future is uncertain. Restructuring Plan On March 25, 1997, the Company adopted a business restructuring plan to close up to 60 under performing stores and one distribution center (the "1997 Restructuring Plan"). As a result, a pre-tax charge of $129.5 million for restructuring costs was recorded in the first quarter of fiscal 1997. The components of the restructuring charge and an analysis of the amounts charged against the accrual for the fiscal year ended January 2, 2000 are outlined in the following table:
ACCRUED 1999 ACTIVITY ACCRUED RESTRUCTURING --------------------------------------- RESTRUCTURING COSTS AS OF RESTRUCTURING ASSET CHANGE IN COSTS AS OF JANUARY 3, 1999 COSTS PAID WRITE-DOWNS ESTIMATE JANUARY 2, 2000 --------------- ------------- ----------- --------- --------------- (IN THOUSANDS) Lease termination and other real estate costs.................... $53,161 $(1,780) $ -- $(43,487) $7,894 Property and equipment write-downs..................... -- -- 2,489 (2,489) -- ------- ------- ------ -------- ------ Total.................... $53,161 $(1,780) $2,489 $(45,976) $7,894 ======= ======= ====== ======== ======
Note: The Accrued Restructuring Costs as of January 2, 2000 are included in liabilities subject to compromise. The closing of nine stores during the first half of fiscal 1998 brought the total number of closures, in accordance with the 1997 Restructuring Plan, to 53 stores and one distribution center. Store closures were completed as of May 1998. The Company closed less than 60 stores primarily due to the inability to negotiate acceptable exit terms from the related lessors. Restructuring costs paid during the fiscal year ended January 2, 2000, relate primarily to lease termination and other real estate costs. The Company paid $1.1 million in contractual rent payments and lease termination fees and $0.6 million in other real estate costs primarily related to utilities, common area maintenance fees, real estate taxes and brokerage costs. In connection with the Chapter 11 Cases, an initial change in estimate of $46.0 million was made to reflect the reduction allowed under Section 502(b)(6) of the Bankruptcy Code and recorded as a reorganization item. Amounts had been accrued according to the remaining leasehold obligations. Section 502(b)(6) limits a lessor's claim to the rent reserved by such lease, without acceleration, for the greater of one year, or 15 percent of the remaining lease, not to exceed three years. Any unpaid rent is included in the 19 21 claim. Partially offsetting this reduction was a $2.5 million increase in estimate, resulting in a net change in estimate at January 2, 2000 of $43.5 million related to lease termination and other real estate costs. The leases remaining on closed locations as of January 2, 2000 vary in length with expiration dates ranging from January 2000 to October 2018. As of January 2, 2000, property and equipment associated with the 1997 Restructuring Plan have been written-down to reflect their estimated fair value. The Company anticipates selling or abandoning substantially all remaining owned property and equipment associated with the 1997 Restructuring Plan. Approximately 3,000 employees were terminated pursuant to the 1997 Restructuring Plan. All such terminations were completed as of May 1998. Rationalization Plan In February 1999, the Company announced a rationalization plan to close up to 132 stores, up to four distribution centers and to reduce corporate overhead (the "Rationalization Plan"). On March 8, 1999, as part of the Rationalization Plan and prior to the filing of the involuntary bankruptcy petition, the Board of Directors approved the adoption of a business restructuring plan to close 106 stores, to close the Dallas distribution center and to reduce the Company's workforce at its Nashville corporate offices by 150 employees. As a result, a pre-tax charge of $99.5 million for restructuring costs was recorded in the first quarter of 1999. On March 29, 1999 and in connection with the Chapter 11 Cases, store leases under this plan were approved for rejection by the Bankruptcy Court. The components of the restructuring charge and the amounts charged against the accrual through fiscal year ended January 2, 2000 are outlined in the following table.
1999 ACTIVITY INITIAL CHARGE ------------------------------------ ACCRUED RECORDED IN ASSET CHANGE IN COSTS AS OF MARCH 1999 COSTS PAID WRITE-DOWNS ESTIMATE JANUARY 2, 2000 -------------- ---------- ----------- --------- --------------- (IN THOUSANDS) Lease termination and other real estate costs....................... $62,469 $ (9,297) $ -- $(14,857) $38,315 Property and equipment write-downs... 24,452 -- (19,298) (5,154) -- Employee severance................... 12,533 (9,237) -- (2,818) 478 ------- -------- -------- -------- ------- Total....................... $99,454 $(18,534) $(19,298) $(22,829) $38,793 ======= ======== ======== ======== =======
Note: The Accrued Costs as of January 2, 2000 are included in liabilities subject to compromise. The stores planned for closure included both owned and leased properties. Lease termination and other real estate costs consist principally of the remaining rental payments required under the closing stores' and distribution center's lease agreements under Section 502(b)(6) of the Bankruptcy Code, net of any actual or reasonably probable sublease income. Section 502(b)(6) limits the lessor's claim to the rent reserved by such lease, without acceleration, for the greater of one year, or 15 percent of the remaining term of the lease, not to exceed three years. Any unpaid rent is included in the claim. The Company experienced lower than expected expenses in lease terminations, dispositions of closed stores and severance payments during the fiscal year ended January 2, 2000. As a result, the Company reduced its estimate for these costs by $23.0 million. Restructuring costs paid during the fiscal year ended January 2, 2000, relate primarily to lease termination and other real estate costs. The Company incurred $2.3 million in contractual rent payments and lease termination fees, $7.0 million in other real estate costs primarily related to utilities, common area maintenance fees, real estate taxes and brokerage costs, and $9.2 million in severance costs. After taking into effect the above asset write-downs, the Company's carrying value of the property and equipment associated with the Rationalization Plan closures is $1.8 million as of January 2, 2000. This entire amount is classified as available for sale as all store closures are now complete. Assets available for sale are considered current assets and are included with "Prepaid expenses and other assets." The Company anticipates selling substantially all owned property and equipment associated with the closed stores. 20 22 The employee severance provision was recorded for the planned termination of approximately 4,400 employees associated with the closures, as well as the reduction of corporate overhead. Substantially all such terminations were completed as of December 1999. Fiscal Year Ended January 3, 1999 Compared to Fiscal Year Ended December 28, 1997 Net loss for fiscal 1998 was $110.3 million, or $1.11 per share, compared to net loss of $91.6 million, or $0.92 per share, for the year ended December 28, 1997 ("fiscal 1997"). The increase in net loss was primarily a result of decreased net sales and a $43.1 million impairment loss with respect to certain fixed assets. Net Sales Net sales were $3.17 billion for fiscal 1998 compared to $3.66 billion for fiscal 1997. The decrease of $493.3 million or 13.5%, was the result of an 8.9% decline in comparable store sales and a decline in net sales from closed facilities of $311.1 million due to the closure of 53 under performing stores during 1997 and 1998. Net sales from operations excluding closed facilities were $2.26 billion for fiscal 1998 compared to $2.44 billion for fiscal 1997, a decrease of $182.2 million or 7.5%. Comparable store sales declined 8.9%. Jewelry comparable store sales increased 3.6%. Improvements in gold sales, jewelry special sales events and warranty sales were offset by sales declines in watches, diamonds and precious and semi-precious stones. Hardline comparable store sales were down 13.6%. Sales improvements in decorative home, seasonal, telephone, home furnishing and photo categories were offset by sales declines in sporting and fitness, toys, small appliances, housewares, audio and home office equipment. Net sales from closed facilities were $913.9 million for fiscal 1998 compared to $1.2 billion for fiscal 1997. Sales from closed facilities for fiscal 1998 decreased from fiscal 1997 due to store closures. Gross Margin In fiscal 1998, gross margin was $754.3 million as compared to $851.0 million in fiscal 1997. The decrease in gross margin dollars was primarily due to the overall decline in sales. Gross margin after cost of merchandise sold and buying and occupancy expenses and excluding closed facilities decreased to $565.5 million, or 25.1% of net sales from operations excluding closed facilities for fiscal 1998, compared to $620.1 million, or 25.4% of net sales from operations excluding closed facilities for fiscal 1997. The reduced gross margin rate reflects a $14.7 million write-down lowering discontinued inventory items to their net realizable value and competition induced price mark-downs, partially offset by a shift to a higher margin merchandise assortment. Gross margin after cost of merchandise sold and buying and occupancy expenses, for closed facilities was $188.8 million, or 20.7% of sales from closed facilities for fiscal 1998 as compared to $230.9 million, or 18.9% of sales from closed facilities for fiscal 1997. The decrease in gross margin was due to store closures. Selling, General and Administrative Expenses Selling, general and administrative expenses declined $20.5 million in fiscal 1998 to $709.1 million from $729.6 million in fiscal 1997. The $20.5 million decline was primarily due to store closures and favorable results from the private label credit card. Selling, general and administrative expenses of operations excluding closed facilities were $552.0 million, or 24.5% of sales from operations excluding closed facilities for fiscal 1998 compared to $516.6 million, or 21.2% of sales from operations excluding closed facilities for fiscal 1997. The increase in selling, general and administrative expenses was primarily attributable to an increase in legal and consulting expenses of operations excluding closed facilities as a result of restructuring and remerchandising activities incurred primarily in the third and fourth quarters of fiscal 1998. This increase as a percent of sales was partially offset by income of $19.6 million recognized from the private label credit card program. 21 23 Selling, general and administrative expenses for closed facilities were $157.1 million for fiscal 1998 compared to $213.0 million in fiscal 1997. The closing of the 44 underperforming stores completed in July 1997 resulted in the decreased selling, general and administrative costs for fiscal 1998. Depreciation and Amortization Depreciation and amortization on owned and leased property and equipment was $57.1 million for fiscal 1998 as compared to $58.2 million for fiscal 1997, a decrease of 2.0%. Capital expenditures, excluding capitalized leases, increased to $50.7 million in fiscal 1998 as compared to $40.8 million in fiscal 1997. The Company closed a net 11 stores in fiscal 1998 as compared to closing a net 40 stores (including the 44 under performing stores) in fiscal 1997. Interest Expense Interest expense on debt and capitalized leases increased to $83.3 million in fiscal 1998 from $78.5 million in fiscal 1997. Interest expense for the year increased primarily due to the term loan being outstanding for the full year partially offset by lower average borrowings against the revolver under the Amended and Restated Credit Facility. Income Tax The Company recognized an income tax benefit of $0.1 million for fiscal 1998 compared to $53.4 million for fiscal 1997. The decrease in the benefit was primarily due to the recording of a full valuation allowance against deferred tax assets of $48.1 million. The effective income tax rate was reduced to 0.1% for fiscal 1998 compared to 37.5% for fiscal 1997. Restructuring Plan The closing of nine stores during the first half of fiscal 1998 brought the total number of closures in accordance with the 1997 Restructuring Plan to 53 stores and one distribution center. Store closures related to the 1997 Restructuring Plan were completed in May 1998. Impairment charges recognized on the nine stores closed in fiscal 1998 were $5.2 million. The components of the restructuring charges and an analysis of the amounts charged against the accrual during fiscal 1998 are outlined in the following table:
ACCRUED 1998 ACTIVITY ACCRUED RESTRUCTURING --------------------------------------- RESTRUCTURING COSTS AS OF RESTRUCTURING ASSET CHANGE IN COSTS AS OF DECEMBER 28, 1997 COSTS PAID WRITE-DOWNS ESTIMATE JANUARY 3, 1999 ----------------- ------------- ----------- --------- --------------- (IN THOUSANDS) Lease termination and other real estate costs................. $73,511 $(13,737) $ -- $ (6,613) $53,161 Property and equipment write-downs........... -- -- 5,706 (5,706) -- Employee severance...... 531 (155) -- (376) -- Other exit costs........ 2,200 -- -- (2,200) -- ------- -------- ------ -------- ------- Total......... $76,242 $(13,892) $5,706 $(14,895) 53,161 ======= ======== ====== ======== ======= Less: Current portion..... (7,864) ------- $45,297 =======
The 1997 Restructuring Plan adopted by the Company in 1997 was for the closure of up to 60 stores and one distribution center. The Company closed less than 60 stores primarily due to the inability to negotiate acceptable exit terms from the related lessors. Restructuring costs paid during fiscal 1998 relate primarily to lease termination and other real estate costs. Lease termination and other real estate costs consist principally of the remaining rental payments required under the closing stores' lease agreements, net of any actual or reasonably probable sublease income, as well as early termination costs. The leases remaining on closed 22 24 locations as of January 3, 1999 vary in length with expiration dates ranging from February 1999 to December 2030. Changes in estimates are representative of conditions existing as of January 3, 1999. Due to favorable lease termination experience in the second half of fiscal 1998 and favorable experience related to the sale of property and equipment associated with the store closures, restructure reserves of $14.9 million were reversed in the fourth quarter of fiscal 1998. The 1997 Restructuring Plan was based on an analysis of individual store performance based on cash flow return on committed capital, suitability within marketing demographic profiles and strategic geographic positioning. After the effect of charges and costs related specifically to the closings, the immediate ongoing impact of the closings on net income was insignificant as the stores closed were near break-even contributors. During the second quarter of fiscal 1997, the Company also began implementing certain remerchandising strategies, including the exit of the low margin computer business and certain components of the wireless communication business. Additional remerchandising decisions were executed in the first quarter of fiscal 1998 with the exit of infant and pet supply categories and certain components of the sporting goods business. In the third quarter of fiscal 1998, the Company completed the remerchandising portion of the Restructuring Plan. Impaired Assets In the fourth quarter of fiscal 1998, the Company recorded a non-cash impairment loss of $43.1 million related to a write-down of the Company's fixed assets. The Company performed a long-lived asset impairment analysis due to projected cash flow losses combined with current operating and cash flow losses at certain store locations. Assets are evaluated for impairment on an individual store basis which management believes is the lowest level for which there are identifiable cash flows. Projected future cash flows (undiscounted and without interest) were compared to the carrying amount of assets at each location. If the carrying amount of the assets exceeded the projected future cash flows, an impairment loss was recognized. Impaired assets were written-down to their estimated fair value. Fair value was based on sales of similar assets or other estimates of fair value such as discounting estimated future cash flows. Considerable management judgment is necessary to estimate fair value. Accordingly, actual results could vary significantly from such estimates. LIQUIDITY AND CAPITAL RESOURCES On March 27, 1999, the Debtors filed the Chapter 11 Cases which will affect the Company's liquidity and capital resources in fiscal 2000. See Item 1. "Business -- Proceedings Under Chapter 11 of the Bankruptcy Code." Availability under the Company's bank credit facility, and trade credit and terms from vendors provided the resources required to support operations, seasonal working capital requirements and capital expenditures during fiscal 1999. The Company's business is highly seasonal with the Company's inventory investment and related short-term borrowing requirements reaching a peak prior to the Christmas season. Historically, positive cash flow from operations has been generated principally in the latter part of the fourth quarter of each fiscal year, in line with the seasonal nature of the Company's business. Net cash provided (used) by operations was $192.6 million for fiscal 1999 as compared to ($291.4) million for fiscal 1998 and ($21.4) million for fiscal 1997. Cash flow from operations increased for fiscal 1999 compared to fiscal 1998 primarily as a result of: (i) reduced disbursements as a result of the bankruptcy filing and the concomitant reclassification of pre-petition liabilities to liabilities subject to compromise; (ii) cash generated from the liquidation of inventory as a result of store closings; and (iii) improved vendor terms, resulting in higher post petition accounts payable balances. Cash flow from operations decreased for fiscal 1998 compared to fiscal 1997 as a result of: (i) decreased earnings attributable in part to cash payments related to restructuring and remerchandising activities; (ii) reductions in accounts payable due to decreased 23 25 purchase volumes as a result of the store closings, a negotiated contraction in payment terms in exchange for revised economics with certain vendors, aggressive use of anticipation discounts or cash in advance payments at year-end and changes in merchandise mix which changed the average terms. These factors were partially offset by inventory liquidations associated with the closing stores. Net cash provided (used) by investing activities was $39.8 million, ($36.2) million, and ($23.3) million for fiscal 1999, 1998, and 1997, respectively. Cash provided in fiscal 1999 by investing activities resulted primarily from proceeds from the sale of real estate assets offset by capital spending. Net cash provided (used) by financing activities was ($304.6) million, $97.1 million and $78.9 million for fiscal 1999, 1998, and 1997, respectively. Cash provided in fiscal 1997 from financing activities reflected a $200 million term loan obtained in connection with the completion of the Company's $900.0 million, five-year Amended and Restated Credit Facility in the third quarter of fiscal 1997. This was partially offset by the retirement of $86.2 million of Senior Notes due 2001 and $17.4 million of debt issuance costs incurred primarily for the Amended and Restated Credit Facility. Additionally, the Company paid $15.8 million in mortgage payments including both prepayments and regularly scheduled payments. In fiscal 1998, cash provided by financing activities reflected $156.0 million in net short-term borrowings. In fiscal 1999, cash used in financing activities of $304.6 million went towards paying down the Company's total debts. Capital Expenditures Capital expenditures in fiscal 1999 and 1998 related primarily to information systems improvements, capital maintenance, remodeling of certain stores and new store construction. In fiscal 1999, the Company opened one store and closed 128 stores, including 106 under performing stores as part of the Rationalization Plan, as compared to the opening of six stores and closing of 17 stores in fiscal 1998. In fiscal 1997, the Company opened five stores and closed 45 stores. Planned capital expenditures for fiscal 2000 are expected to be approximately $65.0 million and are expected to be directed primarily to store remodels, capital maintenance, and information systems improvements. The Company expects to fund these planned expenditures primarily with borrowings under the DIP to Exit Facility and with cash flows from operations including proceeds from inventory clearance sales related to exited categories, subject to Bankruptcy Court approval. Capital Structure The Company's principal sources of liquidity during fiscal 1999 were borrowings under the DIP Facility, which included a $100.0 million term loan and a revolving credit facility with a maximum commitment level of $650.0 million and terms from vendors. At January 2, 2000, the Company had $42.9 million in revolving loans outstanding under the DIP Facility. The Company had $156.0 million in revolving loans outstanding on January 3, 1999. Average short-term borrowings for fiscal 1999 increased to $157.2 million as compared to $55.0 million for fiscal 1998, due primarily to reductions in term loan amounts. Short-term borrowings under the revolver portion of the DIP Facility reached a maximum of $382.2 million during fiscal 1999 as compared to $298.8 million in fiscal 1998. Total debt as a percentage of total capital for fiscal 1999 was 102.9% as compared to 79.8% in fiscal 1998 and 70.2% in fiscal 1997. The 1999 figure exceeds 100% as a result of the shareholder's equity deficit. On December 15, 1998, the Company announced that it had not made the approximately $13.5 million interest payment due December 15, 1998 on its 9% Subordinated Debentures. The related indenture provides for a 30 day grace period. The Company stated that it would evaluate available alternatives during that period. The Company obtained a 30 day waiver with respect to any cross default under the Amended and Restated Credit Facility with respect to the failure to make the December 15, 1998 interest payment. The non-payment of the interest on the 9% Subordinated Debentures was a default under the Amended and Restated Credit Facility and the Company's operating performance, absent a waiver, would have resulted in a breach of the fixed-charge coverage ratio covenants in agreements with First American National Bank and the Canadian 24 26 Imperial Bank of Commerce. On January 14, 1999, the Company made the approximately $13.5 million interest payment on the 9% Subordinated Debentures. As a first step in an effort to effect an out-of-court restructuring plan, on January 20, 1999, the Company completed the Second Amended and Restated Credit Facility, a $750.0 million, 30 month, asset-based credit facility replacing the Amended and Restated Credit Facility. The Second Amended and Restated Credit Facility included $150.0 million in term loans and a maximum of $600.0 million in revolving loans. Financial covenants were subject to amendment pending the finalization of the Company's business plan. The Second Amended and Restated Credit Facility included a $200.0 million sub-facility for standby and trade letters of credit. Interest rates on the Second Amended and Restated Credit Facility were based on either Prime Rate + 1.50% or Eurodollar + 2.75%. The Second Amended and Restated Credit Facility was secured by all material unencumbered assets of the Company, including inventory but excluding previously mortgaged property and leasehold interests. Borrowings under the Second Amended and Restated Credit Facility were limited based on a borrowing base formula which considered eligible inventories, eligible accounts receivable and mortgage values on eligible real properties, and limitations contained in the Company's public senior subordinated debt indenture. The Second Amended and Restated Credit Facility contained certain restrictive covenants, the most restrictive of which included: (a) maintenance of an EBITDA amount, (b) restrictions on dividends and the incurrence of additional indebtedness, (c) restrictions on incurring and assuming liens on property or assets, (d) restrictions on mergers, consolidations, and sales of assets, and (e) a capital spending maximum of $50.0 million annually. Additionally, the Second Amended and Restated Credit Facility required borrowings outstanding under the revolving loans to be less than an amount to be specified at a later date for a period of 30 consecutive days each year. From the date of its completion through the filing of the Chapter 11 Cases and completion of the DIP Facility, availability under the Second Amended and Restated Credit Facility was the Company's primary source of liquidity. On March 29, 1999, the Company entered into the DIP Facility which replaced the Second Amended and Restated Credit Facility and which the Company believed would provide liquidity for the Company's operations while it prepared a reorganization plan. However, there can be no assurance that the Company will be able to access liquidity from the DIP Facility or from any other source, or that such liquidity will be sufficient to meet the Company's needs. On April 27, 1999, the Bankruptcy Court approved the DIP Facility. The DIP facility terminates no later than June 30, 2001. Performance against covenants under the DIP Facility is set forth below:
COVENANT THRESHOLD ACTUAL - -------- ------------- -------------- A. 1999 Capital Expenditures.......................... $50.0 million $25.6 million B. Minimum Availability (February 24, 2000)........... $50.0 million $233.2 million OR Minimum EBITDA (Period ended January 2, 2000)...... $26.0 million $56.7 million
