-----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, MykbDZnBiJsatnWL7xIcHN2zEDRmDnZxOsqe1noAo3DakStaQ0BtUImolxfj6mrl nuqTx4qY+beG28pNNNGSJA== /in/edgar/work/0000950144-00-013196/0000950144-00-013196.txt : 20001110 0000950144-00-013196.hdr.sgml : 20001110 ACCESSION NUMBER: 0000950144-00-013196 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 20001001 FILED AS OF DATE: 20001109 FILER: COMPANY DATA: COMPANY CONFORMED NAME: SERVICE MERCHANDISE CO INC CENTRAL INDEX KEY: 0000089107 STANDARD INDUSTRIAL CLASSIFICATION: [5399 ] IRS NUMBER: 620816060 STATE OF INCORPORATION: TN FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 001-09223 FILM NUMBER: 757561 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-Q 1 g65165e10-q.txt SERVICE MERCHANDISE COMPANY INC 1 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ----------- FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED OCTOBER 1, 2000. Commission File No.1-9223 SERVICE MERCHANDISE COMPANY, INC. (Debtor-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 37027 (Address of Principal Executive Offices) (Zip Code) Registrant's Telephone Number, Including Area Code: (615) 660-6000 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 [ ]. As of October 1, 2000, there were 99,906,123 shares of the Registrant's common stock, $.50 par value, outstanding. 2 TABLE OF CONTENTS
Page No. --- PART I FINANCIAL INFORMATION Consolidated Statements of Operations (Unaudited) - Three and Nine Periods Ended October 1, 2000 and October 3, 1999..........................................3 Consolidated Balance Sheets - October 1, 2000 (Unaudited), October 3, 1999 (Unaudited) and January 2, 2000.......................................................4 Consolidated Statements of Cash Flows (Unaudited) - Nine Periods Ended October 1, 2000 and October 3, 1999........................................................5 Notes to Consolidated Financial Statements (Unaudited).....................................6 Management's Discussion and Analysis of Financial Condition and Results of Operations.....16 Quantitative and Qualitative Disclosure about Market Risk.................................28 PART II OTHER INFORMATION Legal Proceedings.........................................................................29 Defaults Upon Senior Securities...........................................................30 Exhibits and Reports on Form 8-K..........................................................30 SIGNATURES .......................................................................................31
2 3 PART I - FINANCIAL INFORMATION SERVICE MERCHANDISE COMPANY, INC. AND SUBSIDIARIES ITEM 1. FINANCIAL STATEMENTS CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) (Debtor-In-Possession) (in thousands, except per share data)
THREE PERIODS ENDED NINE PERIODS ENDED ----------------------- ------------------------- RESTATED RESTATED OCTOBER 1, OCTOBER 3, OCTOBER 1, OCTOBER 3, 2000 1999 2000 1999 --------- ----------- ----------- ----------- Net sales: Operations excluding exiting categories and closed facilities $ 225,406 $ 250,099 $ 780,772 $ 794,621 Exiting categories and closed facilities 48,932 114,365 254,143 600,216 --------- ----------- ----------- ----------- 274,338 364,464 1,034,915 1,394,837 --------- ----------- ----------- ----------- COSTS AND EXPENSES: Operations excluding exiting categories and closed facilities 168,024 192,149 561,038 601,202 Exiting categories and closed facilities 60,343 92,755 259,429 529,397 --------- ----------- ----------- ----------- 228,367 284,904 820,467 1,130,599 --------- ----------- ----------- ----------- GROSS MARGIN (LOSS) AFTER COST OF MERCHANDISE SOLD AND BUYING AND OCCUPANCY EXPENSES: Operations excluding exiting categories and closed facilities 57,382 57,950 219,734 193,419 Exiting categories and closed facilities (11,411) 21,610 (5,286) 70,819 --------- ----------- ----------- ----------- 45,971 79,560 214,448 264,238 --------- ----------- ----------