Note: EBITDA is calculated as defined in the Second Amendment to the DIP Facility. On February 21, 2000, the Company signed a commitment letter with Fleet Retail Finance Inc. Subject to the expected approval of the Bankruptcy Court and closing, the Company's anticipated four-year, $600.0 million DIP to exit credit facility (the "DIP to Exit Facility") will replace the Company's existing $750.0 million DIP Facility (the "DIP Facility"). The DIP to Exit Facility will be agented by Fleet Retail Finance Inc. ("Fleet"), a co-agent of the DIP Facility, and fully underwritten by FleetBoston Robertson Stephens Inc. The Company believes the DIP to Exit Facility will be structured as a $600.0 million revolver, although Fleet has reserved the right to allocate up to $85.0 million to a term loan prior to closing. The DIP to Exit Facility also is expected to include a letter of credit subfacility of $150.0 million and permits subordinated secured financing in amounts up to an additional $50.0 million on terms reasonably satisfactory to Fleet. The DIP to Exit Facility is expected to require superpriority claim status and a first priority security interest in all assets subject to existing liens, and to contain certain other customary priority provisions. 25 27 The DIP to Exit Facility is expected to be subject to various customary terms and conditions, and must be closed by the Company no later than May 31, 2000. The DIP to Exit Facility is expected to mature four years from closing but can be converted to exit financing by the Company at any time during the four-year term as long as applicable conditions to conversion are satisfied. The interest rate during the first year of the term is anticipated to be LIBOR plus 250 basis points or prime plus 75 basis points; thereafter, the Company believes the interest rate on the DIP to Exit Facility will be subject to quarterly adjustment pursuant to a pricing grid based on availability and/or EBITDA, as defined in the DIP to Exit Facility, with ranges of 200 to 275 basis points over LIBOR and 25 to 100 basis points over prime. The Company believes the DIP to Exit Facility will include various covenants designed to facilitate implementation of the 2000 Business Plan and the Company's anticipated emergence from Chapter 11 in 2001. To fund capital expenditures, including the Company's planned two-year store renovation program, the facility is expected to permit the Company to invest up to $70.0 million of capital expenditures during 2000 (plus certain incremental amounts based on the amount of subleased space completed during the fiscal year). In 2001, the DIP to Exit Facility is expected to permit capital expenditures up to $150.0 million less actual capital expenditures invested during 2000. During 2002 and 2003, the Company anticipates that it may invest up to $50.0 million each year with 100 percent carryover of unexpended amounts from prior years. The DIP to Exit Facility is expected to include a financial covenant test similar to the test in the current DIP Facility. The Company believes it would not breach this financial covenant unless unused borrowing availability falls below $50.0 million and the Company fails to meet specified minimum EBITDA performance (as defined in the DIP to Exit Facility) performance. Expected to be excluded from the EBITDA calculation are revenues and expenses associated with discontinued inventory lines, the Orlando and Montgomery distribution centers and the reduction in force plan (including payroll and severance) except with respect to non-continuing EBITDA amounts in excess of $100.0 million. The Company believes there will be no restrictions in the DIP to Exit Facility on the Company's ability to sublease and lease store space pursuant to the 2000 Business Plan; lease all or part of the corporate headquarters; sell, pursuant to sale-leasebacks or outright, the corporate headquarters, the Orlando and/or Montgomery distribution centers; and/or implement a credit card receivables securitization program. The Company also believes it will retain the ability to complete intercompany restructurings, intercompany asset transfers and intercompany/third-party real estate transactions. Events of default under the Facility are expected to include customary default provisions as well as key management provisions that would trigger a default in the event that both the current Chief Executive Officer and President ceased to be employed, unless at least one of them is replaced by a person reasonably satisfactory to Fleet within 90 days and/or the acquisition by any one person or entity of 50 percent of the voting stock of the Company. Closing of the DIP to Exit Facility is subject to customary closing conditions, including at least $155.0 million of availability at close and no material adverse change in the financial condition, operations or assets of the Company at the time of closing. Conversion of the DIP to Exit Facility to an exit financing is also expected to be based on customary closing conditions, including the Agent's reasonable satisfaction with capital structure, plan of reorganization and any materially revised projections, as well as the achievement by the Company of a specified trailing 12-month EBITDA (which varies depending on time of exit) and certain minimum availability (which varies from $50.0 to $100.0 million) depending on the time of exit. There can be no assurance that the Company will be able to access liquidity from the DIP Facility, or consummate and access liquidity from the DIP to Exit Facility, or from any other source, or that such liquidity will be sufficient to meet the Company's needs. See "Management Discussion and Analysis of Financial Conditions and Results of Operations -- Safe Harbor Statement Under the Private Securities Litigation Reform Act of 1995." Inflation The Company does not believe inflation has had a material impact on the Company's net sales or net earnings (loss) during the last three fiscal years. 26 28 EFFECT OF NEW ACCOUNTING PRONOUNCEMENTS In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities." This pronouncement was to be effective for all fiscal quarters of fiscal years beginning after June 15, 1999. In June 1999, the FASB issued SFAS No. 137, "Accounting for Derivative Instruments and Hedging Activities -- Deferral of the Effective Date of FASB Statement No. 133." This pronouncement postpones the effective date of SFAS No. 133 to all fiscal quarters of fiscal years beginning after June 15, 2000. The Company is currently in the process of analyzing the impact of the adoption of this Statement. YEAR 2000 UPDATE The Year 2000 issue was primarily the result of computer programs using a two-digit format, as opposed to four digits, to indicate the year. As a result, such computer systems would be unable to interpret dates beyond the year 1999, which could have caused a system failure or other computer errors leading to a disruption in the operation of such systems. In 1997, the Company developed a strategic plan to update its information systems in order to meet business needs. As a result of this plan, several major processing systems were replaced or significantly upgraded during 1998 and 1999, and are, for the most part, Year 2000 compliant, including certain point of sale systems, human resources and financial reporting systems. The Company's plan devoted the necessary resources to identify and modify systems potentially impacted by Year 2000, or implement new systems to become Year 2000 compliant in a timely manner. In 1999, the Company executed its year 2000 plan as systems potentially impacted by Year 2000 were identified and, if necessary, were modified. In addition, the Company developed contingency plans for key operational areas that could have been impacted by the Year 2000 problem. Total expenditures for the Year 2000 plan were approximately $2.6 million. The Company did not incur any significant Year 2000 issues during, or after, the move into the new calendar year. 27 29 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. The Company's operations are subject to market risks primarily from changes in interest rates. The Company has immaterial exposure to exchange rate risk. The Company has managed its interest rate risk by entering into interest rate swap agreements and balancing its debt portfolio with both fixed and floating rate borrowings. As of January 2, 2000, the Company was a party to interest rate swaps covering $125.0 million in principal amount of indebtedness and expiring in December 2000. These swaps exchange the Company's floating interest rate exposure on $125.0 million in debt for fixed interest rate exposure. The Company will pay a weighted average fixed rate of 5.97% on the $125.0 million notional amount rather than the three-month LIBOR rate, which was 6.18% as of January 2, 2000. The fair value of the interest rate swap agreements was ($2.3) million as of January 2, 2000. The following table summarizes as of January 2, 2000, the amount of fixed interest rate indebtedness and the amount of variable rate indebtedness that will become due in the stated period. See Note L to the Consolidated Financial Statements. CONTRACTUAL MATURITY DATES OF TERM LOAN AND LONG-TERM DEBT AS OF 1/2/00 (INCLUDING CURRENT PORTION)
2000 2001 2002 2003 2004 THEREAFTER TOTAL FAIR VALUE ------- -------- ------- -------- -------- ---------- -------- ---------- (IN THOUSANDS) Fixed Rate Debt............ $ 5,612 $ 18,382 $ 4,926 $155,389 $158,472 $47,867 $390,648 $109,838 Average interest rate...... 8.91% 8.92% 8.92% 8.91% 8.83% 8.39% Variable Rate Debt......... 27,667 98,500 12,192 -- -- -- 138,359 137,837 -------- -------- Average interest rate...... 7.94% 7.93% 7.03% --% --% --% Total Debt........ $33,279 $116,882 $17,118 $155,389 $158,472 $47,867 $529,007 $247,675 ======== ========
EXPECTED MATURITY DATES OF TERM LOAN AND LONG-TERM DEBT AS OF 1/3/99 (INCLUDING CURRENT PORTION)
1999 2000 2001 2002 2003 THEREAFTER TOTAL FAIR VALUE ------- ------- ------- -------- -------- ---------- -------- ---------- (IN THOUSANDS) Fixed Rate Debt............. $ 3,903 $ 4,417 $18,623 $ 5,074 $155,884 $217,591 $405,492 $164,171 Average interest rate....... 8.96% 8.96% 8.97% 8.97% 9.07% 9.05% Variable Rate Debt.......... 20,138 17,333 3,962 220,008 0 20,300 281,741 272,010 -------- -------- Average interest rate....... 7.09% 7.19% 7.53% 8.26% 3.72% 3.72% Total Debt......... $24,041 $21,750 $22,585 $225,082 $155,884 $237,891 $687,233 $436,181 ======== ========
On March 27, 1999, the Debtors filed the Chapter 11 Cases. As a result of the filing of the Chapter 11 Cases, principal or interest payments may not be made on any pre-petition debt until a plan of reorganization defining the repayment terms has been approved by the Bankruptcy Court. 28 30 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA SERVICE MERCHANDISE COMPANY, INC. AND SUBSIDIARIES (DEBTORS-IN-POSSESSION) CONSOLIDATED STATEMENTS OF OPERATIONS
FISCAL YEAR ENDED ---------------------------------------- JANUARY 2, JANUARY 3, DECEMBER 28, 2000 1999 1997 ---------- ---------- ------------ (IN THOUSANDS, EXCEPT PER SHARE DATA) Net sales: Operations excluding closed facilities.................... $1,970,611 $2,255,595 $2,437,792 Closed facilities......................................... 259,889 913,930 1,224,986 ---------- ---------- ---------- 2,230,500 3,169,525 3,662,778 Cost of merchandise sold and buying and occupancy expenses: Operations excluding closed facilities.................... 1,476,883 1,690,113 1,817,709 Closed facilities......................................... 259,065 725,143 994,053 ---------- ---------- ---------- 1,735,948 2,415,256 2,811,762 ---------- ---------- ---------- Gross margin after cost of merchandise sold and buying and occupancy expenses: Operations excluding closed facilities.................... 493,728 565,482 620,083 Closed facilities......................................... 824 188,787 230,933 ---------- ---------- ---------- 494,552 754,269 851,016 ---------- ---------- ---------- Selling, general and administrative expenses: Operations excluding closed facilities.................... 483,911 552,016 516,612 Closed facilities......................................... 96,853 157,069 213,018 ---------- ---------- ---------- 580,764 709,085 729,630 ---------- ---------- ---------- Other income, net........................................... (38,402) (12,927) (2,571) Restructuring charge (credit)............................... 76,743 (14,895) 129,510 Impairment of assets........................................ -- 43,079 -- Depreciation and amortization: Operations excluding closed facilities.................... 40,063 43,034 41,877 Closed facilities......................................... 2,501 14,038 16,371 ---------- ---------- ---------- 42,564 57,072 58,248 ---------- ---------- ---------- Reorganization items (income)............................... (1,823) -- -- ---------- ---------- ---------- Loss before interest, income tax, extraordinary item, and cumulative effect of a change in accounting principle..... (165,294) (27,145) (63,801) Interest expense (contractual interest $87,360 for the year ended January 2, 2000).................................... 64,835 83,255 78,531 ---------- ---------- ---------- Loss before income tax, extraordinary item, and cumulative effect of a change in accounting principle................ (230,129) (110,400) (142,332) Income tax benefit.......................................... (874) (93) (53,375) ---------- ---------- ---------- Loss before extraordinary item and cumulative effect of a change in accounting principle............................ (229,255) (110,307) (88,957) Extraordinary loss from early extinguishment of debt........ (7,851) -- (2,643) Cumulative effect of a change in recording layaway sales.... (6,566) -- -- ---------- ---------- ---------- Net loss.................................................... $ (243,672) $ (110,307) $ (91,600) ========== ========== ========== Loss Per Common Share -- basic and diluted: Loss before extraordinary item and cumulative effect of a change in accounting principle............................ $ (2.30) $ (1.11) $ (0.89) Extraordinary loss from early extinguishment of debt........ (0.08) -- (0.03) Cumulative effect of a change in recording layaway sales.... (0.07) -- -- ---------- ---------- ---------- Net loss.................................................... $ (2.45) $ (1.11) $ (0.92) ========== ========== ========== Pro forma amounts assuming the new layaway sales recognition is applied retroactively: Loss before extraordinary item.............................. $ (229,255) $ (109,078) $ (84,888) Loss per common share -- basic and diluted.................. $ (2.30) $ (1.09) $ (0.85) Net loss.................................................... $ (237,106) $ (109,078) $ (87,531) Loss per common share -- basic and diluted.................. $ (2.38) $ (1.09) $ (0.88)
The accompanying notes are an integral part of these consolidated financial statements. 29 31 SERVICE MERCHANDISE COMPANY, INC. AND SUBSIDIARIES (DEBTORS-IN-POSSESSION) CONSOLIDATED BALANCE SHEETS
JANUARY 2, JANUARY 3, 2000 1999 ---------- ---------- (IN THOUSANDS, EXCEPT PER SHARE DATA) ASSETS Current Assets: Cash and cash equivalents................................. $ 61,591 $ 133,749 Accounts receivable, net of allowance of $19,474 and $2,999, respectively................................... 13,171 38,098 Refundable income taxes................................... -- 10,769 Inventories............................................... 642,997 896,303 Prepaid expenses and other assets......................... 29,135 24,379 ---------- ---------- TOTAL CURRENT ASSETS.............................. 746,894 1,103,298 Net property and equipment -- owned......................... 353,078 439,710 Net property and equipment -- leased........................ 14,636 21,297 Other assets and deferred charges........................... 47,336 62,590 ---------- ---------- TOTAL ASSETS...................................... $1,161,944 $1,626,895 ========== ========== LIABILITIES AND SHAREHOLDERS' (DEFICIT) EQUITY Liabilities Not Subject To Compromise Current Liabilities: Notes payable............................................. $ 42,977 $ 156,000 Accounts payable.......................................... 67,318 228,373 Accrued expenses.......................................... 181,860 224,813 State and local sales taxes............................... 28,737 1,726 Accrued restructuring costs............................... 38 7,864 Borrowings classified as current.......................... 1,000 220,041 Current maturities of capitalized lease obligations....... 86 8,501 ---------- ---------- TOTAL CURRENT LIABILITIES......................... 322,016 847,318 Long Term Liabilities: Accrued restructuring costs............................... -- 45,297 Long-term debt............................................ 98,500 467,192 Capitalized lease obligations............................. 2,514 41,193 ---------- ---------- TOTAL LONG-TERM LIABILITIES....................... 101,014 553,682 Liabilities Subject To Compromise........................... 755,975 -- ---------- ---------- TOTAL LIABILITIES................................. 1,179,005 1,401,000 ---------- ---------- Commitments and contingencies (Note R) SHAREHOLDERS' (DEFICIT) EQUITY Preferred stock, $1 par value, authorized, 4,600 shares, undesignated as to rate and other rights, none issued................................................. -- -- Series A Junior Preferred Stock, $1 par value, authorized 1,100 shares, none issued.............................. -- -- Common stock, $.50 par value, authorized 500,000 shares, issued and outstanding 100,012 and 100,340 shares, respectively........................................... 50,006 50,170 Additional paid-in capital................................ 6,424 7,680 Deferred compensation..................................... (708) (1,975) Accumulated other comprehensive loss...................... -- (869) Retained (deficit) earnings............................... (72,783) 170,889 ---------- ---------- TOTAL SHAREHOLDERS' (DEFICIT) EQUITY.............. (17,061) 225,895 ---------- ---------- TOTAL LIABILITIES AND SHAREHOLDERS' (DEFICIT) EQUITY.......................................... $1,161,944 $1,626,895 ========== ==========
The accompanying notes are an integral part of these consolidated financial statements. 30 32 SERVICE MERCHANDISE COMPANY, INC. AND SUBSIDIARIES (DEBTORS-IN-POSSESSION) CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' (DEFICIT) EQUITY
ACCUMULATED COMMON STOCK OTHER ----------------- ADDITIONAL COMPREHENSIVE RETAINED COMMON PAR PAID-IN DEFERRED INCOME (DEFICIT) SHARES VALUE CAPITAL COMPENSATION (LOSS) EARNINGS TOTAL ------- ------- ---------- ------------ ------------- --------- --------- (IN THOUSANDS) BALANCE DECEMBER 29, 1996.......... 99,758 $49,879 $ 5,670 $(1,251) $ -- $ 372,796 $ 427,094 Net loss......................... -- -- -- -- -- (91,600) (91,600) Exercise of stock options........ 57 29 75 -- -- -- 104 Shares issued under restricted stock awards................... 621 310 2,393 (2,703) -- -- -- Amortization of deferred compensation................... -- -- -- 948 -- -- 948 Cancellation/forfeiture of restricted stock............... (60) (30) (230) 219 -- -- (41) ------- ------- ------- ------- ----- --------- --------- BALANCE DECEMBER 28, 1997.......... 100,376 50,188 7,908 (2,787) -- 281,196 336,505 Comprehensive loss: Net loss....................... -- -- -- -- -- (110,307) (110,307) Minimum pension liability adjustment................... -- -- -- -- (869) -- (869) --------- Comprehensive net loss......... (111,176) Shares issued under restricted stock awards................... 50 25 83 (108) -- -- -- Amortization of deferred compensation................... -- -- -- 625 -- -- 625 Cancellation/forfeiture of restricted stock............... (86) (43) (311) 295 -- -- (59) ------- ------- ------- ------- ----- --------- --------- BALANCE JANUARY 3, 1999............ 100,340 50,170 7,680 (1,975) (869) 170,889 225,895 Comprehensive loss: Net loss....................... -- -- -- -- -- (243,672) (243,672) Minimum pension liability adjustment................... -- -- -- -- 869 -- 869 --------- Comprehensive net loss......... (242,803) Amortization of deferred compensation................... -- -- -- 356 -- -- 356 Cancellation/forfeiture of restricted stock............... (328) (164) (1,256) 911 -- -- (509) ------- ------- ------- ------- ----- --------- --------- BALANCE JANUARY 2, 2000............ 100,012 $50,006 $ 6,424 $ (708) $ -- $ (72,783) $ (17,061) ======= ======= ======= ======= ===== ========= =========
The accompanying notes are an integral part of these consolidated financial statements. 31 33 SERVICE MERCHANDISE COMPANY, INC. AND SUBSIDIARIES (DEBTORS-IN-POSSESSION) CONSOLIDATED STATEMENTS OF CASH FLOWS
FISCAL YEAR ENDED -------------------------------------- JANUARY 2, JANUARY 3, DECEMBER 28, 2000 1999 1997 ---------- ---------- ------------ (IN THOUSANDS) CASH FLOWS FROM OPERATING ACTIVITIES: Net loss.................................................. $(243,672) $(110,307) $ (91,600) Adjustments to reconcile net loss to net cash Provided (used) by operating activities: Extraordinary loss from early extinguishment of debt... 7,851 -- -- Cumulative effect of a change in accounting principle -- layaway sales........................... 6,566 -- -- Depreciation and amortization(a)....................... 57,059 63,820 62,345 Deferred income tax.................................... -- 24,303 (39,663) Provision for write-off of bad debts................... 17,810 (457) -- Net gain on sale of property and equipment............. (19,567) (12,927) (2,571) Provision for write-down of restricted cash............ 8,819 -- -- Write-down of property and equipment due to asset impairment........................................... -- 43,079 -- Write-down of property and equipment due to restructuring........................................ 16,809 -- 32,915 Reorganization items................................... (1,823) -- -- Reversal of restructuring charges...................... -- (14,895) -- Write-off of debt issue costs.......................... -- -- 2,208 Changes in assets and liabilities: Accounts receivable.................................. (6,358) 5,489 18,324 Inventories.......................................... 256,800 33,515 123,151 Prepaid expenses and other assets.................... 3,644 (7,576) (1,368) Accounts payable..................................... 28,822 (253,862) (157,652) Accrued expenses..................................... 19,178 (36,872) (9,866) Accrued restructuring costs.......................... 29,932 (13,892) 76,242 Income tax........................................... 10,769 (10,769) (33,898) --------- --------- --------- NET CASH PROVIDED (USED) BY OPERATING ACTIVITIES:.... 192,639 (291,351) (21,433) --------- --------- --------- CASH FLOWS FROM INVESTING ACTIVITIES: Additions to property and equipment -- owned.............. (22,957) (50,676) (40,838) Proceeds from sale of property and equipment.............. 49,434 44,845 19,574 Proceeds from sale of property and equipment -- reorganization............................ 4,592 -- -- Restricted cash and other assets, net..................... 8,769 (30,358) (2,006) --------- --------- --------- NET CASH PROVIDED (USED) BY INVESTING ACTIVITIES:.... 39,838 (36,189) (23,270) --------- --------- ---------
32 34 SERVICE MERCHANDISE COMPANY, INC. AND SUBSIDIARIES (DEBTORS-IN-POSSESSION) CONSOLIDATED STATEMENTS OF CASH FLOWS -- (CONTINUED)
FISCAL YEAR ENDED -------------------------------------- JANUARY 2, JANUARY 3, DECEMBER 28, 2000 1999 1997 ---------- ---------- ------------ (IN THOUSANDS) CASH FLOWS FROM FINANCING ACTIVITIES: Short-term borrowings, net................................ (113,023) 156,000 -- Proceeds from long-term debt.............................. 150,000 -- 206,560 Repayment of term loan and long-term debt................. (308,226) (48,002) (101,999) Repayment of capitalized lease obligations................ (6,363) (8,649) (8,395) Debt issuance costs....................................... (22,764) (2,170) (17,350) Debt issuance costs -- reorganization..................... (3,750) -- -- Exercise of stock options (forfeiture of restricted stock), net............................................ (509) (59) 63 --------- --------- --------- NET CASH (USED) PROVIDED BY FINANCING ACTIVITIES..... (304,635) 97,120 78,879 --------- --------- --------- NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS........ (72,158) (230,420) 34,176 CASH AND CASH EQUIVALENTS -- BEGINNING OF YEAR.............. 133,749 364,169 329,993 --------- --------- --------- CASH AND CASH EQUIVALENTS -- END OF YEAR.................... $ 61,591 $ 133,749 $ 364,169 ========= ========= ========= SUPPLEMENTAL DATA: Cash paid (received) during the year for: Interest.................................................. $ 47,308 $ 63,632 $ 78,400 Income tax................................................ $ (19,200) $ (17,442) $ 21,100 Reorganization items...................................... $ 20,420 $ -- $ -- Non-cash financing activities: Other comprehensive income (loss)......................... $ 869 $ (869) $ -- Addition to property -- capital lease..................... $ 2,600 $ -- $ --
- --------------- (a) Includes other amortization classified as either selling, general and administrative expense or interest expense of $14,495 for fiscal 1999, $6,748 for fiscal 1998, $4,058 for fiscal 1997, and $39 of discount amortization classified as interest expense in fiscal 1997. The accompanying notes are an integral part of these consolidated financial statements. 33 35 SERVICE MERCHANDISE COMPANY, INC. AND SUBSIDIARIES (DEBTORS-IN-POSSESSION) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE THREE YEARS ENDED JANUARY 2, 2000 A. DESCRIPTION OF THE BUSINESS The Company is one of the nation's largest retailers of jewelry and offers a selection of brand-name hard goods and other product lines. The major categories of goods offered by the Company are fine jewelry, kitchen and dining, home accents and furniture, looking healthy/staying healthy, season to season, travel and adventure, electronics and kid essentials. Customer purchases typically take place in a Company store, by telephone, or via the internet. The Company is engaged in a highly competitive business and competes with most nationally known jewelry and general retail merchandisers, including department, general merchandise, specialty and discount stores. As of January 2, 2000, the Company operated 223 stores in 32 states. B. PROCEEDINGS UNDER CHAPTER 11 OF THE BANKRUPTCY CODE Proceedings Under Chapter 11 of the Bankruptcy Code On March 15, 1999, five of the Company's vendors filed an involuntary petition for reorganization under Chapter 11 ("Chapter 11") of title 11 of the United States Bankruptcy Code (the "Bankruptcy Code") in the United States Bankruptcy Court for the Middle District of Tennessee (the "Bankruptcy Court") seeking court supervision of the Company's restructuring efforts. On March 27, 1999, the Company and 31 of its subsidiaries (collectively, the "Debtors") filed voluntary petitions with the Bankruptcy Court for reorganization under Chapter 11 under case numbers 399-02649 through 399-02680 (the "Chapter 11 Cases") and orders for relief were entered by the Bankruptcy Court. The Chapter 11 Cases have been consolidated for the purpose of joint administration under Case No. 399-02649. The Debtors are currently operating their businesses as debtors-in-possession pursuant to the Bankruptcy Code. Under the Bankruptcy Code, actions to collect pre-petition indebtedness are stayed and other contractual obligations against the Debtors may not be enforced. In addition, under the Bankruptcy Code the Debtors may assume or reject executory contracts, including lease obligations. Parties affected by these rejections may file claims with the Bankruptcy Court in accordance with the reorganization process. Substantially all pre-petition liabilities are subject to settlement under a plan of reorganization to be voted upon by creditors and equity holders and approved by the Bankruptcy Court. Although the Debtors expect to file a reorganization plan or plans that provide for emergence from bankruptcy in 2000 or 2001, there can be no assurance that a reorganization plan or plans will be proposed by the Debtors or confirmed by the Bankruptcy Court, or that any such plan(s) will be consummated. As provided by the Bankruptcy Code, the Debtors initially had the exclusive right to submit a plan of reorganization for 120 days. On May 25, 1999, the Company received Court approval to extend the period in which the Company has the exclusive right to file or advance a plan of reorganization in its Chapter 11 case. The order extended the Company's exclusive right to file a plan from July 23, 1999 to February 29, 2000, and extended the Company's exclusive right to solicit acceptances of its plan from September 21, 1999 to May 1, 2000. In January 2000, the Company pursued a second extension of the exclusivity period prior to its expiration. On February 2, 2000, the Company received Court approval to extend the period in which the Company has the exclusive right to file or advance a plan from February 29, 2000 to April 30, 2001 and extend the Company's right to solicit acceptances of its plan from May 1, 2000 to June 30, 2001. If the Debtors fail to file a plan of reorganization during such period or extension thereof or if such plan is not accepted by the required number of creditors and equity holders, any party in interest may subsequently file its own plan of reorganization for the Debtors. A plan of reorganization must be confirmed by the Bankruptcy Court, upon certain findings being made by the Bankruptcy Court which are required by the Bankruptcy Code. The Bankruptcy Court may confirm a plan notwithstanding the non-acceptance of the plan by an impaired class of creditors or equity security holders if certain requirements of the Bankruptcy Code are met. A plan of reorganization could also result in holders of the Common Stock receiving no value for their 34 36 SERVICE MERCHANDISE COMPANY, INC. AND SUBSIDIARIES (DEBTORS-IN-POSSESSION) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) interests. Because of such possibilities, the value of the Common Stock is highly speculative, and may have no value. C. FINANCIAL STATEMENT PRESENTATION AND GOING CONCERN MATTERS The accompanying consolidated financial statements have been prepared on a going concern basis of accounting and in accordance with AICPA Statement of Position ("SOP") 90-7 "Financial Reporting by Entities in Reorganization Under the Bankruptcy Code." The Company's consolidated statements of operations presentation changed in fiscal 1997 to disclose the financial statement impact of the inventory liquidations associated with the closed facilities as a result of restructuring and remerchandising activities. The line item "Closed facilities" represents activity specifically identifiable to inventory liquidations conducted in conjunction with (1) the Company's restructuring plan adopted on March 25, 1997 ("Restructuring Plan"); (2) the Company's rationalization plan adopted on March 8, 1999 ("Rationalization Plan") and (3) exiting the computer, infant, pet supply and other merchandise categories and certain components of the wireless communication and sporting goods categories as part of a remerchandising program. As of January 2, 2000, primarily all of the aforementioned merchandise categories have been liquidated. All activity for these items is classified in "Closed facilities." Prior year amounts reflect operating results for these same facilities and merchandise classifications. Selling, general and administrative expenses for closed facilities do not include any allocation of corporate overhead. The Company's recent losses and the Chapter 11 Cases raise substantial doubt about the Company's ability to continue as a going concern. The consolidated financial statements do not include any adjustments relating to recoverability and classification of recorded asset amounts or the amount and classification of liabilities that might be necessary should the Company be unable to continue as a going concern. The ability of the Company to continue as a going concern and appropriateness of using the going concern basis is dependent upon, among other things, (i) the Company's ability to comply with its debtor-in-possession financing agreements, (ii) confirmation of a plan of reorganization under the Bankruptcy Code, (iii) the Company's ability to achieve profitable operations after such confirmation, and (iv) the Company's ability to generate sufficient cash from operations to meet its obligations. As described in Note B, the Company intends to submit a plan for reorganization to the Bankruptcy Court. Management believes that the plan of reorganization, as it is being developed and subject to approval of the Bankruptcy Court, along with cash provided by the debtor-in-possession facility and operations, will provide sufficient liquidity to allow the Company to continue as a going concern; however, there can be no assurance that the sources of liquidity will be available or sufficient to meet the Company's needs. A plan of reorganization could materially change the amounts currently recorded in the consolidated financial statements. The consolidated financial statements do not give effect to any adjustment to the carrying value of assets or amounts and classifications of liabilities that might be necessary as a result of the Chapter 11 Cases. The Company continues to develop its fiscal 2000 business plans, which may include additional store closings, changes in merchandise assortments, changes in its distribution networks and overhead costs; and is considering various options with respect to the Restated Retirement Plan, the ESP and the Savings and Investment Plan, which may include reinstatement, amendments, termination or substitution of such plans, among other things. D. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Principles of consolidation: The consolidated financial statements include the accounts of the Company and its subsidiaries, all of which are wholly-owned. All significant intercompany transactions and balances have been eliminated. 35 37 SERVICE MERCHANDISE COMPANY, INC. AND SUBSIDIARIES (DEBTORS-IN-POSSESSION) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Fiscal year: The Company maintains its books using a 52/53 week year ending on the Sunday closest to the end of the calendar year. There were 52 weeks in the fiscal years ended January 2, 2000 and December 28, 1997. There were 53 weeks in the fiscal year ended January 3, 1999. Use of estimates: The preparation of the consolidated financial statements, in conformity with generally accepted accounting principles, requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and related notes to the consolidated financial statements. Changes in such estimates may affect amounts reported in future periods. Cash and cash equivalents: Cash and cash equivalents include cash on hand and short-term, highly liquid investments which generally include commercial paper and institutional money market funds with an original maturity date less than 30 days. These investments are valued at cost, which approximates market, and have a weighted-average interest rate of 5.8% for the fiscal year ended January 3, 1999. There were no investments recorded at January 2, 2000. Accounts receivable: Accounts receivable includes primarily trade accounts, vendor allowances and receivables for income earned on the private label credit card. Inventories: Inventories are valued at the lower of cost or market. Cost is determined utilizing the first-in, first-out method and includes certain buying and warehousing costs. Advertising: The Company generally expenses the costs of producing and distributing advertising the first time the advertising takes place. Net advertising expense was $110.6 million, $133.0 million and $135.0 million for fiscal 1999, 1998 and 1997, respectively. Advertising costs of $5.6 million and $10.6 million were included in prepaid expenses at January 2, 2000 and January 3, 1999, respectively. Property and equipment -- owned: Owned property and equipment are stated at cost. Depreciation and amortization are provided principally on the straight-line method over a period of five to 10 years for furniture, fixtures and equipment and 30 years for buildings. Leasehold improvements are depreciated over the lesser of the life of the asset or the real estate lease term. Property and equipment -- capitalized leases: Capitalized leases are recorded at the lower of fair value of the leased property or the present value of the minimum lease payments at the inception of the lease. Amortization of leased property is computed using the straight-line method over the lesser of the life of the leased asset or the term of the lease. Deferred charges and other assets: Deferred charges consist primarily of debt issuance costs and deferred finance charges which are amortized over the life of the related debt. This amortization is classified as interest expense. Other assets include restricted cash required by the World Financial Network National Bank private label credit card agreement. Derivative financial instruments: As part of a strategy to maintain an acceptable level of exposure to the risk of interest rate fluctuation, the Company has developed a targeted mix of fixed-rate versus variable rate debt. The Company utilizes interest rate swaps to manage this mix. All outstanding interest rate swaps have been designated as hedges of debt instruments. The Company recognizes interest differentials as adjustments to interest expense in the period they occur. Gains and losses on terminations of interest rate swaps would be deferred and amortized to interest expense over the shorter of the original term of the agreements or the remaining life of the associated outstanding debt. The counterparties to these instruments are major financial institutions. The fair value of the Company's interest rate swap agreements is based on dealer quotes. These values represent the amounts the Company would receive or pay to terminate the agreements taking into consideration current interest rates. These counterparties expose the Company to credit risk in the event of non-performance; however, the Company does not anticipate non-performance by the other parties. The Company does not hold or issue derivative financial instruments for trading purposes. 36 38 SERVICE MERCHANDISE COMPANY, INC. AND SUBSIDIARIES (DEBTORS-IN-POSSESSION) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities." This pronouncement was to be effective for all fiscal quarters of fiscal years beginning after June 15, 1999. In June 1999, the FASB issued SFAS No. 137, "Accounting for Derivative Instruments and Hedging Activities -- Deferral of the Effective Date of FASB Statement No. 133." This pronouncement postpones the effective date of SFAS No. 133 to all fiscal quarters of fiscal years beginning after June 15, 2000. The Company is currently in the process of analyzing the impact of the adoption of this Statement. Impairment of assets: The Company reviews long-lived assets for impairment whenever events or changes in circumstances indicate that net book value of the asset may not be recoverable in accordance with the SFAS No. 121, "Accounting for Impairment of Long-Lived Assets to Be Disposed Of." The impact of SFAS No. 121 for fiscal 1998 is disclosed in Note G in these consolidated financial statements. Stock-based compensation: The Company accounts for stock-based employee compensation in accordance with Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations. The pro forma impact of the fair value method of accounting for stock-based employee compensation is disclosed in Note M to these consolidated financial statements in accordance with SFAS No. 123, "Accounting for Stock-Based Compensation." Store opening costs: Costs of opening new stores are charged to operations as incurred. Income tax: The Company reports income taxes in accordance with SFAS No. 109, "Accounting for Income Taxes." Under SFAS No. 109, the asset and liability method is used for computing future income tax consequences of events, which have been recognized in the Company's consolidated financial statements or income tax returns. Deferred income tax expense or benefit is the change during the year in the Company's deferred income tax assets and liabilities. Net earnings (loss) per common share: Net earnings (loss) per common share for all periods have been computed in accordance with SFAS No. 128, "Earnings Per Share." Basic net earnings (loss) per common share is computed by dividing net earnings (loss) by the weighted average number of common shares outstanding during the year. Diluted net earnings (loss) per common share is computed by dividing net earnings (loss) by the weighted-average number of common shares outstanding during the year plus incremental shares that would have been outstanding upon the assumed vesting of dilutive restricted stock and the assumed exercise of dilutive stock options. See Note N for a reconciliation of basic and diluted earnings (loss) per share. Comprehensive income (loss): Comprehensive income (loss) is reported in accordance with SFAS No. 130, "Reporting Comprehensive Income." Other comprehensive income (loss) includes minimum pension liability adjustments. See Note P for reporting of minimum pension liabilities. Cumulative effect of a change in accounting principle: The Company changed its method of accounting for layaway sales. Layaway sales for 1999 have been recognized upon delivery of merchandise to the customer. Layaway sales in prior years were recognized when the initial layaway deposit was received. The Company changed its method of accounting for layaway sales in response to the Securities and Exchange Commission's Staff Accounting Bulletin: No. 101 -- Revenue Recognition In Financial Statements. The amount of cash received upon initiation of the layaway is recorded as a deposit liability within accrued expenses. The cumulative effect of the change for periods prior to fiscal 1999 is an increase in net loss of $6,566 or ($0.07) per share. The pro forma amounts shown on the Consolidated Statement of Operations have been adjusted for the effect of retroactive application on sales and cost of sales. See Note U. Retirement Plans and Other Postretirement Benefits: The Company reports all information on its retirement plans and other postretirement benefits in accordance with SFAS No. 132, "Employers' Disclosure 37 39 SERVICE MERCHANDISE COMPANY, INC. AND SUBSIDIARIES (DEBTORS-IN-POSSESSION) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) about Pensions and Other Postretirement Benefits". All periods reported have been stated in accordance with SFAS 132. See Note P. Segment Reporting: The Company adopted SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information" in 1998. See Note T. Reclassification: Certain reclassifications have been made to fiscal 1998 and 1997 to conform to the fiscal 1999 presentation. E. RESTRUCTURING PLANS 1997 Restructuring Plan On March 25, 1997, the Company adopted a business-restructuring plan to close up to 60 under performing stores and one distribution center (the "1997 Restructuring Plan"). As a result, a pre-tax charge of $129.5 million for restructuring costs was recorded in the first quarter of fiscal 1997. The components of the restructuring charge and an analysis of the amounts charged against the accrual for the fiscal year ended January 2, 2000 are outlined in the following table:
ACCRUED 1999 ACTIVITY ACCRUED RESTRUCTURING --------------------------------------- RESTRUCTURING COSTS AS OF RESTRUCTURING ASSET CHANGE IN COSTS AS OF JANUARY 3, 1999 COSTS PAID WRITE-DOWNS ESTIMATE JANUARY 2, 2000 --------------- ------------- ----------- --------- --------------- (IN THOUSANDS) Lease termination and other real estate costs................... $53,161 $(1,780) $ -- $(43,487) $7,894 Property and equipment write-downs............. -- -- 2,489 (2,489) -- ------- ------- ------ -------- ------ Total........... $53,161 $(1,780) $2,489 $(45,976) $7,894 ======= ======= ====== ======== ======
Note: The Accrued Restructuring Costs as of January 2, 2000 are included in liabilities subject to compromise. The closing of nine stores during the first half of fiscal 1998 brought the total number of closures, in accordance with the 1997 Restructuring Plan, to 53 stores and one distribution center. Store closures were completed as of May 1998. The Company closed less than 60 stores primarily due to the inability to negotiate acceptable exit terms from the related lessors. Restructuring costs paid during the fiscal year ended January 2, 2000, relate primarily to lease termination and other real estate costs. The Company incurred $1.1 million in contractual rent payments and lease termination fees and $0.6 million in other real estate costs primarily related to utilities, common area maintenance fees, real estate taxes and brokerage costs. In connection with the Chapter 11 Cases, an initial change in estimate of $46.0 million was made to reflect the reduction allowed under Section 502(b)(6) of the Bankruptcy Code and recorded as a reorganization item. Amounts had been accrued according to the remaining leasehold obligations. Section 502(b)(6) limits a lessor's claim to the rent reserved by such lease, without acceleration, for the greater of one year, or 15 percent of the remaining lease, not to exceed three years. Any unpaid rent is included in the claim. Partially offsetting this reduction is a $2.5 million increase in estimate, resulting in a net change in estimate at January 2, 2000 of $43.5 million related to lease termination and other real estate costs. The leases remaining on closed locations as of January 2, 2000 vary in length with expiration dates ranging from January 2000 to October 2018. 38 40 SERVICE MERCHANDISE COMPANY, INC. AND SUBSIDIARIES (DEBTORS-IN-POSSESSION) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) As of January 2, 2000, property and equipment associated with the 1997 Restructuring Plan have been written-down to reflect their estimated fair value. The Company anticipates selling or abandoning substantially all remaining owned property and equipment associated with the 1997 Restructuring Plan. Approximately 3,000 employees were terminated pursuant to the 1997 Restructuring Plan. All such terminations were completed as of May 1998. Rationalization Plan In February 1999, the Company announced a rationalization plan to close up to 132 stores, up to four distribution centers and to reduce corporate overhead (the "Rationalization Plan"). On March 8, 1999, as part of the Rationalization Plan and prior to the filing of the involuntary bankruptcy petition, the Board of Directors approved the adoption of a business restructuring plan to close 106 stores, to close the Dallas distribution center and to reduce the Company's workforce at its Nashville corporate offices by 150 employees. As a result, a pre-tax charge of $99.5 million for restructuring costs was recorded in the first quarter of 1999. On March 29, 1999 and in connection with the Chapter 11 Cases, store leases under this plan were approved for rejection by the Bankruptcy Court. The components of the restructuring charge and the amounts charged against the accrual through fiscal year ended January 2, 2000 are outlined in the following table.
1999 ACTIVITY INITIAL CHARGE ------------------------------------ ACCRUED RECORDED IN ASSET CHANGE IN COSTS AS OF MARCH 1999 COSTS PAID WRITE-DOWNS ESTIMATE JANUARY 2, 2000 -------------- ---------- ----------- --------- --------------- (IN THOUSANDS) Lease termination and other real estate costs.......... $62,469 $ (9,297) $ -- $(14,857) $38,315 Property and equipment write- downs...................... 24,452 -- (19,298) (5,154) -- Employee severance........... 12,533 (9,237) -- (2,818) 478 ------- -------- -------- -------- ------- Total.............. $99,454 $(18,534) $(19,298) $(22,829) $38,793 ======= ======== ======== ======== =======
Note: The Accrued Costs as of January 2, 2000 are included in liabilities subject to compromise. The stores planned for closure included both owned and leased properties. Lease termination and other real estate costs consist principally of the remaining rental payments required under the closing stores' and distribution center lease agreements under Section 502(b)(6) of the Bankruptcy Code, net of any actual or reasonably probable sublease income. Section 502(b)(6) limits the lessor's claim to the rent reserved by such lease, without acceleration, for the greater of one year, or 15 percent of the remaining term of the lease, not to exceed three years. Any unpaid rent is included in the claim. The Company experienced lower than expected expenses in lease terminations, dispositions of closed stores and severance payments during the fiscal year ended January 2, 2000. As a result, the Company reduced its estimate for these costs by $23.0 million. Restructuring costs paid during the fiscal year ended January 2, 2000, relate primarily to lease termination and other real estate costs. The Company incurred $2.3 million in contractual rent payments and lease termination fees, $7.0 million in other real estate costs primarily related to utilities, common area maintenance fees, real estate taxes and brokerage costs, and $9.2 million in severance costs. After taking into effect the above asset write-downs, the Company's carrying value of the property and equipment associated with the Rationalization Plan closures is $1.8 million as of January 2, 2000. This entire amount is classified as available for sale as all store closures are now complete. Assets available for sale are considered current assets and are included with "Prepaid expenses and other assets". The Company anticipates selling substantially all owned property and equipment associated with the closures. 39 41 SERVICE MERCHANDISE COMPANY, INC. AND SUBSIDIARIES (DEBTORS-IN-POSSESSION) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) The employee severance provision was recorded for the planned termination of approximately 4,400 employees associated with the closures, as well as the reduction of corporate overhead. Substantially all such terminations were completed as of December 1999. F. PROPERTY AND EQUIPMENT Property and equipment consist of the following:
JANUARY 2, JANUARY 3, 2000 1999 ---------- ---------- (IN THOUSANDS) Owned assets: Land........................................................ $ 84,039 $ 97,161 Buildings................................................... 297,761 386,071 Furniture, fixtures and equipment........................... 293,368 399,221 Leasehold improvements...................................... 70,622 108,375 Construction in progress.................................... -- 66 Other....................................................... 1,990 2,484 --------- --------- 747,780 993,378 Less: Accumulated depreciation and amortization............. (394,702) (553,668) --------- --------- Owned assets, net........................................... $ 353,078 $ 439,710 ========= ========= Capitalized leases: Real estate................................................. $ 55,710 $ 93,251 Furniture, fixtures and equipment........................... 1,598 7,046 --------- --------- 57,308 100,297 Less: Accumulated amortization.............................. (42,672) (79,000) --------- --------- Capitalized leases, net..................................... $ 14,636 $ 21,297 ========= =========
G. IMPAIRED ASSETS In the fourth quarter of fiscal 1998, the Company recorded a non-cash impairment loss of $43.1 million related to a write-down of the Company's fixed assets. The Company performed a long-lived impairment analysis due to projected cash flow losses combined with current operating and cash flow losses at certain store locations. Assets are evaluated for impairment on an individual store basis which management believes is the lowest level for which there are identifiable cash flows. Projected future cash flows (undiscounted and without interest) were compared to the carrying amount of assets at each location. If the carrying amount of the assets exceeded the projected future cash flows, an impairment loss was recognized. Impaired assets were written-down to their estimated fair value. Fair value was based on sales of similar assets or other estimates of fair value such as discounting estimated future cash flows. Considerable management judgment is necessary to 40 42 SERVICE MERCHANDISE COMPANY, INC. AND SUBSIDIARIES (DEBTORS-IN-POSSESSION) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) estimate fair value. Accordingly, actual results could vary significantly from such estimates. The following table is a summary of the impairment charges recognized:
1998 IMPAIRMENT AMOUNT -------------- (IN THOUSANDS) Land........................................... $ 3,196 Buildings...................................... 6,501 Furniture and Fixtures......................... 16,470 Leasehold Improvements......................... 12,011 Capital Lease Assets........................... 4,901 ------- Total................................ $43,079 =======
H. BORROWINGS This note contains information regarding the Company's short-term borrowings and long-term debt as of January 2, 2000. As a result of the filing of the Chapter 11 Cases, no principal or interest payments were made on any pre-petition unsecured debt after March 15, 1999. Any plan of reorganization defining the repayment terms must be approved by the Bankruptcy Court. From September 1997 through January 20, 1999, the Company had a five-year, $900.0 million, fully committed asset-based credit facility (the "Amended and Restated Credit Facility"). The Amended and Restated Credit Facility included $200.0 million in term loans and up to a maximum of $700.0 million in revolving loans including a $175.0 million sub-facility for letters of credit. The Amended and Restated Credit Facility was set to mature on September 10, 2002. Interest rates on the Amended and Restated Credit Facility were subject to change based on a financial performance-based grid and could not exceed a rate of LIBOR + 2.25% on revolving loans and LIBOR + 2.50% on the term loan. There was a commitment fee of 0.375% on the undrawn portion of the revolving loans. Term loan borrowings under the Amended and Restated Credit Facility were $196.0 million as of January 3, 1999. Short-term borrowings were $156.0 million under the Amended and Restated Credit Facility at January 3, 1999. On January 20, 1999, the Company completed a $750.0 million, 30-month asset-based credit facility (the "Second Amended and Restated Credit Facility") which replaced the Amended and Restated Credit Facility. The Second Amended and Restated Credit Facility included $150.0 million in term loans and a maximum of $600.0 million in revolving loans. The Second Amended and Restated Credit Facility included a $200.0 million sub-facility for standby and trade letters of credit. Interest rates on the Second Amended and Restated Facility were based on either Prime Rate + 1.5% or LIBOR + 2.75%. On March 29, 1999, the Company entered into a 27-month, $750.0 million fully committed asset-based debtor-in-possession credit facility (the "DIP Facility") which replaced the Second Amended and Restated Credit Facility. The Bankruptcy Court approved the DIP Facility on an interim basis on March 29, 1999 and granted final approval on April 27, 1999. The DIP Facility, which matures on June 30, 2001, includes $100.0 million in term loans and up to a maximum of $650.0 million in revolving loans including a $200.0 million sub-facility for letters of credit. Interest rate spreads on the DIP Facility are LIBOR + 2.25% on Eurodollar loans and Prime Rate + 1.25% on Alternate Base Rate loans. Short-term borrowings related to the DIP Facility were $43.0 million as of January 2, 2000. Outstanding borrowings under the term loan of the DIP Facility were $99.5 million as of January 2, 2000. There is a commitment fee of 0.375% on the undrawn portion of the revolving loans under the DIP Facility. 41 43 SERVICE MERCHANDISE COMPANY, INC. AND SUBSIDIARIES (DEBTORS-IN-POSSESSION) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) The DIP Facility is secured by all material unencumbered assets of the Company and its subsidiaries, including inventory, but excluding previously mortgaged property. Borrowings under the DIP Facility are limited based on a borrowing base formula which considers eligible inventories, eligible accounts receivable, mortgage values on eligible real properties, eligible leasehold interests, available cash equivalents and in-transit cash. The DIP Facility had an initial borrowing base reserve of $125.0 million which was reduced by $75.0 million on April 27, 1999, the date of final approval of the 1999 Operating Plan by the DIP Facility lenders. The remaining borrowing base reserve of $50.0 million was eliminated during the third quarter upon adoption of financial covenants for the DIP Facility. Availability under the facility continues unless the Company breaches both the financial covenants for the DIP facility. As of January 2, 2000, the Company was in compliance with its financial covenants. An extraordinary loss on the early extinguishment of debt was recorded in the amount of $7.9 million during the first quarter ended April 4, 1999. This charge related to the write-off of deferred financing charges paid in conjunction with the Company's prior Amended and Restated Credit Facility and Second Amended and Restated Credit Facility upon the completion of the DIP financing. Borrowings consists of the following:
JANUARY 2, JANUARY 3, 2000 1999 ---------- ---------- (IN THOUSANDS) 9% Senior Subordinated Debentures, payable in equal installments in 2003 and 2004............................. $300,000 $ 300,000 Term loan, repaid in 1999................................... -- 196,000 DIP facility term loan, variable interest rate at January 2, 2000 of 8.08% payable in varying amounts to 2001.......... 99,500 -- 8 3/8% Senior Notes due 2001................................ 13,799 13,799 First Mortgage Secured Notes, variable interest rate at January 2, 2000 of 6.64%, payable in varying amounts from 1998 to 2002.............................................. 38,858 62,707 Real Estate Mortgage Financing Notes, weighted-average fixed interest rate at January 2, 2000 of 9.12%, payable in mortgage installments to 2011............................. 58,591 69,264 Mortgage notes payable, weighted-average fixed interest rate at January 2, 2000 of 8.08%, payable in varying amounts to 2022...................................................... 18,259 21,163 Industrial Revenue Bonds, fixed and variable interest rates, weighted-average interest rate at January 2, 2000 of 3.5%, payable in varying amounts to 2024........................ -- 24,300 -------- --------- 529,007 687,233 Less: Borrowings not subject to compromise classified as noncurrent................................................ (98,500) -- Less: Borrowings not subject to compromise classified as current................................................... (1,000) (220,041) -------- --------- Long-term debt subject to compromise........................ $429,507 $ 467,192 ======== =========
42 44 SERVICE MERCHANDISE COMPANY, INC. AND SUBSIDIARIES (DEBTORS-IN-POSSESSION) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) The future scheduled contractual principal payments for the Company's borrowings (which are subject to being restructured in connection with the Chapter 11 Cases) were as follows as of January 2, 2000:
CONTRACTUAL PRINCIPAL PAYMENTS ------------------ (IN THOUSANDS) Fiscal Year 2000...................................... $ 33,279 2001...................................... 116,882 2002...................................... 17,118 2003...................................... 155,389 2004...................................... 158,472 Thereafter................................ 47,867 -------- Total........................... $529,007 ========
During fiscal 1997, the Company retired $86.2 million of the Company's $100.0 million 8 3/8% Senior Notes due 2001. As a result of this early retirement, the Company recorded an extraordinary loss of $2.0 million after tax, or $0.02 per share. Additionally, a non-cash extraordinary loss of $0.6 million, or $0.01 per share, was recorded to write-off deferred financing charges associated with the replacement of the Company's $525.0 million Reducing Revolving Credit Facility with the $950.0 million Amended and Restated Credit Facility of September, 1997. The Company ceased accruing interest on the 8 3/8% Senior Notes on March 16, 1999, in accordance with SOP 90-7. The 9% Senior Subordinated Debentures are subordinated to all senior indebtedness of the Company, as defined, and are callable, at the Company's option, at a premium of 104.5%, which decreases annually until reaching par in December 2000. Interest on the debentures is payable semi-annually in June and December. The Company delayed its interest payment due December 15, 1998. The payment was made January 14, 1999. The non-payment of the interest was a default under the Amended and Restated Credit Facility and the Company's operating performance, absent a waiver, would have resulted in a breach of the fixed-charge coverage ratio covenants in agreements with First American National Bank and the Canadian Imperial Bank of Commerce. A waiver was granted to the Company by those parties to waive the default until January 15, 1999. The default was cured upon payment. The Company ceased accruing interest on the 9% Senior Subordinated Debentures on March 16, 1999, in accordance with SOP 90-7. Mortgages are collateralized by property and equipment having a net book value of approximately $22.3 million at January 2, 2000. The Company has commercial and standby letters of credit under the DIP Facility used to secure corporate obligations. The commercial letters of credit have contractual amounts totaling $50.4 million and $57.4 million at January 2, 2000 and January 3, 1999, respectively. The standby letters of credit have contractual amounts totaling $27.2 million and $49.0 million at January 2, 2000 and January 3, 1999, respectively. I. LEASE COMMITMENTS The Company has both capital and operating lease agreements for stores and other facilities as well as for certain furniture, fixtures and equipment. Under most of these lease agreements, the Company pays taxes, insurance and maintenance costs. Initial lease terms for stores generally range from 10 to 25 years with renewal periods for an additional five years. Certain store leases provide for additional contingent rental payments based on a percentage of sales in excess of specified minimum amounts. 43 45 SERVICE MERCHANDISE COMPANY, INC. AND SUBSIDIARIES (DEBTORS-IN-POSSESSION) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Future minimum lease payments as of January 2, 2000 (inclusive of leases at closed stores that have not yet been terminated) are as follows:
CAPITALIZED LEASES ------------------------- FURNITURE, FIXTURES AND OPERATING REAL ESTATE EQUIPMENT LEASES ----------- ---------- --------- (IN THOUSANDS) Fiscal Year 2000............................................... $ 7,987 $243 $ 33,303 2001............................................... 7,184 139 33,594 2002............................................... 6,607 -- 31,895 2003............................................... 6,154 -- 30,692 2004............................................... 5,168 -- 28,234 Thereafter......................................... 17,275 -- 148,282 -------- ---- -------- Total minimum payments............................. 50,375 382 $306,000 ======== Less: Imputed interest and executory costs......... (18,991) (16) -------- ---- Present value of net minimum lease payments........ 31,384 366 Less: Long-term capitalized lease obligations not subject to compromise............................ (2,514) -- Less: Current maturities not subject to compromise....................................... (86) -- -------- ---- Capitalized lease obligations subject to compromise....................................... $ 28,784 $366 ======== ====
Minimum sublease rentals, not deducted from above, to be received in the future under noncancellable operating subleases aggregated $2.8 million at January 2, 2000. Minimum lease rentals to be received in the future on noncancellable leases of owned properties aggregated $6.4 million at January 2, 2000. Capitalized real estate and equipment leases are at effective interest rates of approximately 12.9% and 7.7%, respectively, as of January 2, 2000. Rental expense, net of lease income on owned properties and sublease income on leased properties, consists of the following:
FISCAL YEAR ----------------------------- 1999 1998 1997 ------- ------- ------- (IN THOUSANDS) Minimum rentals....................................... $49,028 $71,537 $74,163 Contingent rentals.................................... -- 962 1,237 Sublease rental income................................ (2,485) (3,353) (3,792) Owned properties rental income........................ (2,527) (3,768) (3,962) ------- ------- ------- Net rental expense.................................... $44,016 $65,378 $67,646 ======= ======= =======
J. LIABILITIES SUBJECT TO COMPROMISE "Liabilities subject to compromise" refers to certain liabilities incurred prior to the commencement of the Chapter 11 Cases. These liabilities consist primarily of amounts outstanding under long-term debt and also include accounts payable, accrued interest, accrued restructuring costs, and other accrued expenses. These amounts represent the Company's estimate of known or potential claims to be resolved in connection with the 44 46 SERVICE MERCHANDISE COMPANY, INC. AND SUBSIDIARIES (DEBTORS-IN-POSSESSION) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Chapter 11 Cases. Such claims remain subject to future adjustments. Adjustments may result from (1) negotiations; (2) actions of the Bankruptcy Court; (3) further development with respect to disputed claims; (4) future rejection of additional executory contracts or unexpired leases; (5) the determination as to the value of any collateral securing claims; (6) proofs of claim; or (7) other events. The Bankruptcy Court set May 15, 2000 as the last date for parties to file proofs of claim with respect to pre-petition obligations. Payment terms for these amounts, which are considered long-term liabilities at this time, will be established in connection with the Chapter 11 Cases. The Company has received approval from the Bankruptcy Court to pay certain pre-petition and post-petition employee wages, salaries, benefits and other employee obligations, to pay vendors and other providers in the ordinary course for goods and services received after March 15, 1999, and to honor customer service programs, including warranties, returns, layaways and gift certificates. The principal categories of claims classified as liabilities subject to compromise under reorganization proceedings are identified below.
JANUARY 2, 2000 --------------- (IN THOUSANDS) Accounts payable............................................ $189,877 Accrued expenses............................................ 60,754 Accrued restructuring costs: 1997 Restructuring Plan................................... 7,894 1999 Rationalization Plan................................. 38,793 Long-term debt.............................................. 429,507 Capitalized lease obligations............................... 29,150 -------- Total............................................. $755,975 ========
Contractual interest expense not recorded on certain pre-petition debt totaled $22.5 million for the year ended January 2, 2000. K. REORGANIZATION ITEMS Expenses and income directly incurred or realized as a result of the Chapter 11 Cases have been segregated from the normal operations and are disclosed separately. The major components are as follows:
FISCAL YEAR ENDED JANUARY 2, 2000 ----------------- (IN THOUSANDS) Reduction of accrued rent for rejected leases............... $(45,981) Professional fees........................................... 18,364 Store closing costs......................................... 11,754 Loss on disposal of assets.................................. 9,827 Other administrative items.................................. 4,213 -------- Total reorganization items (income) expense................. $ (1,823) ========
Reduction of accrued rent for rejected leases: In connection with the Chapter 11 Cases, the 1997 Restructuring Plan was adjusted to reflect the reduction allowed under Section 502(b)(6) of the Bankruptcy Code. An amount had been accrued according to the remaining leasehold obligation. Section 502(b)(6) limits the lessor's claim to the rent reserved by such 45 47 SERVICE MERCHANDISE COMPANY, INC. AND SUBSIDIARIES (DEBTORS-IN-POSSESSION) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) leases, without acceleration, for the greater of one year, or 15 percent, not to exceed three years, of such leases, plus any unpaid rent. Professional fees: "Professional fees" relates to legal, accounting and other professional costs. Store closing costs: Subsequent to the announcement of the Rationalization Plan and commencement of the Chapter 11 Cases, the Company identified an additional 18 stores for closure. The costs associated with these closing stores include rent, common area maintenance, utilities, asset write-downs and severance. The rent amount has been adjusted to reflect the reduction allowed under Section 502(b)(6) of the Bankruptcy Code. Income was recorded for a change in the estimated closing costs as a result of the Company's favorable experience disposing of selected stores during the fiscal year ended January 2, 2000. Loss on disposal of assets: "Loss on disposal of assets" consists of losses associated with the sale of real property and the sale of certain assets of one of the Company's subsidiaries, B.A. Pargh Co., Inc. Other administrative items: "Other administrative items" consists of administrative items, directly attributable to the Chapter 11 Cases. L. FAIR VALUE OF FINANCIAL INSTRUMENTS The fair value of financial instruments has been estimated by the Company using available market information as of January 2, 2000 and January 3, 1999, and valuation methodologies considered appropriate to the circumstances.
JANUARY 2, 2000 JANUARY 3, 1999 ---------------------- ---------------------- CARRYING ESTIMATED CARRYING ESTIMATED AMOUNT FAIR VALUE AMOUNT FAIR VALUE -------- ---------- -------- ---------- (IN THOUSANDS) Assets: Cash and cash equivalents............. $ 61,591 $ 61,591 $133,749 $133,749 Liabilities: 9% Senior Subordinated Debentures..... 300,000 27,750 300,000 64,125 Term Loan............................. 99,500 99,500 196,000 196,000 Mortgages............................. 115,708 119,149 153,134 145,529 Industrial Revenue Bonds.............. -- -- 24,300 24,300 Notes payable to banks................ -- -- 156,000 156,000 8 3/8% Senior Notes................... 13,799 1,276 13,799 6,227
Cash and cash equivalents: The carrying amount approximates fair value due to the short maturity of these instruments (less than three months). 46 48 SERVICE MERCHANDISE COMPANY, INC. AND SUBSIDIARIES (DEBTORS-IN-POSSESSION) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 9% Senior Subordinated Debentures and 8 3/8% Senior Notes: Fair value is based on quoted market prices from the New York Stock Exchange at January 3, 1999. Fair value at January 2, 2000 based on indicative price reported by the Daily Bankruptcy Review. Notes payable to banks, Term Loan and Mortgages: Fair value is based on management's estimate of the present value of estimated future cash flows discounted at the current market rate for financial instruments with similar characteristics and maturities. Industrial Revenue Bonds: The carrying value approximates the fair value. Due to the variable rate nature of the instruments, the interest rate paid by the Company is equivalent to the current market rate demanded by investors; therefore, the instruments trade at par. Derivatives: As of January 2, 2000, the Company was party to interest rate swaps covering $125.0 million in principal amount of indebtedness and expiring in December 2000. These swaps exchange the floating interest rate exposure on the $125.0 million of debt for fixed interest rate exposure. The Company will pay a weighted average fixed rate of 5.97% on the $125.0 million notional amount rather than the three-month LIBOR rate, which was 6.18% as of January 2, 2000. As of January 2, 2000, these instruments had no carrying value. The fair value of interest rate swap agreements are estimated based on quotes from dealers of these instruments and represent the estimated amounts the Company would expect to pay or receive to terminate the agreements. The fair value of the Company's interest rate swap agreements was $0.4 million and ($2.3) million as of January 2, 2000 and January 3, 1999, respectively. M. STOCK OPTIONS AND AWARDS Under the Company's employee stock incentive plans, the Compensation Committee of the Board of Directors ("Compensation Committee") has authority to grant the following types of awards: (a) stock options; (b) stock appreciation rights; (c) restricted stock; (d) deferred stock; (e) stock purchase rights and/or (f) other stock-based awards. Awards are exercisable subject to terms and conditions as determined by the Compensation Committee with no awards exercisable ten years after the date of grant. In fiscal 1991, the Board of Directors adopted the 1991 Directors' Equity Plan for nonemployee directors. Under the Second Amended and Restated Directors' Plan eligible directors annually receive stock options exercisable for 3,000 shares of the Company's common stock. The plan was amended in fiscal 1998 and 1997 to increase the number of shares covered by option grants to directors and to permit participating nonemployee directors to receive all or any portion of their quarterly retainer in the form of an option to purchase shares of the Company's common stock, respectively. The stock options are granted with an exercise price equal to the fair market value of the Company's common stock as of the date of grant, are exercisable in 20% installments beginning one year from the date of grant and expire ten years from the grant date. An aggregate of 296,875 shares of the Company's common stock is authorized to be issued under this plan. During fiscal 1995, the Company amended and restated the 1989 Employee Stock Incentive Plan ("Stock Incentive Plan") to increase the number of shares issuable, to extend the term during which awards may be made under the Stock Incentive Plan and to limit the amount of stock-based awards that may be granted to any single officer or key employee under that plan. Options are generally granted with a three to five-year vesting requirement. At January 2, 2000, there were approximately 5.1 million shares of unissued common stock reserved for issuance under the Company's Stock Incentive Plan. 47 49 SERVICE MERCHANDISE COMPANY, INC. AND SUBSIDIARIES (DEBTORS-IN-POSSESSION) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) On October 16, 1998, the Company repriced options granted between August 1, 1989 and September 30, 1998 with grant prices ranging from $1.59 per share to $10.13 per share. For each option exchanged, one new option was issued with an exercise price of $1.25 per share. A total of 6.4 million options were repriced and are exercisable in equal one-third installments beginning one year from the date of grant. The repriced options expire five years from the grant date. Stock options: A summary of the status of the Company's two fixed stock option plans for fiscal 1999, 1998 and 1997, and changes during those years is presented below:
FISCAL YEAR -------------------------------------------------------------------- 1999 1998 1997 -------------------- -------------------- -------------------- WEIGHTED- WEIGHTED- WEIGHTED- AVERAGE AVERAGE AVERAGE EXERCISE EXERCISE EXERCISE FIXED OPTIONS SHARES PRICE SHARES PRICE SHARES PRICE - ------------- ------- --------- ------- --------- ------- --------- (SHARES IN THOUSANDS) Outstanding, beginning of year...................... 7,909 $1.96 9,126 $4.65 5,759 $5.35 Granted..................... 5 0.38 7,282 1.31 5,034 3.92 Exercised................... -- -- -- -- (57) 1.91 Forfeited or canceled....... (4,003) 1.82 (8,499) 4.30 (1,610) 5.54 ------- ------- ------- Outstanding, end of year.... 3,911 2.11 7,909 1.96 9,126 4.65 ======= ======= ======= Options exercisable at year-end.................. 1,791 3.09 1,176 5.41 2,970 5.22 Weighted-average fair value of options granted during the year.................. $0.41 $0.52 $2.19
The following table summarizes information about fixed stock options outstanding at January 2, 2000:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE --------------------------------------- ------------------------- WEIGHTED- NUMBER AVERAGE WEIGHTED- NUMBER WEIGHTED- OUTSTANDING REMAINING AVERAGE EXERCISABLE AVERAGED AT JANUARY 2, CONTRACTUAL EXERCISE AT JANUARY 2, EXERCISE RANGE OF EXERCISE PRICES 2000 LIFE PRICE 2000 PRICE - ------------------------ ------------- ----------- --------- ------------- --------- (SHARES IN THOUSANDS) $0.07 - 2.19 3,222 4.00 $1.23 1,123 $1.19 2.20 - 4.75 326 5.82 4.11 306 4.12 4.76 - 6.50 89 6.42 4.98 88 4.98 6.51 - 10.13 274 2.58 9.11 274 9.11 ----- ----- $0.07 - 10.13 3,911 4.11 2.11 1,791 3.09 ===== =====
Had the fair value of options granted under these plans beginning in 1995 been recognized as compensation expense on a straight-line basis over the vesting period of the grant in accordance with SFAS 48 50 SERVICE MERCHANDISE COMPANY, INC. AND SUBSIDIARIES (DEBTORS-IN-POSSESSION) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) No. 123, the Company's net loss and net loss per share would have been adjusted to the pro forma amounts indicated below:
FISCAL YEAR ------------------------------------- 1999 1998 1997 ---------- ---------- --------- (IN THOUSANDS, EXCEPT PER SHARE DATA) Net loss As reported.................................... $(243,672) $(110,307) $(91,600) Pro forma...................................... $(247,707) $(115,121) $(94,285) Net loss per share -- basic and diluted As reported.................................... $ (2.45) $ (1.11) $ (0.92) Pro forma...................................... $ (2.48) $ (1.15) $ (0.94)
The pro forma effect on net loss for fiscal 1999, 1998 and 1997 is not representative of the pro forma effect on net earnings (loss) in future years because it does not take into consideration pro forma compensation expense related to grants made prior to 1995. The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions applied to options granted:
FISCAL YEAR ------------------------------------------- 1999 1998 1997 ------------ ------------ ----------- Dividend yield............................. N/A N/A N/A Expected volatility........................ 58% 48% 47% Risk-free interest rate range.............. 4.5% to 4.6% 4.2 to 5.8% 5.9 to 6.8% Expected life.............................. 6 Years 3 to 6 Years 6 Years
Restricted stock awards: Periodically, the Company issues shares of restricted stock under provisions of the Stock Incentive Plan. A total of 288,334 restricted shares remained outstanding at January 2, 2000. These remaining shares will vest at various dates through the year 2002. During the vesting periods, none of such shares may be sold, transferred, pledged or assigned. During the restriction period, holders of the shares may exercise full voting rights and receive all dividends with respect to those shares. Restricted stock activity for the last three fiscal years was as follows:
FISCAL YEAR ---------------------- 1999 1998 1997 ---- ----- ----- (SHARES IN THOUSANDS) Outstanding, beginning of year.............................. 626 675 512 Granted..................................................... 0 51 621 Vested...................................................... (9) (26) (398) Forfeited or canceled....................................... (329) (74) (60) ---- ----- ----- Outstanding, end of year.................................... 288 626 675 ==== ===== ===== Weighted-average fair value of restricted stock granted during the year........................................... N/A $1.15 $4.35
No deferred compensation was recorded during fiscal 1999 in connection with restricted stock awards, compared to $0.1 million in fiscal 1998. Deferred compensation amortization relating to restricted stock awards of $0.4 million in fiscal 1999, $0.6 million in fiscal 1998 and $0.9 in 1997 was charged to operations. Service Merchandise Foundation option: The Service Merchandise Foundation ("Foundation"), a private charitable foundation, was formed in 1990. As a charitable contribution, the Company granted the 49 51 SERVICE MERCHANDISE COMPANY, INC. AND SUBSIDIARIES (DEBTORS-IN-POSSESSION) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Foundation an option to purchase approximately 1.9 million shares of common stock at $2.20 per share, the then current market price. The option is exercisable in whole or in part from the date of grant until October 15, 2000. Under applicable Internal Revenue Service rulings, the stock option may not be exercised directly by the Foundation. The Foundation may sell all or a part of the option to unrelated not-for-profit entities, which may then exercise the option directly. The option is not treated as granted and outstanding until such time as the Foundation sells all or part of it. N. EARNINGS PER SHARE The following table reconciles weighted-average shares used in the earnings per share calculation for fiscal 1999, 1998 and 1997, respectively:
INCOME SHARES PER SHARE (NUMERATOR) (DENOMINATOR) AMOUNT ----------- ------------- --------- (IN THOUSANDS, EXCEPT PER SHARE DATA) FOR THE YEAR ENDED JANUARY 2, 2000: Basic EPS -- before extraordinary item and cumulative effect of a change in accounting principle................................... $(229,255) 99,721 $(2.30) ====== Effect of dilutive securities: None........................................ -- -- --------- ------ Diluted EPS -- before extraordinary item and cumulative effect of a change in accounting principle................................... $(229,255) 99,721 $(2.30) ========= ====== ====== FOR THE YEAR ENDED JANUARY 3, 1999: Basic EPS...................................... $(110,307) 99,703 $(1.11) ====== Effect of dilutive securities: None........................................ -- -- --------- ------ Diluted EPS.................................... $(110,307) 99,703 $(1.11) ========= ====== ====== FOR THE YEAR ENDED DECEMBER 28, 1997: Basic EPS -- before extraordinary item......... $ (88,957) 99,930 $(0.89) ====== Effect of dilutive securities: None........................................ -- -- --------- ------ Diluted EPS -- before extraordinary item....... $ (88,957) 99,930 $(0.89) ========= ====== ======
The following table includes options to purchase shares of common stock which were outstanding at the end of the respective fiscal year but were not included in the computation of diluted earnings per share because the options' exercise prices were greater than the average market price of the common shares. Fiscal 1999, 50 52 SERVICE MERCHANDISE COMPANY, INC. AND SUBSIDIARIES (DEBTORS-IN-POSSESSION) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 1998 and 1997 include all options to purchase shares of common stock and restricted stock, as they were anti-dilutive in the computation of diluted earnings per share.
NUMBER SHARES OUTSTANDING AT RANGE OF YEAR RANGE OF GRANT DATES YEAR-END RANGE OF PRICES EXPIRATION DATES - ---- -------------------- -------------- --------------- ------------------- 1999 08/01/8 - 01/04/99 4.2 million $0.07 - $10.13 01/15/00 - 01/04/99 1998 08/01/89 - 12/29/98 8.5 million $0.07 - $10.38 08/01/99 - 12/29/98 1997 04/23/88 - 11/03/97 9.8 million $2.20 - $10.38 04/23/98 - 11/03/97
During fiscal 1999 and 1998, the Common Stock traded on the New York Stock Exchange (the "NYSE") under the symbol "SME." On March 17, 1999, the NYSE notified the Company that it was reviewing the listing status of the Company's listed securities, including the Common Stock. On December 2, 1999, the NYSE announced that trading in the Common Stock was suspended effective on that date and that the NYSE would apply with the SEC for delisting of the Common Stock. Subsequent to December 2, 1999, the Common Stock has been traded on the National Quotation Bureau, LLC Pink Sheets (the "Pink Sheets") and on the OTC Bulletin board under the symbol "SVCDQ". O. SHAREHOLDERS' RIGHTS PLAN Under the 1998 Shareholder Rights Plan, Series A Junior Preferred Stock Purchase Rights (the "Rights") were issued for each outstanding share of Common Stock to shareholders of record at the close of business on February 9, 1998. Each Right entitles the registered holders to purchase from the Company one one-hundredth of a share (a "Unit") of Series A Junior Preferred Stock, par value $1 per share (the "Preferred Stock"), at a purchase price of $10 per Unit, subject to adjustment. Initially, the Rights will attach to all certificates representing shares of outstanding Common Stock, and no separate Rights Certificates will be distributed. The Rights will separate from the Common Stock, and the Distribution Date will occur, upon the earlier of (i) 10 days following public announcement ("Stock Acquisition Date") that a person or group of affiliated persons (other than the Company, or certain of its affiliates) (an "Acquiring Person") has acquired, obtained the right to acquire, or otherwise obtained beneficial ownership of 15% or more of the then outstanding shares of Common Stock, or (ii) 10 days (or such date as may be determined by the Board of Directors prior to any person becoming an "Acquiring Person") following the date that a tender offer or exchange offer that would result in a person or group beneficially owning 15% or more of the then outstanding shares of Common Stock is first published or sent or given to shareholders. The Rights are not exercisable until the Distribution Date and will expire at the close of business on the tenth anniversary of the Rights Agreement unless earlier redeemed by the Company as described below. If any person becomes the beneficial owner of 15% of the Common Stock or if a 15% or more shareholder engages in certain self-dealing transactions or a merger with the Company where the Company is not the surviving corporation, each Right will entitle the shareholder, under alternative circumstances, to buy either securities of the Company or securities of an acquiring company (depending on the form of the transaction) at an exercise price that will be half of the market value of such securities at the time. At any time until ten days following the Stock Acquisition Date, a majority of the Board of Directors may redeem the Rights in whole, but not in part, at a price of $.01 per Right, payable, at the election of such majority of Board of Directors, in cash or shares of Common Stock. P. RETIREMENT PLANS The Company has a defined benefit pension plan (the "Restated Retirement Plan") in which all employees of the Company are eligible to participate upon reaching age 21 and completing one year of qualified service, as defined in the Restated Retirement Plan. Benefits are based on years of service and 51 53 SERVICE MERCHANDISE COMPANY, INC. AND SUBSIDIARIES (DEBTORS-IN-POSSESSION) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) employee compensation. Contributions to the Restated Retirement Plan had been intended to provide not only for benefits attributed to service to date, but also for benefits expected to be earned in the future. The Company's funding policy had been to contribute at least the amount required by the Employee Retirement Income Security Act of 1974, but no more than the maximum tax deductible amount. In fiscal 1999, 1998, and 1997 the Company made contributions of approximately $20.0 thousand, $3.4 million, and $4.8 million, respectively, to the Restated Retirement Plan. The assets held by the Restated Retirement Plan primarily include common stock, long-term corporate bonds and long-term government bonds. The Company maintains a non-qualified supplemental retirement plan, the Executive Security Plan (the "ESP"), which covers certain management employees hired or promoted to their job level prior to February 18, 1989. The ESP provides salary continuation and or death benefits equal to two times the participant's annual salary at retirement or at age 65. Employees who complete 20 years of service and terminate employment prior to attaining retirement age are entitled to a death benefit up to age 65, at which time they can elect salary continuation and/or a death benefit. Salary continuation benefits are paid from the general assets of the Company. On August 31, 1999, the Bankruptcy Court approved a motion by the Company to amend the Restated Retirement Plan and the ESP. The amendment to the Restated Retirement Plan ceased the accrual of benefits, disallowed new enrollments to the Plan and vested benefits already accrued under the Plan effective September 30, 1999. The amendment to the ESP, covering approximately 165 former and current management associates, ceased the accrual of benefits and suspended payments effective September 30, 1999. Those actions to cease the accrual of benefits under the Restated Retirement Plan and the ESP, as well as the reduction in employees as a result of the 1999 Rationalization Plan, resulted in curtailment (gains) and losses of ($11.5) million and $1.8 million, respectively. The following valuation results are based on actuarial assumptions and methods mandated by SFAS No. 132 and SFAS No. 87 "Employers Accounting for Pensions."
RESTATED EXECUTIVE RETIREMENT PLAN SECURITY PLAN ------------------- ------------------- 1999 1998 1999 1998 -------- ------- ------- -------- (IN THOUSANDS) CHANGE IN BENEFIT OBLIGATION Benefit obligation at beginning of year........... $ 72,719 $65,394 $10,944 $ 10,099 Service cost...................................... 4,356 5,568 58 176 Interest cost..................................... 4,490 4,333 178 722 Actuarial loss.................................... (1,896) 7,308 (1,294) 543 Benefits paid..................................... (18,408) (9,884) (200) (596) Curtailment....................................... (11,462) -- -- -- -------- ------- ------- -------- Benefit obligation at end of year................. $ 49,799 $72,719 $ 9,686 $ 10,944 ======== ======= ======= ======== CHANGE IN PLAN ASSETS Fair value of plan assets at beginning of year.... $ 74,599 $73,445 $ -- $ -- Actual return on plan assets...................... 6,401 7,646 -- -- Employer contribution............................. 20 3,392 200 596 Benefits paid..................................... (18,408) (9,884) (200) (596) -------- ------- ------- -------- Fair value of plan assets at end of year.......... $ 62,612 $74,599 $ -- $ --
52 54 SERVICE MERCHANDISE COMPANY, INC. AND SUBSIDIARIES (DEBTORS-IN-POSSESSION) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
RESTATED EXECUTIVE RETIREMENT PLAN SECURITY PLAN ------------------- ------------------- 1999 1998 1999 1998 -------- ------- ------- -------- (IN THOUSANDS) ======== ======= ======= ======== RECONCILIATION OF FUNDED STATUS Funded status..................................... $ 12,813 $ 1,880 $(9,686) $(10,944) Amounts not recognized............................ (4,217) (4,642) -- -- Unrecognized net actuarial loss (gain)............ 706 12,786 (1,373) 1,721 Unrecognized prior service cost................... -- (663) -- -- Unrecognized transition obligation................ -- (1,897) 2,546 2,910 -------- ------- ------- -------- Net amount recognized............................. $ 9,302 $ 7,464 $(8,513) $ (6,313) ======== ======= ======= ======== AMOUNTS RECOGNIZED ON THE BALANCE SHEET Prepaid benefit cost.............................. $ 9,302 $ 7,464 $ -- $ -- Accrued benefit liability......................... -- -- (9,686) (10,092) Intangible asset.................................. -- -- 1,173 2,910 Accumulated and other comprehensive loss*......... -- -- -- 869 -------- ------- ------- -------- Net amount recognized............................. $ 9,302 $ 7,464 $(8,513) $ (6,313) ======== ======= ======= ======== *Change in other comprehensive loss Intangible asset.................................. $ -- $ -- $ (240) $ 240 Accrued pension benefit cost...................... -- -- (629) 629 -------- ------- ------- -------- Total other comprehensive (income) loss........... $ -- $ -- $ (869) $ 869 ======== ======= ======= ========
RESTATED RETIREMENT PLAN ----------------------------- 1999 1998 1997 ------- ------- ------- (IN THOUSANDS) NET PERIODIC PENSION COST Service Cost................................................ $ 4,356 $ 5,568 $ 6,049 Interest Cost............................................... 4,490 4,332 4,850 Expected return on assets................................... (6,424) (6,282) (6,099) Amortization of net transition amount....................... (284) (379) (379) Amortization of prior service cost.......................... (98) (162) (165) Recognized net loss......................................... -- -- 239 Gain due to curtailment..................................... (3,857) -- (273) ------- ------- ------- Net periodic pension cost................................... $(1,817) $ 3,077 $ 4,222 ======= ======= =======
53 55 SERVICE MERCHANDISE COMPANY, INC. AND SUBSIDIARIES (DEBTORS-IN-POSSESSION) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
EXECUTIVE SECURITY PLAN -------------------------- 1999 1998 1997 ------ ------ ------ (IN THOUSANDS) NET PERIODIC PENSION COST Service Cost................................................ $ 58 $ 176 $ 198 Interest Cost............................................... 178 722 702 Amortization of net transition amount....................... 364 364 364 Recognized net loss......................................... -- 31 -- Curtailments................................................ 1,800 -- -- ------ ------ ------ Net periodic pension cost................................... $2,400 $1,293 $1,264 ====== ====== ======
RESTATED RETIREMENT PLAN AND EXECUTIVE SECURITY PLAN ----------------------------- WEIGHTED AVERAGE ACTUARIAL ASSUMPTIONS Discount rate............................................... 7.75% 6.75% 7.25% Expected long-term rate of return on assets................. 9.50% 9.50% 9.50% Future salary increases..................................... 3.50% 3.50% 4.00%
Q. EMPLOYEE SAVINGS PLAN The Service Merchandise Company, Inc. Savings and Investment Plan (the "Plan") is a voluntary salary deferral plan under Section 401(k) of the Internal Revenue Code. All employees of the Company (other than seasonal and temporary employees) are eligible to participate upon reaching age 21 and completing one qualifying year of service, as defined in the Plan. Eligible employees may elect to defer from 1% to 15% of their compensation, subject to certain limitations. The Company will match, based on earnings performance, up to 50% of the first 6% of employees' salary deferrals. Deferrals and matching contributions are invested in securities and investments as permitted by the Plan and directed by each employee. Company contributions to the Plan were $0.0, $0.6 million and $1.3 million for fiscal 1999, 1998 and 1997, respectively. The Company match percentage equaled 0.0% in fiscal 1999, 10% in fiscal 1998 and 20% in fiscal 1997. 54 56 SERVICE MERCHANDISE COMPANY, INC. AND SUBSIDIARIES (DEBTORS-IN-POSSESSION) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) R. INCOME TAXES Deferred income tax assets and liabilities at January 2, 2000 and January 3, 1999 are comprised of the following:
JANUARY 2, JANUARY 3, 2000 1999 ---------- ---------- (IN THOUSANDS) Deferred income tax assets: Financial accruals.......................................... $ 41,088 $ 42,220 Capitalized leases.......................................... 5,488 8,511 Tax credit and loss carryover............................... 97,388 12,304 Capitalized legal fees...................................... 11,656 1,739 --------- -------- Deferred income tax asset................................... 155,620 64,774 --------- -------- Deferred income tax liabilities: Depreciation................................................ (10,402) (13,473) Layaway sales............................................... -- (1,884) Pension liability........................................... (3,086) (2,315) Inventory................................................... (7,338) (4,606) Other....................................................... (349) (743) --------- -------- Deferred income tax liability............................... (21,175) (23,021) --------- -------- Net deferred income tax asset............................... $ 134,445 $ 41,753 ========= ======== Net current deferred income tax asset....................... $ 16,830 $ 20,182 Net long-term deferred income tax asset..................... 117,615 21,571 --------- -------- 134,445 41,753 Valuation Allowance......................................... (134,445) (41,753) --------- -------- Net Deferred income tax asset............................... $ -- $ -- ========= ========
The Company has recorded a full valuation allowance on net deferred tax assets as realization of such assets in future years is uncertain. The provision for income taxes, net of tax benefit of $1.6 million in fiscal 1997 on the extraordinary loss from early extinguishment of debt, consists of the following:
FISCAL YEAR -------------------------------- 1999 1998 1997 -------- -------- -------- Current income taxes: Federal............................................ $ (564) $(19,134) $(11,896) State and local.................................... (310) (423) (759) -------- -------- -------- (874) (19,557) (12,655) Deferred benefit -- tax attributes................. (80,234) (12,304) (40,720) Deferred benefit -- other.......................... (10,217) (9,985) -- Valuation allowance................................ 90,451 41,753 -- -------- -------- -------- Total income tax benefit........................... $ (874) $ (93) $(53,375) ======== ======== ========
55 57 SERVICE MERCHANDISE COMPANY, INC. AND SUBSIDIARIES (DEBTORS-IN-POSSESSION) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) At January 2, 2000, the Company had federal net operating loss carry forwards of $255.4 million and state net operating loss carry forwards of $279.1 million, which expire beginning in 2019 and 2001, respectively. A reconciliation of the provision for income taxes to the federal statutory rate is as follows:
FISCAL YEAR ---------------------- 1999 1998 1997 ----- ----- ---- Statutory federal tax rate.................................. 35.0% 35.0% 35.0% State and local income taxes, net of federal benefit........ 1.3% 1.3% 1.3% Valuation allowance......................................... (37.0)% (37.8)% -- Other....................................................... 1.1% 1.6% 1.2% ----- ----- ---- Effective tax rate.......................................... 0.4% 0.1% 37.5% ===== ===== ====
S. OTHER COMMITMENTS AND CONTINGENCIES On January 28, 1997, the Company and Service Credit Corp. (the "Subsidiary"), a wholly-owned subsidiary, entered into an agreement with World Financial Network National Bank ("WFNNB") for the purpose of providing a private label credit card to the Company's customers. The contract requires the Subsidiary to maintain a 3.0% credit risk reserve for the outstanding balances, which are owned by WFNNB. The purpose of this reserve is to offset future potential negative spreads and portfolio losses. The negative spreads or losses may result from potential increased reimbursable contractual program costs. The 3.0% credit risk reserve is held by the Subsidiary, which is not in Chapter 11, in the form of cash and cash-equivalents. On April 28, 1999, WFNNB advised the Company that WFNNB has projected that such portfolio losses and negative spreads will be at least approximately $9.0 million. The Company does not have in its possession sufficient information to determine the accuracy or validity of WFNNB's projection. Pending confirmation of the accuracy of WFNNB's projection and a resolution of the Company's rights and remedies, the Company has made provision for such potential liability during fiscal 1999 by maintaining an allowance on the 3.0% credit risk reserve of $9.0 million. On July 16, 1999, the Company filed a complaint against WFNNB in the Bankruptcy Court alleging, among other things, breach of contract and violation of the automatic stay provisions of the Bankruptcy Code by WFNNB with respect to and in connection with the January 1997 private label credit card program agreement between the Company, the Subsidiary and WFNNB (the "World Financial Agreement"). Under the World Financial Agreement, a program was established pursuant to which, among other things, WFNNB agreed to issue credit cards to qualifying Company customers for the purchase of goods and services from the Company. While the ultimate result of this litigation cannot be determined or predicted with any accuracy at this time, the Company intends to pursue available remedies against WFNNB. On August 20, 1999, over the objection of WFNNB, the Bankruptcy Court authorized the Company to enter into an agreement with Household Bank (SB), N.A. ("Household") for the purpose of offering new private label credit cards to those customers of the Company who meet Household's credit standards. The Company's prior private label credit card program with WFNNB was suspended in March of 1999, and the rights and liabilities of WFNNB, the Company and the Subsidiary are the subject of the litigation referred to in the preceding paragraph. On September 23, 1999, WFNNB filed a motion to dismiss the Company's complaint and a separate motion seeking to have the complaint litigated in the United States District Court for the Middle District of Tennessee (the "District Court"), rather than the Bankruptcy Court. The Company filed timely oppositions to both motions, and, on October 27, 1999, the District Court denied WFNNB's motion to have the complaint 56 58 SERVICE MERCHANDISE COMPANY, INC. AND SUBSIDIARIES (DEBTORS-IN-POSSESSION) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) litigated in the District Court. The Bankruptcy Court scheduled a hearing on December 6, 1999, to consider WFNNB's motion to dismiss and the Company's opposition thereto. On December 6, 1999, the Bankruptcy Court entered an order dismissing the Company's complaint. On December 16, 1999, the Company filed a motion asking the Court to clarify the order issued on December 6, 1999, and to grant the Company leave to file an amended complaint (the "Company's Motion"). On January 11, 2000, WFNNB responded with an objection to the Company's Motion. The Company was involved in litigation, investigations and various legal matters during the fiscal year ended January 2, 2000, which are being defended and handled in the ordinary course of business. While the ultimate results of these matters cannot be determined or predicted, management believes that they will not have a material adverse effect on the Company's results of operations or financial position. Any potential liability may be affected by the Chapter 11 Cases. T. SEGMENT REPORTING The Company manages its business on the basis of one reportable segment. See Note A for a brief description of the Company's business. As of January 2, 2000, all of the Company's operations are located within the United States. The following data is presented in accordance with SFAS No. 131 for all periods presented.
YEARS ENDED ---------------------------------------- JANUARY 2, JANUARY 3, DECEMBER 28, 2000 1999 1997 ---------- ---------- ------------ CLASSES OF SIMILAR PRODUCTS (IN THOUSANDS) - --------------------------- Net sales: Hardlines........................................... $1,445,230 $2,249,628 $2,725,837 Jewelry............................................. 785,270 919,897 936,941 ---------- ---------- ---------- Total net sales............................. $2,230,500 $3,169,525 $3,662,778 ========== ========== ==========
U. QUARTERLY FINANCIAL INFORMATION -- UNAUDITED The Company has historically incurred a net loss throughout the first three quarters of the year due to the seasonality of its business. The results of operations for the first three quarters are not necessarily indicative of the operating results for the entire fiscal year. A change in accounting principle regarding layaway sales was adopted during the thirteen weeks ended January 2, 2000. The restated amounts below reflect the effect of the retroactive application of the change as of January 4, 1999. 57 59 SERVICE MERCHANDISE COMPANY, INC. AND SUBSIDIARIES (DEBTORS-IN-POSSESSION) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
13 WEEKS ENDED -------------------------------------------------- APRIL 4, JULY 4, OCTOBER 3, JANUARY 2, 1999 1999 1999 2000 --------- --------- ---------- ---------- (IN THOUSANDS, EXCEPT PER SHARE DATA) Net sales as originally reported.............. $ 510,509 $ 518,264 $366,485 Effect of change in accounting for layaway sales....................................... 1,186 414 (2,021) --------- --------- -------- Net sales as restated......................... $ 511,695 $ 518,678 $364,464 $835,663 ========= ========= ======== ======== Gross margin as originally reported(a)........ $ 96,801 $ 87,219 $ 80,399 Effect of change in accounting for layaway sales....................................... 487 173 (841) --------- --------- -------- Gross margin as restated...................... $ 97,288 $ 87,392 $ 79,558 $230,314 ========= ========= ======== ======== Net earnings (loss) as originally reported.... $(168,338) $(100,594) $ 3,967 Effect of change in accounting for layaway sales....................................... 487 173 (841) Extraordinary loss............................ 7,851 -- -- --------- --------- -------- Net earnings (loss) before cumulative effect of change in accounting principle and extraordinary loss as restated.............. (160,000) (100,421) 3,126 $ 28,040 Extraordinary loss............................ (7,851) -- -- -- Cumulative effect of change in accounting for layaway sales............................... (6,566) -- -- -- --------- --------- -------- -------- Net earnings (loss) as restated............... $(174,417) $(100,421) $ 3,126 $ 28,040 ========= ========= ======== ======== Per common share -- basic and diluted Net earnings (loss) as originally reported.... $ (1.69) $ (1.01) $ 0.04 Effect of change in accounting for layaway sales....................................... 0.01 -- (0.01) Extraordinary loss............................ 0.08 -- -- --------- --------- -------- Earnings (loss) before cumulative effect and extraordinary loss as restated.............. (1.60) (1.01) 0.03 $ 0.28 Extraordinary loss............................ (0.08) -- -- -- --------- --------- -------- -------- Cumulative effect of change in accounting for layaway sales............................... (0.07) -- -- -- --------- --------- -------- -------- Net earnings (loss) as restated............... $ (1.75) $ (1.01) $ 0.03 $ 0.28 ========= ========= ======== ========
58 60 SERVICE MERCHANDISE COMPANY, INC. AND SUBSIDIARIES (DEBTORS-IN-POSSESSION) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
14 WEEKS 13 WEEKS ENDED ENDED ------------------------------------------- ---------- MARCH 29, JUNE 28, SEPTEMBER 27, JANUARY 3, 1998 1998 1998 1999 --------- -------- ------------------ ---------- Net sales............................... $594,182 $685,112 $604,987 $1,285,244 ======== ======== ======== ========== Gross margin(a)......................... $143,101 $163,564 $138,254 $ 309,350 ======== ======== ======== ========== Net loss................................ $(24,101) $ (6,337) $(38,098) $ (41,771) ======== ======== ======== ========== Per common share -- basic and diluted Net loss................................ $ (0.24) $ (0.06) $ (0.38) $ (0.42) ======== ======== ======== ========== Pro forma amounts assuming the new layaway sales recognition is applied retroactively: Net sales............................... $593,990 $687,221 $603,622 $1,287,647 ======== ======== ======== ========== Gross margin............................ $143,020 $164,434 $137,689 $ 310,354 ======== ======== ======== ========== Net loss................................ $(24,181) $ (5,467) $(38,663) $ (40,767) ======== ======== ======== ========== Per common share -- basic and diluted Net loss................................ $ (0.24) $ (0.05) $ (0.39) $ (0.41) ======== ======== ======== ==========
- --------------- (a) Gross margin after cost of merchandise sold and buying and occupancy expenses. V. SUBSEQUENT EVENTS Subsequent Event -- 2000 Business Plan On February 21, 2000, the Company's Board of Directors approved its 2000 Business Plan. Key components of the 2000 Business Plan include exiting certain unprofitable hardlines categories, including toys, juvenile, sporting goods, most consumer electronics and most indoor furniture. As part of the 2000 Business Plan, the Company plans to eliminate between 5,000 and 6,000 positions in stages during 2000 and 2001, including approximately 350 distribution center and 200 corporate positions. The Company announced an initiative to reformat its existing stores as part of the 2000 Business Plan, which would result in excess store space becoming available for subleasing or other real estate transactions. Another important element to the Company's strategy is the convergence of the Internet and store selling environments. Each store will feature Internet kiosks that will provide immediate access to the Company's web site, www.servicemerchandise.com, its bridal and gift registry, and its store directory. The Company also stated that the plan or plans of reorganization currently being considered involve a debt conversion of the Company's prepetition unsecured claims into new common equity of the reorganized company. Under such circumstances, the Company's existing common stock is highly speculative and is likely worthless if the current plan of reorganization under consideration is consummated. Subsequent Event -- DIP and exit credit facility On February 21, 2000, the Company signed a commitment letter with Fleet Retail Finance Inc. Following the expected approval of the Bankruptcy Court and closing, the Company's new four-year, $600.0 million DIP and exit credit facility (the "Facility") will replace the Company's existing $750.0 million DIP facility (the "DIP facility"). The Facility will be agented by Fleet Retail Finance Inc. ("Fleet"), a co-agent of the DIP facility, and fully underwritten by FleetBoston Robertson Stephens Inc. 59 61 SERVICE MERCHANDISE COMPANY, INC. AND SUBSIDIARIES (DEBTORS-IN-POSSESSION) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) The Facility is presently structured as a $600.0 million revolver, although Fleet has reserved the right to allocate up to $85.0 million to a term loan prior to closing. The Facility also includes a letter of credit subfacility of $150.0 million and permits subordinated secured financing in amounts up to an additional $50.0 million on terms reasonably satisfactory to Fleet. The Facility requires superpriority claim status and a first priority security interest in all assets subject to existing liens, and contains certain other customary priority provisions. The Facility is subject to various customary terms and conditions, and must be closed by the Company no later than May 31, 2000. The Facility will mature four years from closing but can be converted to exit financing by the Company at any time during the four-year term as long as applicable conditions to conversion are satisfied. The interest rate during the first year of the term is LIBOR plus 250 basis points or prime plus 75 basis points; thereafter, the interest rate on the Facility is subject to quarterly adjustment pursuant to a pricing grid based on availability and/or EBITDA, as defined in the Facility, with ranges of 200 to 275 basis points over LIBOR and 25 to 100 basis points over prime. The Facility includes various covenants designed to facilitate implementation of the 2000 Business Plan and the Company's anticipated emergence from Chapter 11 in 2001. To fund capital expenditures, including the Company's planned two-year store renovation program, the facility will permit the Company to invest up to $70.0 million of capital expenditures during 2000 (plus certain incremental amounts based on the amount of subleased space completed during the fiscal year). In 2001, the Facility will permit capital expenditures up to $150.0 million less actual capital expenditures invested during 2000. During 2002 and 2003, the Company may invest up to $50.0 million each year with 100 percent carryover of unexpended amounts from prior years. The Facility will include a financial covenants test similar to the test in the current DIP Facility. The Company would not breach this financial covenant unless unused borrowing availability falls below $50.0 million and the Company fails to meet specified minimum EBITDA performance (as defined in the Facility) performance. Excluded from the EBITDA calculation are revenues and expenses associated with discontinued inventory lines, the Orlando and Montgomery distribution centers and the reduction in force plan (including payroll and severance) except with respect to non-continuing EBITDA amounts in excess of $100.0 million. There are no restrictions in the Facility on the Company's ability to sublease and lease store space pursuant to the 2000 Business Plan; lease all or part of the corporate headquarters; sell, pursuant to sale-leasebacks or outright, the corporate headquarters, the Orlando and/or Montgomery distribution centers; and/or implement a credit card receivables securitization program. The Company also retains the ability to complete intercompany restructurings, intercompany asset transfers and intercompany/third-party real estate transactions. Events of default under the Facility include customary default provisions as well as key management provisions that would trigger a default in the event that both the current Chief Executive Officer and President ceased to be employed, unless at least one of them is replaced by a person reasonably satisfactory to Fleet within 90 days and/or the acquisition by any one person or entity of 50 percent of the voting stock of the Company. Closing of the Facility is subject to customary closing conditions, including at least $155.0 million of availability at close and no material adverse change in the financial condition, operations or assets of the Company at the time of closing. Conversion of the Facility to an exit financing is also based on customary closing conditions, including the Agent's reasonable satisfaction with capital structure, plan of reorganization and any materially revised projections, as well as the achievement by the Company of a specified trailing 12-month EBITDA (which varies depending on time of exit) and certain minimum availability (which varies from $50.0 to $100.0 million) depending on the time of exit. 60 62 SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS AND RESERVES (IN THOUSANDS)
COL. A COL. B COL. C COL. D COL. E ADDITIONS BALANCE AT CHARGED TO CHARGED TO BEGINNING OF COSTS AND OTHER ACCOUNTS DEDUCTIONS BALANCE AT DESCRIPTION PERIOD EXPENSES (DESCRIBE) (DESCRIBE)(A) END OF PERIOD - ----------- ------------ ---------- -------------- ------------- ------------- INVENTORY VALUATION ALLOWANCE INCLUDED UNDER THE BALANCE SHEET CAPTION "INVENTORY" Year ended January 2, 2000........................ $25,017 $ -- -- $(11,992) $ 13,025 Year ended January 3, 1999........................ $16,945 $50,144 -- $(42,072) $ 25,017 Year ended December 28, 1997...................... $10,048 $44,226 -- $(37,329) $ 16,945 DEFERRED TAX ASSET VALUATION ALLOWANCE INCLUDED UNDER THE BALANCE SHEET CAPTION "DEFERRED INCOME TAXES" Year ended January 2, 2000........................ $41,753 $92,692 -- $ -- $134,445 Year ended January 3, 1999........................ $ -- $41,753 -- $ -- $ 41,753 Year ended December 28, 1997...................... $ -- $ -- -- $ -- $ -- ALLOWANCE FOR DOUBTFUL ACCOUNTS INCLUDED UNDER THE BALANCE SHEET CAPTION "ACCOUNTS RECEIVABLE" Year ended January 2, 2000........................ $ 2,999 $15,751 -- $ (724) $ 19,474 Year ended January 3, 1999........................ $ 3,456 $ 4,541 -- $ (4,998) $ 2,999 Year ended December 28, 1997...................... $ 4,593 $ 4,388 -- $ (5,525) $ 3,456 ALLOWANCE FOR UNCOLLECTIBLE VENDOR DEBITS INCLUDED UNDER THE BALANCE SHEET CAPTION "ACCOUNTS PAYABLE" Year ended January 2, 2000........................ $ 4,300 $ 1,447 -- $ -- $ 5,747 Year ended January 3, 1999........................ $ -- $ 4,300 -- $ -- $ 4,300 Year ended December 28, 1997...................... $ -- $ -- -- $ -- $ --
61 63 INDEPENDENT AUDITORS' REPORT To the Board of Directors and Shareholders Service Merchandise Company, Inc. Brentwood, Tennessee We have audited the accompanying consolidated balance sheets of Service Merchandise Company, Inc. and subsidiaries (Debtors-in-Possession) as of January 2, 2000 and January 3, 1999, and the related consolidated statements of operations, changes in shareholders' (deficit) equity, and cash flows for each of the three fiscal years in the period ended January 2, 2000. Our audits also included the financial statement schedule listed in the Index at Item 14. These financial statements and this financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Service Merchandise Company, Inc. and subsidiaries (Debtors-in-Possession) as of January 2, 2000 and January 3, 1999, and the results of their operations and cash flows for each of the three fiscal years in the period ended January 2, 2000, in conformity with generally accepted accounting principles. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects the information set forth therein. As discussed in Note D to the consolidated financial statements, in 1999 the Company changed its method of recording layaway sales. As discussed in Note B, the Company has filed for reorganization under Chapter 11 of the Federal Bankruptcy Code. The accompanying financial statements do not purport to reflect or provide for the consequences of the bankruptcy proceedings. In particular, such financial statements do not purport to show (a) as to assets, their realizable value on a liquidation basis or their availability to satisfy liabilities, (b) as to prepetition liabilities, the amounts that may be allowed for claims or contingencies, or the status and priority thereof, (c) as to stockholder accounts, the effect of any changes that may be made in the capitalization of the Company, or (d) as to operations, the effect of any changes that may be made in its business. The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. The Company has experienced recurring losses and has a deficiency in net assets. These matters raise substantial doubt about its ability to continue as a going concern. The consolidated financial statements do not include adjustments that might result from the outcome of this uncertainty. DELOITTE & TOUCHE LLP Nashville, Tennessee February 4, 2000 (February 21, 2000 as to Note V) 62 64 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH INDEPENDENT AUDITORS ON ACCOUNTING AND FINANCIAL DISCLOSURE No reportable items. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT DIRECTORS OF THE REGISTRANT The following is a list of directors, their ages, positions and business experience as of the date hereof:
NAME AND POSITION AGE EXPERIENCE - ----------------- --- ---------- Raymond Zimmerman 67 Chairman of the Board since January 1999; Chairman of the Board Chairman of the Board from October 1981 through January 1998; Chief Executive Officer from October 1981 to April 1997; President from July 1984 to November 1994 and from 1981 to October 1983. Board member of The Limited Stores, Columbus, Ohio. S. Cusano 46 Chief Executive Officer since March 1999; Chief Executive Officer Executive Vice President and Chief Financial Officer from April 1997 to March 1999; Vice President and Chief Financial Officer from July 1993 to April 1997; Group Vice President -- Finance from December 1991 to July 1993. Charles Septer 48 President and Chief Operating Officer President and Chief Operating Officer since March 1999; Senior Vice President, Jewelry Merchandising since 1988. Richard P. Crane, Jr. 60 Practicing Attorney, Partner, Musick, Peeler & Garrett, Los Angeles, California; Board member of North American Gaming, Inc. R. Maynard Holt, J.D. 60 R. Maynard Holt, Business Consulting & Insurance, Nashville, Tennessee. Charles V. Moore 60 President and Board member of Trainer, Wortham & Company, Inc., Investment Counselors, New York, New York. Harold Roitenberg 73 President of Roitenberg Investments, Inc., Minneapolis, Minnesota; Board member of Damark International, Inc.
EXECUTIVE OFFICERS OF THE REGISTRANT The following is a list of executive officers, their ages, positions and business experience during the past five years as of the date hereof:
NAME AND POSITION(1) AGE EXPERIENCE - -------------------- --- ---------- S. Cusano 46 Chief Executive Officer since March 1999; Chief Executive Officer Executive Vice President and Chief Financial Officer from April 1997 to March 1999; Vice President and Chief Financial Officer from July 1993 to April 1997; Group Vice President -- Finance from December 1991 to July 1993. Charles Septer 48 President and Chief Operating Officer President and Chief Operating Officer since March 1999; Senior Vice President, Jewelry Merchandising since 1988.
63 65
NAME AND POSITION(1) AGE EXPERIENCE - -------------------- --- ---------- C. Steven Moore 37 Chief Administrative Officer since March Chief Administrative Officer, Senior Vice 1999, Senior Vice President since February President, General Counsel and Corporate 9, 1999; Corporate Secretary since August Secretary 1996; Vice President and General Counsel since August 1996; Senior Corporate Attorney from November 1994 to August 1996; Corporate Attorney from May 1992 to November 1994. Thomas L. Garrett, Jr. 46 Senior Vice President and Chief Financial Senior Vice President and Chief Financial Officer since March 1999; Vice President Officer and Treasurer since July 1996; Treasurer, Magma Copper Company from July 1992 to May 1996. Gary Sease 56 Senior Vice President, Logistics since Senior Vice President, Logistics September 1996; Senior Vice President, Operations Services of American National Can Company from September 1992 to September 1996. Jerry E. Foreman 45 Senior Vice President, Merchandising since Senior Vice President, Hardlines June 1999; President and Chief Operating Merchandising, E-Commerce Officer of Ingram Industries Subsidiary, Retailer Services, Inc. from January 1996 to June 1999; President and Chief Operating Officer, Ingram Merchandising Inc. from March 1995 to January 1996; Service Merchandise Co., Inc. from 1976 to 1995, most recently Vice President of Merchandising. Kenneth A. Conway 43 Vice President and Controller since June Vice President and Controller 1999; Vice President -- Controller and Assistant Secretary, PETsMART, Inc. from September 1992 to June 1999; Controller and Assistant Secretary, STOR Furnishings International, Inc. from April 1987 to September 1992; Senior Accountant, Price Waterhouse from June 1982 to April 1987. R. John Pindred 33 Vice President and Treasurer since April Vice President and Treasurer 1999; Director of Commercial Development, Koch Industries from December 1997 to April 1999; Vice President of Financial Planning and Analysis, Service Merchandise Co. from August 1996 to December 1997; Manager of Price Risk, BHP Copper from April 1991 to August 1996; Mill Metallurgist, Noranda Minerals from January 1990 to April 1991.
- --------------- (1) All Executive Officers serve at the pleasure of the Board of Directors. SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE Section 16(a) of the Securities Exchange Act of 1934, as amended, requires the Company's directors, the Company's executive officers and persons who beneficially own more that ten percent of the Common Stock to file reports of ownership and changes in ownership with the SEC. Such directors, officers and greater than ten percent shareholders are required by SEC regulations to furnish the Company with copies of all Section 16(a) forms they file. Based solely on the Company's review of the copies of such forms furnished to the Company, or written representations from certain reporting persons, the Company believes that during fiscal 1999 its directors, officers and greater than ten percent beneficial owners were in compliance with all applicable filing requirements. 64 66 ITEM 11. EXECUTIVE COMPENSATION This item contains information with respect to compensation paid to the Company's Seven Named Officers and its Directors. SUMMARY COMPENSATION TABLE
LONG-TERM COMPENSATION AWARDS ANNUAL COMPENSATION ----------------------- ------------------------------------------ SECURITIES OTHER RESTRICTED UNDERLYING ANNUAL STOCK OPTIONS/ ALL OTHER NAME AND PRINCIPAL POSITION SALARY BONUS COMPENSATION AWARDS SARS COMPENSATION DURING FISCAL 1999 YEAR ($) ($) ($)(1) ($)(2) (#) ($)(3) --------------------------- ---- -------- ---------- ------------ ---------- ---------- ------------ S. Cusano............................. 1999 $650,000 $1,685,467(4) -- -- 31,738 Chief Executive Officer 1998 406,906 -- -- -- 579,500 4,050 1997 369,616 25,000 -- 31,250(9) 425,000 2,300 Charles Septer........................ 1999 500,000 969,334(5) -- -- -- 1,268 President and Chief Operating 1998 366,296 -- -- -- 402,153 2,818 Officer 1997 349,860 -- -- -- 240,000 2,757 C. Steven Moore....................... 1999 350,000 410,175(6) -- -- -- 809 Senior Vice President, Chief 1998 190,000 -- -- -- -- 390 Administrative Officer, 1997 160,000 -- -- -- -- 283 General Counsel and Secretary Thomas L. Garrett, Jr................. 1999 315,000 379,780(7) -- -- -- 662 Senior Vice President and 1998 262,501 -- -- -- -- 26,656 Chief Financial Officer 1997 250,000 -- -- -- -- 390 Gary Sease............................ 1999 318,270 306,494(8) -- -- -- 802 Senior Vice President 1998 324,861 -- -- -- 290,000 5,765 Logistics 1997 309,000 50,000 -- -- -- 12,173 Gary M. Witkin(9)..................... 1999 742,630 -- -- -- -- 2,337,885(10) President and CEO 1998 756,911 -- 30,000 -- 999,999 8,794 1997 773,614 108,150 30,000 -- 1,000,000 5,474 Bettina Whyte(11)..................... 1999 --(12) -- -- -- -- -- CEO
- --------------- (1) Mr. Witkin received a non-accountable expense allowance of $30,000 in fiscal 1998 and 1997. (2) The value of outstanding restricted stock awards as of January 2, 2000 are as follows:
NUMBER OF NAME SHARES VALUE ---- --------- ----- S. Cusano................................................... 3,334 283 C. Steven Moore............................................. 20,000 1,700 Thomas Garrett.............................................. 20,000 1,700
Dividends are payable on restricted stock when and if it is paid on unrestricted stock. No dividends were paid in the reported fiscal years. 65 67 (3) Represents estimated Company contributions in benefits derived from payments by the Company for group life insurance. The amount of such benefits for 1999 is set forth in the following table:
GROUP TERM LIFE INSURANCE -------------- S. Cusano................................................... $1,638 Charles Septer.............................................. $1,268 C. Steven Moore............................................. $ 809 Thomas L. Garrett, Jr....................................... $ 662 Gary Sease.................................................. $ 802 Gary M. Witkin.............................................. $ 156 Bettina Whyte............................................... $ 0
(4) Mr. Cusano's Bonus includes $1,288,000 paid pursuant to an amendment to his severance agreement with the Company effective February 1, 1999. Mr. Cusano also received $195,000 under the Company's employee retention program and earned $195,000 under the same program which was paid on January 31, 2000. Mr. Cusano also earned $7,467 under the Company's 1999 Incentive Bonus Program which is to be paid by March 31, 2000. (5) Mr. Septer's Bonus includes $500,000 paid pursuant to his employment agreement dated March 23, 1999. Mr. Septer also received $150,000 under the Company's employee retention program and earned $150,000 under the same program which was paid on January 31, 2000. Mr. Septer also earned $169,334 under the Company's 1999 Incentive Bonus Program which is to be paid by March 31, 2000. (6) Mr. Moore's Bonus includes $31,175 paid pursuant to the Company's 1998 Incentive Bonus Program. Mr. Moore also received $78,750 under the Company's employee retention program and earned $78,750 under the same program which was paid on January 31, 2000. Mr. Moore also earned $221,500 under the Company's 1999 Incentive Bonus Program which is to be paid by March 31, 2000. (7) Mr. Garrett's Bonus includes $76,435 paid pursuant to the Company's 1998 Incentive Bonus Program. Mr. Garrett also received $59,063 under the Company's employee retention program and earned $59,063 under the same program which was paid on January 31, 2000. Mr. Garrett also earned $185,220 under the Company's 1999 Incentive Bonus Program which is to be paid by March 31, 2000. (8) Mr. Sease's Bonus includes $59,676 paid pursuant to the Company's employee retention program and $59,676 earned under the same program which was paid on January 31, 2000. Mr. Sease also earned $187,143 under the Company's 1999 Incentive Bonus Program which is to be paid by March 31, 2000. (9) Mr. Witkin resigned as President and CEO on January 4, 1999. (10) Includes $2,317,890 payment provided in the agreement with the Company dated January 7, 1999 in connection with his resignation as President and CEO. (11) Ms. Whyte served as the Company's CEO from February 8, 1999 through March 23, 1999 pursuant to the Company's agreement. (12) Ms. Whyte is a principal in J. Alix and Associates and received no direct compensation from the Company for her services as the Company's CEO. During fiscal 1999, the Company paid J. Alix and Associates $2,093,446 for services rendered by all J. Alix personnel assigned to the Company's engagement and expenses of $120,613. 66 68 OPTIONS/SAR EXERCISE AND YEAR-END VALUE TABLE The following table provides information as to options exercised or held by the Seven Named Officers during fiscal 1999. None of the Named Officers has been granted SARs.
NUMBER OF SECURITIES VALUE OF UNEXERCISED UNDERLYING UNEXERCISED IN-THE-MONEY OPTIONS/SARS AT OPTION/SARS AT SHARES ACQUIRED VALUE FISCAL YEAR-END(#) FISCAL YEAR-END(#) NAME ON EXERCISE REALIZED EXERCISABLE/UNEXERCISABLE(1) EXERCISABLE/UNEXERCISABLE(1) - ---- --------------- -------- ---------------------------- ---------------------------- S. Cusano................ -- -- 193,167/386,333 $0/$0 Charles Septer........... -- -- 134,051/268,102 $0/$0 C. Steven Moore.......... -- -- 10,335/20,670 $0/$0 Thomas L. Garrett, Jr. ................... -- -- 41,667/83,333 $0/$0 Gary Sease............... -- -- 96,667/193,333 $0/$0 Gary M. Witkin........... -- -- 0/0 $0/$0 Bettina Whyte............ -- -- 0/0 $0/$0
- --------------- (1) The number of unexercised options and/or SARs available at fiscal year-end, whether exercisable or Unexercisable, includes out-of-the money options, and the value of unexercised options and/or SARs available at fiscal year-end does not include out-of-the money options. DIRECTOR COMPENSATION In fiscal 1999, directors not otherwise employed as officers of the Company received an annual fee of $23,000. In addition, Directors were paid $1,250 per in-person Board meeting and $300 per telephonic Board meeting. Mr. Holt, Chairman of the Audit Committee and member of the Compensation Committee, received an additional $5,250 for the year for his committee service. Mr. Moore, Chairman of the Compensation Committee, received an additional $1,000 for the year for his committee service. Mr. Roitenberg, member of the Audit and Compensation Committees, received an additional $1,250 for the year for his committee service. Mr. Crane, member of the Audit Committee, received an additional $1,000 for the year for his committee service. Under the Directors' Deferred Compensation Plan, implemented in 1991, directors have the option of deferring receipt of their fees until a period following their service as a director or until retirement age. Under the Second Amended and Restated Directors' Equity Plan each nonemployee director receives on the date of the Annual Meeting of Shareholders, options to purchase 3,000 shares of Common Stock at an exercise price equal to the fair market value of such shares on the date of grant. The options expire 10 years from the date of grant and are exercisable in installments of twenty percent each year beginning one year from the date of grant. The options become immediately exercisable on a director's death or disability or on the date a "change in control" is deemed to occur under the Amended and Restated 1989 Employee Stock Incentive Plan. See "Change in Control Provisions Under the Company's Stock Incentive Plans." The Second Amended and Restated Directors' Equity Plan provides nonemployee directors the option to apply their cash retainer payment to acquire options to purchase shares of Common Stock of the Company. During 1999 no options were granted to any of the Directors under this plan. From January 29, 1998 until his resignation on January 7, 1999, James E. Poole served as Chairman of the Board. The Company and Mr. Poole entered into an agreement providing that so long as Mr. Poole served as Chairman of the Board he was to receive $10,000 per month as compensation. The agreement also provided for certain compensation upon death, disability or removal from office, secretarial assistance and reimbursement of reasonable expenses. In connection with his resignation as Chairman of the Board and his retirement from the Board of Directors, the Company paid Mr. Poole $250,000. 67 69 SEVERANCE AND INDEMNIFICATION AGREEMENTS; EMPLOYMENT AGREEMENTS; CHANGE IN CONTROL PROVISIONS During fiscal 1999, the Company had severance agreements with each of the Named Officers currently employed by the Company. The severance agreements were entered into in December 1998, and with respect to Mr. Garrett, March 1999, and replaced severance agreements previously in place with the Named Officers (other than Mr. Garrett). Mr. Cusano's severance agreement was subsequently amended as described below, and Mr. Cusano, Mr. Septer and Mr. Moore subsequently entered into employment agreements as described below, which replaced each of their severance agreements. The severance agreements in place during fiscal 1999 with Messrs. Sease and Garrett and the employment agreements of Messrs. Cusano, Septer and Moore described below provide for the payment of compensation in the form of salary continuation in the amount of two times the officer's maximum annual base salary plus bonuses paid in the preceding twelve months and continuation of certain healthcare benefits, if the employment of the Named Officer is terminated for any reason other than the officer's death, disability, or for cause. If the Named Officer is terminated or deemed to be terminated within two years of a Change in Control, he will be entitled to salary continuation in the amount of three times the officer's maximum annual base salary. A Change in Control under these agreements is the same as that used in the Company's Stock Incentive Plan described below. Under the terms of these agreements, the employment of a Named Officer is deemed terminated for cause if he engages in (i) willful misconduct materially injurious to the Company; (ii) acts of dishonesty or fraud; (iii) willful violations of obligations not to compete with the Company or disclose confidential information. If the employment of a Named Officer is terminated for death or for cause, he will be entitled only to his base salary through the date of termination. If the employment is terminated by reason of disability, the officer will be entitled only to his base salary through the date of termination and such amounts as he is entitled to receive under the Company's disability insurance policies. The agreements provide that these Named Officers will not engage in various activities competitive with the business of the Company for a period of two year from the date of any termination giving rise to salary continuation payments. The assumption by the Company of these employment and severance agreements was approved by the Bankruptcy Court on May 25, 1999 with the modifications that, (i) excluded from the definition of Change in Control is an event (that would otherwise be a Change in Control) that occurs in connection with the substantial consummation of a plan of reorganization and (ii) the period of non-competition is increased to two years. Gary M. Witkin entered into an agreement with the Company January 7, 1999 pursuant to which he resigned as President, Chief Executive Officer, and as a director. The agreement provides for (i) the payment to Mr. Witkin of $2,317,890, (ii) continuation of health care coverage for the shorter of two years or his eligibility for coverage with another employer, (iii) the transfer of title to his Company provided automobile. The agreement requires Mr. Witkin to cooperate with the Company in litigation and related proceedings. Mr. Witkin is obligated under the agreement to maintain certain matters in confidence and not to compete with the Company. On January 8, 1999, the Company entered into a retention agreement (the "JA Agreement") with Jay Alix & Associates ("Jay Alix"), pursuant to which Jay Alix assumed management responsibility for the Company. Under the JA Agreement, Bettina M. Whyte was the principal responsible for the overall engagement. On February 8, 1999, she was designated Chief Executive Officer by the Board. She resigned on March 23, 1999. The JA Agreement contains standard indemnification provisions, including indemnification provisions for the benefit of Ms. Whyte. Effective February 1, 1999, the Company entered into an agreement (the "February Agreement") with S. Cusano, then the Executive Vice President and Chief Financial Officer, amending and restating his severance agreement with the Company. Under the terms of this restated agreement, Mr. Cusano resigned effective May 20, 1999, but agreed to continue as Executive Vice President and Chief Financial Officer through the effective date of his resignation. The agreement provides for (i) the payment to Mr. Cusano of $1,288,000 in installments payable through May 20, 1999, in addition to his regular pay while employed with the Company, (ii) the vesting of all unvested stock options held by him on May 20, 1999, (iii) the immediate transfer of title to his Company provided automobile, (iv) the continuation of health care benefits for the shorter of two years or his eligibility for coverage with another employer, and (v) the payment of Mr. Cusano's 68 70 attorney's fees. The Company has the right to terminate him at any time. If he is terminated for Cause (defined as (a) the willful engaging in misconduct materially injurious to the Company, (b) acts of dishonesty or fraud, or (c) the willful violation of obligations not to compete with the Company or disclose confidential information) the Company can stop further payments and recoup prior incentive payments made. If his employment is terminated for death or for cause, he will be entitled only to his base salary through the date of termination. If the employment is terminated by reason of disability, the officer will be entitled only to his base salary through the date of termination, and such amounts as he is entitled to receive under the Company's disability insurance policies. The agreement provides that Mr. Cusano will not compete with the Company during the term of the Agreement. On March 23, 1999, the Company appointed Mr. Cusano as Chief Executive Officer. In connection therewith, the Company and Mr. Cusano entered into an employment agreement with an initial term of three years which renews automatically for additional one year terms unless either party gives appropriate notice to the other party. The agreement provides for a base salary of $650,000 with the opportunity to receive an annual incentive bonus. Any such annual incentive bonus would be subject to offset by up to one-third of the amounts paid to Mr. Cusano pursuant to the February Agreement between the Company and Mr. Cusano. In connection with his appointment as President and Chief Operating Officer, on March 23, 1999, the Company and Mr. Septer entered into an employment agreement with an initial term of three years which renews automatically for additional one year terms unless either party gives appropriate notice to the other party. The agreement provides for a base salary of $500,000. The agreement provides that Mr. Septer will be paid a bonus of $250,000 on each of March 26, 1999 and April 23, 1999 (the "Special Bonus") and that he will be entitled to receive an annual incentive bonus pursuant to the Company's annual bonus plan offset by up to one-third of the amount of the Special Bonus. In connection with his appointment as Senior Vice President, Chief Administrative Officer and General Counsel, on March 23, 1999, the Company and Mr. Moore entered into an employment agreement with an initial term of three years which renews automatically for additional one year terms unless either party gives appropriate notice to the other party. The agreement provides for a base salary of $350,000 with the opportunity to receive an annual incentive bonus. On May 5, 1999, the Bankruptcy Court approved the Company's employee retention program which includes a stay bonus program (the "Stay Bonus Program") applicable to the Named Officers, among others. Pursuant to the Stay Bonus Program, for fiscal year 1999, Mr. Cusano earned $390,000, Mr. Septer earned $300,000, Mr. Moore earned $157,500, Mr. Garrett earned $118,125, and Mr. Sease earned $119,350. The Company also has indemnification agreements with each of its directors and Named Officers providing for contractual rights of indemnification to the fullest extent permitted by Tennessee law. CHANGE IN CONTROL PROVISIONS UNDER THE COMPANY'S STOCK INCENTIVE PLANS Under the Stock Incentive Plan, any stock options and SAR's which are not then exercisable will become fully exercisable and vested upon a change in control or a potential change in control. Similarly, a change in control or a potential change in control will result in the lapsing of restrictions applicable to restricted stock and other stock-based awards and such shares and awards being deemed fully vested. Stock options, SARs, limited SARs, restricted stock and other stock-based awards will, in such instances, unless otherwise determined by the Compensation Committee in is sole discretion, be cashed out on the basis of the change in control price as defined in the plan. A change in control occurs if (i) any person becomes a beneficial owner directly or indirectly of 20% or more of the total voting stock of the Company (subject to certain exceptions); (ii) as a result of, or in connection with, any cash tender or exchange offer, merger or other business combination or similar transaction, less than a majority of the combined voting power of the then outstanding securities of the Company is held in the aggregate by the holders of Company securities entitled to vote generally in the election of directors immediately prior to such transaction; or (iii) during any period of two consecutive years, individuals who at the beginning of such period constitute the Board of Directors cease for any reason to constitute at least a majority thereof. A potential change in control means (i) approval by the shareholders of an aggregate which, if completed, would constitute a change in control, or (ii) the acquisition 69 71 by a person of 5% or more of the total voting stock of the Company and the adoption by the Board of a resolution that a potential change in control, as defined in the plan, has occurred. Options and shares of restricted stock granted under the Second Amendment and Restated Directors' Equity Plan become immediately vested on the date a "change in control" is deemed to occur under the Stock Incentive Plan. PENSION PLAN The Company's pension plan (the "Pension Plan") which is qualified under Section 401(a) of the Internal Revenue Code of 1986, as amended (the "Code"), includes all full-time employees who are at least age twenty-one with one year of qualified service as defined by the Pension Plan. Directors who are not officers or employees of the Company do not participate. In 1996, the Pension Plan was changed to a traditional final average compensation plan, with monthly benefits on years of service. Participants in the Pension Plan as of January 1, 1998 are provided certain minimum benefits reflecting the provisions of the prior Pension Plan based on compensation received during 1998. The following table shows the estimated annual pension benefits payable to a covered participant at normal retirement age, based on selected compensation and years of service compensations:
YEARS OF SERVICE ----------------------------------------------- REMUNERATION 15 20 25 30 35 - ------------ ------- ------- ------- ------- ------- $125,000 $19,958 $26,610 $33,263 $39,915 $46,568 150,000 25,583 34,110 42,638 51,165 59,693 175,000 27,833 37,110 46,388 55,665 64,943 200,000 27,833 37,110 46,388 55,665 64,943 225,000 27,833 37,110 46,388 55,665 64,943 250,000 27,833 37,110 46,388 55,665 64,943 300,000 27,833 37,110 46,388 55,665 64,943 400,000 27,833 37,110 46,388 55,665 64,943 450,000 27,833 37,110 46,388 55,665 64,943 500,000 27,833 37,110 46,388 55,665 64,943
Compensation covered by the plan generally includes all compensation earned by a participant, including elective deferrals to qualified plans but excluding severance payments, expense reimbursements and allowances, and other non-wage items. However, for purposes of determining benefits, compensation covered by the plan is limited to $160,000. As a result, covered compensation for each of the Named Officers is limited to $160,000 by Section 401 (a)(17) of the Code. In addition, annual benefits payable from the plan are limited to $130,000 by Section 415 of the Code. These limitations are indexed periodically for inflation. The estimated credited years of service covered by the plan for each of the persons named in the compensation table are:
AS OF DECEMBER 31, 1999 AS OF AGE 65 ----------------------- ------------ S. Cusano.......................................... 8 27 Charles Septer..................................... 18 35 C. Steven Moore.................................... 3 35 Thomas L. Garrett, Jr.............................. 3 22 Gary Sease......................................... 3 12 Gary M. Witkin..................................... N/A N/A Bettina Whyte...................................... N/A N/A
On August 31, 1999, the Bankruptcy Court approved a motion by the Company to amend the Pension Plan. The amendment ceased the accrual of benefits, disallowed new enrollments to the plan and vested benefits already accrued under the plan effective September 30, 1999. 70 72 Retirement benefits are computed on the basis of a straight life annuity, unless the participant elects another method of payment. If the participant is married, the benefit is converted into an actuarially equivalent joint and 50% survivor benefit. The benefits shown in the table above are not subject to deduction for Social Security or other offset amounts. The Company is considering various options with respect to the Restated Retirement Plan, which may include reinstatement, amendments, termination or substitution, among other things. EXECUTIVE SECURITY PROGRAM The Company maintains a non-qualified supplemental retirement plan (the "ESP") which covers certain management employees hired or promoted to their job level prior to February 28, 1989. The plan provides salary continuation and/or death benefits equal to two times the participant's annual salary at retirement age or at age 65. Participants who complete 20 years of service and terminate employment prior to attaining retirement age are eligible for a death benefit up to age 65, at which time they may elect salary continuation and/or death benefits. Salary continuation benefits are paid from the general assets of the Company. The benefit accrual under the ESP was frozen effective September 30, 1999. There were approximately 75 active employees covered as of January 1, 2000. Approximately 35 retirees were eligible to receive benefits as of April, 1999 and approximately 46 terminated vested participants are entitled to a future benefit. The Company maintains Corporate Owned Life Insurance (COLI) policies purchased on participants covered by the plan prior to the Tax Reform Act of 1986. The Company continues to maintain COLI policies following termination or retirement of covered employees, other than with respect to Mr. Zimmerman. See Item 13. "Certain Relationships and Related Transactions". Of the Named Officers, only Charles Septer is a participant in the ESP. Upon retirement and if Mr. Septer chose to waive 100% of the death benefit, Mr. Septer's annual installment benefit would be approximately $71,900. Continuation of the ESP is subject to Bankruptcy Court approval. On August 31, 1999, the Bankruptcy Court approved a motion by the Company to amend the ESP. The amendment ceased the accrual of benefits and suspended payments effective September 30, 1999. Claims under the ESP are classified as liabilities subject to compromise by the Company. See "Notes to Consolidated Financial Statements -- J. Liabilities Subject to Compromise." During 1999 an ESP committee was formed and the Company is working with the committee to resolve claims. The Company is considering various options with respect to the Executive Security Program which may include reinstatement, amendments, termination or substitution, among other things. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The following table sets forth, as of February 27, 2000, certain information regarding the beneficial ownership of Common Stock by all directors of the Company (unless otherwise noted), the Company's Chief Executive Officer as of January 2, 2000, the four most highly compensated executive officers of the Company other than such Chief Executive Officer, by all directors and executive officers as a group, and all other persons beneficially owning greater than five percent of the Common Stock. The Company believes each director or officer, except as otherwise indicated, has sole voting and investment power over the shares of Common Stock listed as beneficially owned by him. 71 73 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
NUMBER OF SHARES PERCENT OF NAME BENEFICIALLY OWNED CLASS(1) - ---- ------------------ ---------- Raymond Zimmerman........................................... 4,396,624 24,341(2) 392,070(3) 566,280(4) ------------ 5,379,315(5) 5.3% Richard P. Crane............................................ 14,113(6) Charles V. Moore............................................ 163,695(7)(8) R. Maynard Holt............................................. 11,189(6)(9) Harold Roitenberg........................................... 43,563(10) S. Cusano................................................... 225,373(11) Charles Septer.............................................. 143,593(12) C. Steven Moore............................................. 30,335(13) Thomas L. Garrett, Jr. ..................................... 66,667(14) Gary Sease.................................................. 96,667(15) All directors and executive officers as a group (15 persons).................................................. 7,557,160(16) 7.5%
- --------------- (1) Percentages representing less than 1% of the outstanding shares of Common Stock are not shown. (2) Shares held by the Equitable Trust Company in an IRA account. (3) Represents 239,748 shares owned of record by Mr. Zimmerman as trustee for two nieces and 152,322 shares as to which Mr. Zimmerman is trustee under the will of Mary K. Zimmerman. (4) Represents 405,000 shares owned of record by the Raymond Zimmerman Family Foundation and 161,280 shares owned of record by the Zimmerman Foundation. (5) The address for Mr. Zimmerman is 7100 Service Merchandise Drive, Brentwood, Tennessee 37027. (6) Includes currently exercisable options to acquire 4,500 shares granted under the Second Amended and Restated Directors' Equity Plan. (7) Includes currently exercisable options to acquire 68,297 shares granted under the Second Amended and Restated Directors' Equity Plan. (8) Includes 9,280 shares owned by Mr. Moore as custodian for two minor children. (9) Includes 1,937 shares owned of record by Mr. Holt as trustee for the R. Maynard Holt Profit Sharing Plan, a qualified profit sharing plan under the Internal Revenue Code, 2,100 shares owned by Mr. Holt's wife and 2,000 shares owned by Mr. Holt's mother. (10) Includes 28,564 shares owned by Roitenberg Investments, Inc., which is 100% owned by Mr. Roitenberg, and currently exercisable options to acquire 13,495 shares granted under the Second Amended and Restated Directors' Equity Plan. (11) Includes 32,206 restricted shares of Common Stock held by the Company until restrictions lapse. (12) Includes 1,148 shares held by Mr. Septer's wife (who is an employee of the Company) and currently exercisable options to acquire 134,051 shares granted under the Amended and Restated 1989 Stock Incentive Plan. (13) Includes currently exercisable options to acquire 10,335 shares granted under the Amended and Restated 1989 Stock Incentive Plan. (14) Includes currently exercisable options to acquire 41,667 shares granted under the Amended and Restated 1989 Stock Incentive Plan. (15) Includes currently exercisable options to acquire 96,667 shares granted under the Amended and Restated 1989 Stock Incentive Plan. (16) Includes currently exercisable options to acquire 845,845 shares granted under the Second Amended and Restated Directors' Equity Plan and the Amended and Restated 1989 Stock Incentive Plan. 72 74 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The Company leased one store property from Raymond Zimmerman. For the fiscal year ended January 2, 2000, Mr. Zimmerman received $33,750 under this lease. The rent that has been paid under this lease is comparable to rent paid by lessees of similar properties in the same general location, and the terms of such lease are at least as favorable to the Company as the terms that could be obtained from unaffiliated persons. The Company also entered into certain other contractual arrangements with certain of its directors and executive officers during fiscal 1999. See Item 1 "Executive Compensation -- Severance and Indemnification Agreements; Employment Agreements; Change in Control Provisions." On September 28, 1999, the Bankruptcy Court approved the substitution of Service Realty Company, Inc. ("SRC") for Starwood Ceruzzi Benderson, LLC ("Starwood") as buyer for certain property owned by the Company and located in Nashville, Tennessee. While SRC is not an affiliate of the Company or a debtor in the Chapter 11 Cases, SRC's president, Raymond Zimmerman, is also executive chairman of the Board of Directors of the Company. SRC purchased the property in connection with the exercise of a right of first refusal with respect to the property granted to it pursuant to a certain Operating Agreement executed December 18, 1996, by and between the Company and SRC. The terms of sale, including a purchase price of $650,000, were otherwise identical to those offered by Starwood and previously approved by the Bankruptcy Court by order dated July 18, 1999. On September 28, 1999, the Bankruptcy Court approved the transfer of a certain split dollar insurance policy insuring the life of Raymond Zimmerman from the Company to Mr. Zimmerman. The consideration paid by Mr. Zimmerman, approximately $730,000, was equal to the cash surrender value of the policy, which the Company could otherwise have received. The transfer of the policy also relieved the Company of premium obligations of approximately $114,000 per year. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE, AND REPORTS ON FORM 8-K (a) Documents filed as a part of this report. 1. Financial Statements See Item 8. Financial Statements and Supplementary Data 2. Financial Statement Schedule Schedule II Valuation and Qualifying Accounts and Reserves 3. Exhibits Required by Item 601 of Regulation S-K. See Exhibit Index. EXHIBITS FILED WITH THIS FORM 10-K:
EXHIBIT NO. IN EXHIBIT NO. UNDER DOCUMENT ITEM 601 OF WHERE REGULATION S-K BRIEF DESCRIPTION ORIGINALLY FILED - ----------------- ----------------- ---------------- 4.19 First Amendment to Post-Petition Credit Agreement dated as of May 6, 1999, by and among the Registrant, Citicorp USA, Inc., as administrative agent, Bank Boston, N.A., as documentation agent and collateral monitoring agent, and Salomon Smith Barney, Inc., as sole arranger and book manager. 21 Subsidiaries of the Registrant. 23 Independent Auditors' consent. 27 Financial Data Schedule for the fiscal year ended January 2, 2000.
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EXHIBIT NO. IN EXHIBIT NO. UNDER DOCUMENT ITEM 601 OF WHERE REGULATION S-K BRIEF DESCRIPTION ORIGINALLY FILED - ----------------- ----------------- ---------------- EXHIBITS INCORPORATED HEREIN BY REFERENCE: 3.1 Registrant's Charter, as amended February 5, 1998 which is 3.1 incorporated herein by reference to the Registrant's Form 10-K for the fiscal year ended December 28, 1997. 3.2 Registrant's By-Laws, as amended (restated in electronic 3.2 format only for the purpose of filing with the Commission) which is incorporated by reference to the Registrant's Form 10-K for the fiscal year ended January 3, 1999. 4.1 Amended and Restated Rights Agreement dated November 4, 1998 99.2 which is incorporated herein by reference from Registrant's Form 8-K dated November 4, 1998. 4.2 Note Purchase Agreement dated as of June 28, 1990 concerning 4.2a the refinancing of $90 million of the Real Estate Bridge Loan under Credit Agreement dated as of July 24, 1989 among the Registrant, Various Banks and Chemical Bank as Agent, which is incorporated herein by reference from the Registrant's Form 10-Q for the second quarter ended June 30, 1990. 4.3 Trust Indenture dated as of June 28, 1990 concerning the 4.2b refinancing of $90.0 million of the Real Estate Bridge Loan under the Credit Agreement dated as of July 24, 1989 among the Registrant, Various Banks and Chemical Bank as Agent, which is incorporated herein by reference from the Registrant's Form 10-Q for the second quarter ended June 30, 1990. 4.4 Indenture, dated as of February 15, 1993, between the 4.1 Registrant and First American National Bank, as Trustee, regarding the Registrant's $300,000,000 of 9% Senior Subordinated Debentures due 2004, which is incorporated herein by reference from the Registrant's 4.5 Form 8-K dated February 17, 1993. First Supplemental 4.2 Indenture, dated as of February 15, 1993, between the Registrant and First American National Bank, as Trustee, regarding the Registrant's $300,000,000 of 9% Senior Subordinated Debentures due 2004, which is incorporated herein by reference from the Registrant's Form 8-K dated February 17 1993. 4.6 Form of Debenture, regarding the Registrant's $300,000,000 4.3 of 9% Senior Subordinated Debentures due 2004, which is incorporated herein by reference from the Registrant's Form 8-K dated February 17, 1993. 4.7 Form of Notes, regarding the Registrant's $100,000,000 of 4.3 8 3/8% Senior Notes due 2001, which is incorporated herein by reference from the Registrant's Form 8-K dated October 26, 1993. 4.8 Conditional Loan Commitment dated as of September 9, 1996, 4.2 concerning the $75.0 million Real Estate Mortgage Financing among Service Merchandise Company, Inc., and First Union National Bank of North Carolina which is incorporated herein by reference from the Registrant's Form 10-Q for the third quarter ended September 29, 1996.
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EXHIBIT NO. IN EXHIBIT NO. UNDER DOCUMENT ITEM 601 OF WHERE REGULATION S-K BRIEF DESCRIPTION ORIGINALLY FILED - ----------------- ----------------- ---------------- 4.9 Loan Agreement dated as of October 4, 1996 concerning the 4.2a $75.0 million Real Estate Mortgage Financing among SMC-SPE-1, Inc., and First Union National Bank of North Carolina which is incorporated herein by reference from the Registrant's Form 10-Q for the third quarter ended September 29, 1996. 4.10 Loan Agreement dated as of October 4, 1996 concerning the 4.2b $75.0 million Real Estate Mortgage Financing among SMC-SPE-2, Inc., and First Union National Bank of North Carolina which is incorporated herein by reference from the Registrant's Form 10-Q for the third quarter ended September 29, 1996. 4.11 First Amendment to Loan Agreement dated as of November 7, 4.19 1996 concerning the $75.0 million Real Estate Mortgage Financing among SMC-SPE-2, Inc., and First Union National Bank of North Carolina which is incorporated herein by reference to the Registrant's Form 10-K for the fiscal year ended December 29, 1996. 4.12 Second Amendment to Loan Agreement dated as of December 20, 4.20 1996 concerning the $75.0 million Real Estate Mortgage Financing among SMC-SPE-2, Inc., and First Union National Bank of North Carolina which is incorporated herein by reference to the Registrant's Form 10-K for the fiscal year ended December 29, 1996. 4.13 Third Amendment to Loan Agreement dated as of January 16, 4.22 1997 concerning the $75.0 million Real Estate Mortgage Financing among SMC-SPE-2, Inc., and First Union National Bank of North Carolina which is incorporated herein by reference to the Registrant's Form 10-K for the fiscal year ended December 29, 1996. 4.14 Note Issuance Agreement dated September 30, 1997 among 4.15 Service Merchandise Company, Inc., H.J. Wilson Co., Inc. and The Long-Term Credit Bank of Japan, Ltd. which is incorporated herein by reference to the Registrant's Form 10-K for the fiscal year ended December 28, 1997 4.15 Post-Petition Credit Agreement dated as of March 29, 1999, 4.17 by and among the Registrant, Citicorp USA, Inc., as administrative agent, Bank Boston, N.A., as documentation agent and collateral monitoring agent, and Salomon Smith Barney, Inc., as sole arranger and book manager which is incorporated by reference to the Registrant's Form 10-K for the fiscal year ended January 3, 1999. 4.16 Master Security Agreement dated as of March 29, 1999 by and 4.18 among Registrant and the Guarantors as Grantors and Citicorp, USA, Inc. as Administrative Agent which is incorporated by reference to the Registrant's Form 10-K for the fiscal year ended January 3, 1999. 4.17 Second Amendment to Post-Petition Credit Agreement dated as 99.2 of September 29, 1999 by and among the Registrant, Citicorp USA, Inc., as administrative agent, Bank Boston, N.A., as documentation agent and collateral monitoring agent, and Salomon Smith Barney, Inc., as sole arranger and book manager which is incorporated by reference to the Registrant's Form 8-K dated October 7, 1999.
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EXHIBIT NO. IN EXHIBIT NO. UNDER DOCUMENT ITEM 601 OF WHERE REGULATION S-K BRIEF DESCRIPTION ORIGINALLY FILED - ----------------- ----------------- ---------------- 10.1 Stock Option Pledge Agreement between Service Merchandise 10.2 Company, Inc., and the Service Merchandise Foundation dated October 15, 1990, which is incorporated herein by reference from the Registrant's Form 10-K for the fiscal year ended December 29, 1990. 10.2 Aircraft Lease Agreement dated as of June 26, 1998 between 10.1 the Registrant and General Electric Capital Corporation which is incorporated herein by reference from the Registrant's Form 10-Q for the second quarter ended June 28, 1998. EXECUTIVE COMPENSATION PLANS AND ARRANGEMENTS: 10.3 Form of Indemnification Agreement between the Registrant and Exhibit A each of Messrs. Zimmerman, Crane, Holt, Moore, Roitenberg, Cusano, Mulet and Septer which is incorporated herein by reference from the Registrant's Proxy Statement dated April 19, 1989. 10.4 Directors' Deferred Compensation Plan, which is incorporated 10.1 herein by reference from the Registrant's Form 10-K for the fiscal year ended December 29, 1990. 10.5 Key Executive Severance Plan Agreement for execution by 10.2 certain key executives in replacement of employment contracts which is incorporated herein by reference from the Registrant's Form 10-Q for the third quarter ended October 2, 1994. 10.6 Amended and Restated 1989 Employee Stock Incentive Plan 10.2 which is incorporated herein by reference from the Registrant's Form 10-K for the fiscal year ended January 1, 1995. 10.7 Retirement Benefits Agreement dated as June 25, 1998 which 10.1 is incorporated herein by reference from the Registrant's Form 10-Q for the third quarter ended September 27, 1998. 10.8 Letter Agreement II between the Registrant and Jay Alix & 10.9 Associates dated March 23, 1999 which is incorporated by reference to the Registrant's Form 10-K for the fiscal year ended January 3, 1999. 10.9 Form of Severance Agreement Amendment between the Registrant 10.10 and each of Messrs. [Cusano, Mulet, Sease and Septer] which is incorporated by reference to the Registrant's Form 10-K for the fiscal year ended January 3, 1999. 10.10 Letter Agreement among the Registrant and S. Cusano dated 10.14 February 1, 1999 which is incorporated by reference to the Registrant's Form 10-K for the fiscal year ended January 3, 1999. 10.11 Second Amended and Restated Directors' Equity Plan which is 10.15 incorporated by reference to the Registrant's Form 10-K for the fiscal year ended January 3, 1999. 10.12 Employment Agreement between the Registrant and S. Cusano 10.16 dated March 23, 1999 which is incorporated by reference to the Registrant's Form 10-K for the fiscal year ended January 3, 1999. 10.13 Employment Agreement between the Registrant and Charles 10.17 Septer dated March 23, 1999 which is incorporated by reference to the Registrant's Form 10-K for the fiscal year ended January 3, 1999.
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EXHIBIT NO. IN EXHIBIT NO. UNDER DOCUMENT ITEM 601 OF WHERE REGULATION S-K BRIEF DESCRIPTION ORIGINALLY FILED - ----------------- ----------------- ---------------- 10.14 Employment Agreement between Registrant and C. Steven Moore 10.18 dated March 23, 1999 which is incorporated by reference to the Registrant's Form 10-K for the fiscal year ended January 3, 1999. 10.15 Commitment Letter and Term Sheet of Fleet Retail Finance 99.2 Inc. for Debtor-in-Possession Credit Facility and post-confirmation Revolving Credit Facility dated February 21, 2000 which is incorporated by reference to the Registrant's Form 8-K dated February 25, 2000.
(b) Reports on Form 8-K. During the quarter ended January 2, 2000, the Company filed the following four reports on Form 8-K: (i) dated October 7, 1999 announcing that its lenders had approved an amendment to the $750.0 million debtor-in-possession financing agreement that provided for the release of the $50.0 million borrowing base reserve which had been in effect pending negotiation of financial covenants; (ii) dated October 27, 1999 attaching the Monthly Operating Report filed with the Bankruptcy Court for the period ending October 3, 1999; (iii) dated November 24, 1999 attaching the Monthly Operating Report filed with the Bankruptcy Court for the period ending October 31, 1999; and (iv) dated December 22, 1999 attaching the Monthly Operating Report filed with the Bankruptcy Court for the period ending November 28, 1999. 77 79 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) 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. SERVICE MERCHANDISE COMPANY, INC. By: /s/ S. CUSANO ------------------------------------ S. Cusano Chief Executive Officer March 15, 2000 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. /s/ RAYMOND ZIMMERMAN - -------------------------------------------------------- Raymond Zimmerman Chairman of the Board March 15, 2000 /s/ S. CUSANO - -------------------------------------------------------- S. Cusano Director and Chief Executive Officer (Principal Executive Officer) March 15, 2000 /s/ RICHARD P. CRANE, JR. - -------------------------------------------------------- Richard P. Crane, Jr. Director March 15, 2000 /s/ CHARLES V. MOORE - -------------------------------------------------------- Charles V. Moore Director March 15, 2000 /s/ R. MAYNARD HOLT - -------------------------------------------------------- R. Maynard Holt Director March 15, 2000
78 80 /s/ HAROLD ROITENBERG - -------------------------------------------------------- Harold Roitenberg Director March 15, 2000 /s/ CHARLES SEPTER - -------------------------------------------------------- Charles Septer Director, President and Chief Operating Officer March 15, 2000 /s/ THOMAS L. GARRETT, JR. - -------------------------------------------------------- Thomas L. Garrett, Jr. Senior Vice President and Chief Financial Officer (Principal Financial Officer) March 15, 2000 /s/ KENNETH A. CONWAY - -------------------------------------------------------- Kenneth A. Conway Vice President -- Controller and Chief Accounting Officer (Principal Accounting Officer) March 15, 2000
79 EX-4.19 2 FIRST AMENDMENT TO POST-PETITION CREDIT AGREEMENT 1 EXHIBIT 4.19 EXECUTION COPY FIRST AMENDMENT TO POST-PETITION CREDIT AGREEMENT AND MASTER SECURITY AGREEMENT FIRST AMENDMENT (this "Amendment"), dated as of May 6, 1999, to POST-PETITION CREDIT AGREEMENT dated as of March 29, 1999, among SERVICE MERCHANDISE COMPANY, INC., a Tennessee corporation and a debtor and debtor-in-possession under chapter 11 of the Bankruptcy Code (as defined in the Credit Agreement referenced below) (the "Borrower"), the financial institutions and other entities identified from time to time parties thereto as a Lender (as defined in the Credit Agreement referenced below), CITICORP USA, INC., a Delaware corporation ("Citicorp"), as collateral agent and administrative agent for the Lenders (in such capacity, the "Administrative Agent"), and BANKBOSTON, N.A., a national banking association ("BankBoston"), as documentation agent and collateral monitoring agent for the Lenders (in such capacities, the "Collateral Monitoring Agent") and to MASTER SECURITY AGREEMENT dated as of March 29, 1999, by and among the Borrower, the Subsidiaries of the Borrower party thereto (the "Grantors"), and the Administrative Agent. W I T N E S S E T H: WHEREAS, pursuant to the above-referenced Post-Petition Credit Agreement (as, supplemented or otherwise modified from time to time, the "Credit Agreement") the Lenders have agreed to make, and have made, Loans to the Borrower and have issued Letters of Credit for the account of the Borrower; and WHEREAS, pursuant to the above-referenced Master Security Agreement (as, supplemented or otherwise modified from time to time, the "Security Agreement") (i) the Grantors guaranteed the prompt and complete payment and performance by the Borrower of the Credit Agreement Obligations, (ii) as security for the Grantors' obligations, the Grantors granted the Administrative Agent, for the benefit of the Secured Parties, a security interest in substantially all of their tangible and intangible property and (iii) as security for the Borrower's Credit Agreement Obligations, the Borrower granted the Administrative Agent, for the benefit of the Secured Parties, a security interest in substantially all of its tangible and intangible property; and WHEREAS, the Borrower and the Lenders have agreed to amend certain of the provisions of the Credit Agreement and the Security Agreement, upon the terms and subject to the conditions set forth below; 2 NOW, THEREFORE, in consideration of the premises and the mutual covenants and provisions hereinafter contained, the parties hereto hereby agree as follows: 1. DEFINED TERMS. Capitalized terms used herein and not defined herein but defined in the Credit Agreement are used herein as defined in the Credit Agreement. 2. AMENDMENT TO SUBSECTION 1.1. (a) The definition of "Notes" in subsection 1.1 of the Credit Agreement is hereby amended by inserting the words, "Term Notes" immediately after the words "Revolving Credit Notes." (b) Clause (i) of the definition of "Permitted Expenses" in subsection 1.1 of the Credit Agreement is hereby amended by deleting such clause in its entirety and inserting in its place the following clause (i): "(i)(A) allowed professional fees and disbursements incurred by the professionals (the "Professionals") retained, pursuant to sections 327(a) or (e) of the Bankruptcy Code under a general retainer (excepting ordinary course professionals) or 1103(a), by the Loan Parties and up to two statutory committees (each, a "Committee") appointed in the Reorganization Cases and (B) the expenses of any member of any such committee allowed under section 503(b)(3)(F) of the Bankruptcy Code, which collectively may not exceed the sum of $3,000,000 in the aggregate, inclusive of any holdbacks required by the Bankruptcy Court, for post-default services, plus professional fees and disbursements previously incurred, accrued or invoiced prior to such Event of Default and the delivery of notice as provided below, to the extent previously or subsequently allowed, and" (e) The definition of "Real Property Amortization Amount" in subsection 1.1 of the Credit Agreement is hereby amended by deleting the definition thereof in its entirety and inserting in its place following definition: "Real Property Amortization Amount;" with respect to all Eligible Mortgaged Real Property at any time, an amount equal to (a) $500,000 times (b) the number of full three-month periods that have been elapsed since the Effective Date. 3. AMENDMENT TO SUBSECTION 3.1(A). The first sentence of subsection 3.1(a) of the Credit Agreement is hereby amended by adding the words "(the "Interim Maximum Amount")" before the period but after the words "the Borrowing Base at such time and $500,000,000." 2 3 4. AMENDMENT TO SUBSECTION 4.1(c). Subsection 4.1(c) of the Credit Agreement is hereby amended and restated in its entirety as follows: "(c) The Borrower shall repay the Term Loans and the Revolving Loans within three Business Days after the receipt by the Borrower or any Restricted Subsidiary of any Asset Sale Proceeds in respect of the Collateral other than (i) Collateral related to the Initial GOB Stores in an amount equal to such Asset Sale Proceeds and (ii) other Collateral from additional GOB stores in an aggregate amount in any Fiscal Year not to exceed $15,000,000, such payment to be applied to Term Loans and Revolving Loans pro rata in accordance with the aggregate principal amount of Term Loans then outstanding and Revolving Credit Commitments then in effect. The Borrower shall repay the Revolving Loans within three business days after the receipt by the Borrower or any Restricted Subsidiary of any other Asset Sale Proceeds in an amount equal to such Asset Sale Proceeds. The application of any repayment pursuant to this subsection 4.1(c) shall be made first to ABR Loans and second to Eurodollar Loans. Amounts prepaid on account of the Term Loans shall be applied to installments of the Term Loans in the inverse order of their maturity and may not be reborrowed." 5. AMENDMENT TO SUBSECTION 8.11. The cross-reference in subsection 8.11 to "subsection 8.5(e)" is hereby revised to be a cross-reference to "subsection 8.5(f)". 6. AMENDMENT TO SUBSECTION 9(m). Subsection 9(m) of the Credit Agreement is hereby amended and restated in its entirety as follows: "Any of the Reorganization Cases shall be dismissed, suspended or converted to a case under chapter 7 of the Bankruptcy Code (which, in the case of a conversion, such Reorganization Case(s) individually or together with any Reorganization Case that was previously or is simultaneously converted own or possess assets whose value exceeds $2,000,000, which value shall be determined by reference to the schedule of assets and liabilities filed with the Bankruptcy Court (unless such conversion occurs prior to the filing of such schedules, in which case any conversion shall constitute an Event of Default) or a trustee shall be appointed in any of the Reorganization Cases, or an application shall be filed by a Loan Party for the approval of, or there shall arise, any other claim having priority senior to or pari passu with the claims of the Administrative Agent and the Lenders under the Loan Documents or any other claim having priority over any or all administrative expenses of the kind specified in sections 503(b) or 507(b) of the Bankruptcy Code (other than Permitted Expenses); provided that (i) upon the occurrence of an Event of Default caused by the appointment of a chapter 11 trustee and (ii) provided no other Event of Default shall have occurred, the Lenders will in good faith negotiate a stipulation with such trustee, the terms and conditions of which are reasonably acceptable to the Lenders and the Agents, for the use of such collateral for a period of not less than five Business Days; or 3 4 7. AMENDMENT TO SUBSECTION 9(r)(v). Clause (v) of subsection 9(r) of the Credit Agreement is hereby amended by adding the words "if such motion is not dismissed within 60 days of the filing thereof" before the semicolon but immediately following the words "under section 506(e) of the Bankruptcy Code." 8. AMENDMENT TO SUBSECTION 11.1. (a) Clause (i) of Subsection 11.1 of the Credit Agreement is hereby amended and restated in its entirety as follows: "reduce the amount or extend the scheduled date of maturity of any Loan or of any installment thereof, or reduce the stated rate of any interest or fee payable hereunder, or extend the scheduled date of any payment thereof, increase the amount or extend the expiration date of any Lender's Commitment, or amend subsection 4.1(c) or the definitions of "Initial GOB Stores" or "Asset Sale Proceeds" as used in subsection 4.1(c), in each case without the consent of each Lender adversely affected thereby." (b) A new clause (vii) in inserted therein (and the present clauses (vii) through (x) are renumbered accordingly) as follows: "(vii) amend or modify the definitions of Majority Lenders or Required Lenders without the consent of all the Lenders," 9. AMENDMENT TO SUBSECTION 11.6(c). Subsection 11.6(c) of the Credit Agreement is hereby amended by: (i) capitalizing the word "affiliate" in the first sentence thereof and adding the words "or for the purposes of the Term Loans, engaged in the business of investing in loans" after the words "or other entity that is then engaged in the business of lending money"; and (ii) amending and restating clause (d) of the first proviso thereto in its entirety as follows: "(d) any Lender may make an assignment consisting solely of Term Loans (without regard to the requirements of clause (a) above) so long as the aggregate principal amount of Term Loans so assigned (if less than the Assignor's entire interest) is at least $5,000,000, and" 10. AMENDMENT TO SUBSECTION 11.6(e). Subsection 11.6(e) of the Credit Agreement is hereby amended capitalizing the word "affiliate" in the first sentence thereof. 11. AMENDMENT TO SUBSECTION 3.6(a). Subsection 3.6(a) of the Security Agreement is hereby amended by deleting the words "five days' notice" in the sixth sentence thereof and replacing therefor the words "five Business Days notice". 4 5 12. AMENDMENT TO SUBSECTION 3.7. Subsection 3.7 of the Security Agreement is hereby amended by deleting the words "five days' notice" in the first sentence thereof and replacing therefor the words "five Business Days notice". 13. AMENDMENT TO SUBSECTION 11.1(a). Subsection 11.1(a) of the Security Agreement is hereby amended by adding the words "or subsection 5.5(b)" immediately after the words "subsection 3.5" in the proviso thereto. 14. CONDITIONS PRECEDENT TO THE EFFECTIVENESS OF THIS AMENDMENT. This Amendment shall become effective as of the date hereof on the date (the "Amendment Effective Date") when the following conditions precedent have been satisfied: (a) Certain Documents. The Administrative Agent shall have received, on or before the Amendment Effective Date, all of the following, all of which shall be in form and substance satisfactory to the Administrative Agent, in sufficient originally executed copies for each of the Lenders: (i) this Amendment, executed by the Borrower and the Lenders constituting the Required Lenders; (ii) the Acknowledgement attached hereto executed by each Subsidiary Guarantor, and (iii) such additional documentation as the Agents or the Required Lenders may reasonably require. (b) Representations and Warranties. Each of the representations and warranties made by the Borrowers or the Subsidiary Guarantors in or pursuant to the Credit Agreement, as amended hereby, and the other Loan Documents to which the Borrower or any of the Subsidiary Guarantors is a party or by which the Borrower or any of the Subsidiary Guarantors is bound, shall be true and correct in all material respects on and as of the Amendment Effective Date (other than representations and warranties in any such Loan Document which expressly speak as of a different date). (c) Corporate and Other Proceedings. All corporate and other proceedings, and all documents, instruments and other legal matters in connection with the transactions contemplated by this Amendment shall be satisfactory in all respects in form and substance to the Administrative Agent and the Required Lenders. (d) No Event of Default. No Event of Default or Default shall have occurred and be continuing on the Amendment Effective Date. 15. REPRESENTATIONS AND WARRANTIES. On and as of the date hereof after giving effect to this Amendment, the Borrower hereby represents and warrants to the Lenders as follows: 5 6 (a) Each of the representations and warranties contained in Section 5 of the Credit Agreement or in any certificate, document or financial or other statement furnished at any time under or in connection therewith are true and correct in all material respects on and as of the such date as if made on and as of such date, except to the extent that such representations and warranties specifically relate to an earlier date, in which case such representations and warranties shall be true and correct in all material respects as of such earlier date; provided that references therein to the "Credit Agreement" shall be deemed to include this Amendment; (b) No Default or Event of Default has occurred and is continuing. 16. CONTINUING EFFECT; NO OTHER AMENDMENTS. Except as expressly amended hereby, all of the terms and provisions of the Credit Agreement and the other Loan Documents are and shall remain in full force and effect. The amendments contained herein shall not constitute an amendment of any other provision of the Credit Agreement or the other Loan Documents or for any other purpose except as expressly set forth herein. 17. GOVERNING LAW; COUNTERPARTS; MISCELLANEOUS. (a) THIS AMENDMENT SHALL BE GOVERNED BY, AND CONSTRUED AND INTERPRETED IN ACCORDANCE WITH, THE LAW OF THE STATE OF NEW YORK. (b) This Amendment may be executed in any number of counterparts and by the different parties on separate counterparts, each of which counterparts when executed and delivered shall be an original, but all of which shall together constitute one and the same instrument. (c) Section captions used in this Amendment are for convenience only and shall not affect the construction of this Amendment. (d) From and after the effective date hereof, all references in the Credit Agreement to the "Agreement" shall be deemed to be references to such Agreement as modified hereby. [THE REMAINDER OF THIS PAGE IS INTENTIONALLY LEFT BLANK] 6 7 IN WITNESS WHEREOF, the undersigned parties have executed this FIRST AMENDMENT TO POST-PETITION CREDIT AGREEMENT and MASTER SECURITY AGREEMENT to be effective for all purposes as of the Amendment Effective Date. SERVICE MERCHANDISE COMPANY, INC. as the Borrower By: /s/ Thomas L. Garrett, Jr. ----------------------------------- Name: Thomas L. Garrett, Jr. Title: CFO SIGNATURE PAGE TO FIRST AMENDMENT TO POST-PETITION CREDIT AGREEMENT AND MASTER SECURITY AGREEMENT 8 CITICORP USA, INC., as Administrative Agent, as a Lender By: /s/ Claudia Slacik --------------------------------- Claudia Slacik Vice President CITIBANK, N.A. as an Issuing Bank By: /s/ Claudia Slacik --------------------------------- Claudia Slacik Vice President SIGNATURE PAGE TO FIRST AMENDMENT TO POST-PETITION CREDIT AGREEMENT AND MASTER SECURITY AGREEMENT 9 BANKBOSTON, N.A., as Documentation Agent and Collateral Monitoring Agent, as a Lender, and as an Issuing Bank By: /s/ Betsy Ratto -------------------------------- Betsy Ratto Vice President SIGNATURE PAGE TO FIRST AMENDMENT TO POST-PETITION CREDIT AGREEMENT AND MASTER SECURITY AGREEMENT 10 NATIONAL CITY COMMERCIAL FINANCE, INC., as a Lender By: /s/ Thomas R. Poe -------------------------------------- Name: Thomas R. Poe Title: President & CEO, National City Commercial Finance SIGNATURE PAGE TO FIRST AMENDMENT TO POST-PETITION CREDIT AGREEMENT AND MASTER SECURITY AGREEMENT 11 HELLER FINANCIAL, INC. as a Lender By: /s/ T. Bukoroski ------------------------------- Name: T. Bukoroski Title: Sr. Vice President SIGNATURE PAGE TO FIRST AMENDMENT TO POST-PETITION CREDIT AGREEMENT AND MASTER SECURITY AGREEMENT 12 FOOTHILL CAPITAL CORPORATION as a Lender By: /s/ Michael P. Baranocoski ------------------------------ Name: Michael P. Baranocoski Title: Vice President SIGNATURE PAGE TO FIRST AMENDMENT TO POST-PETITION CREDIT AGREEMENT AND MASTER SECURITY AGREEMENT 13 JACKSON NATIONAL LIFE INSURANCE COMPANY, as a Lender By: PFM FINANCE, INC., its Attorney-in-Fact By: /s/ Jeffrey J. Podwika ---------------------------- Name: Jeffrey J. Podwika Title: Vice President Attorney-in-Fact SIGNATURE PAGE TO FIRST AMENDMENT TO POST-PETITION CREDIT AGREEMENT AND MASTER SECURITY AGREEMENT 14 ACKNOWLEDGMENT Reference is hereby made to the Master Security Agreement (as defined in the Credit Agreement) to which each of the undersigned is a party. Each of the undersigned hereby consents to the terms of the foregoing First Amendment to Post-Petition Credit Agreement and agrees that the terms thereof shall not affect in any way its obligations and liabilities under the Master Security Agreement or any other Loan Document, all of which obligations and liabilities shall remain in full force and effect and each of which is hereby affirmed. B.A. PARGH, INC. H.J. WILSON CO., INC. H.J. WILSON CO. REALTY, INC. HOMEOWNERS WAREHOUSE, INC. SERVICE MERCHANDISE CO. BROAD, INC. SERVICE MERCHANDISE COMPANY OF IOWA, INC. SERVICE MERCHANDISE COMPANY OF KANSAS, INC. SERVICE MERCHANDISE CO. NO 30, INC. SERVICE MERCHANDISE CO. NO 34, INC. SERVICE MERCHANDISE CO. NO 35, INC. SERVICE MERCHANDISE CO. NO 51, INC. SERVICE MERCHANDISE CO. NO 93, INC. SERVICE MERCHANDISE CO. NO 99, INC. SERVICE MERCHANDISE FINANCIAL CO., INC. SERVICE MERCHANDISE INDIANA PARTNERS (by its Partners Service Merchandise Co. No. 34, Inc., and Service Merchandise Co. No. 35, Inc.) SERVICE MERCHANDISE OF TENNESSEE LIMITED PARTNERSHIP (by its General Partner, Service Merchandise Company, Inc.) SERVICE MERCHANDISE OF TEXAS LIMITED PARTNERSHIP (by its General Partner, Service Merchandise Company, Inc.) SMC-HC, INC. THE TOY STORE, INC. WHOLESALE SUPPLY COMPANY, INC. A.F.S. MARKETING SERVICES, INC. SERVICE MERCHANDISE OF NEW YORK, INC. SERVICE MERCHANDISE OFFICE SUPPLY, INC. SERVICE MERCHANDISE SHOWROOMS, INC. SERVICE MERCHANDISE RM, INC. THE McNALLY SUPPLY COMPANY TRAVEL MANAGEMENT CONSULTANTS, INC. PROMOTABLES, INC. as Guarantors By: /s/ Thomas L. Garrett, Jr. ------------------------------------- Name: Thomas L. Garrett, Jr. Title: CFO ACKNOWLEDGMENT TO FIRST AMENDMENT TO POST-PETITION CREDIT AGREEMENT AND MASTER SECURITY AGREEMENT EX-21 3 SUBSIDIARIES OF THE REGISTRANT 1 Exhibit 21 SUBSIDIARIES OF THE REGISTRANT The following is a list of subsidiaries of the Registrant as of January 2, 2000 all of which are wholly-owned:
PARENT STATE OF INCORPORATION Service Merchandise Company, Inc. Tennessee SUBSIDIARIES Service Merchandise Co. Broad, Inc. Tennessee Service Credit Corp. Tennessee Service Merchandise Co. No. 34, Inc. Tennessee Service Merchandise Co. No. 35, Inc. Tennessee Service Merchandise Co. No. 51, Inc. Illinois Service Merchandise Co. No. 93, Inc. Tennessee Service Merchandise Co. No. 30, Inc. Tennessee Service Merchandise Co. No. 99, Inc. Nevada Service Merchandise Company of Iowa, Inc. Tennessee Service Merchandise Company of Kansas, Inc. Tennessee The Toy Store, Inc. Tennessee B. A. Pargh Co., Inc. Tennessee Service Merchandise Showrooms, Inc. Tennessee Wholesale Supply Company, Inc. Tennessee Homeowners Warehouse, Inc. Florida Service Merchandise RM, Inc. Tennessee The McNally Supply Company Tennessee SMC Aviation, Inc. New Hampshire H. J. Wilson Co., Inc. Louisiana Service Merchandise Co. of New York, Inc. Tennessee Travel Management Consultants, Inc. Tennessee A. F. S. Marketing Services, Inc. Tennessee Service Merchandise Financial Co., Inc. Tennessee Service Merchandise Indiana Partners Indiana Service Merchandise of Tennessee, Limited Partnership Delaware Service Merchandise of Texas, Limited Partnership Delaware Service Merchandise Co., SPE-1, Inc. Delaware Service Merchandise Co., SPE-2, Inc. Delaware Service Merchandise Co., HC, Inc. Delaware Promotables, Inc. Tennessee Service Merchandise Office Supply, Inc. Tennessee Surplus Assurance Company, Ltd. Bermuda H. J. Wilson Co. Realty, Inc. Texas
1 EX-23 4 INDEPENDENT AUDITORS' CONSENT 1 EXHIBIT 23 INDEPENDENT AUDITORS' CONSENT We consent to the incorporation by reference in Registration Statement Nos. 33-60201, 33-7079, 33-11340, 33-30983 and 33-50185 on Form S-8 of our report dated February 4, 2000 (February 21, 2000 as to Note V) (which expresses an unqualified opinion and includes explanatory paragraphs concerning the change in accounting for recording layaway sales, the Company's filing for reorganization under Chapter 11 of the Federal Bankruptcy Code, and substantial doubt about the Company's ability to continue as a going concern), appearing in the Annual Report on Form 10-K of Service Merchandise Company, Inc. for the fiscal year ended January 2, 2000. /s/ DELOITTE & TOUCHE LLP Nashville, Tennessee March 14, 2000 EX-27 5 FINANCIAL DATA SCHEDULE
5 1,000 YEAR JAN-02-2000 JAN-04-1999 JAN-02-2000 61,591 0 13,171 19,474 642,997 746,894 805,088 437,374 1,161,944 322,016 429,507 0 0 100,012 (67,067) 1,161,944 2,230,500 2,230,500 1,735,948 1,735,948 623,328 0 64,835 (230,129) (874) (229,255) 0 (7,851) (6,566) (243,672) (2.45) (2.45) Amount represents the number of $0.50 par value common shares outstanding. Amount includes (i) depreciation and amortization; (ii) selling, general and administrative expenses. The Company changed its method of accounting for layaway sales. Layaway sales for 1999 have been recognized upon delivery of merchandise to the customer. Layaway sales in prior years were recognized when the initial layaway deposit was received.
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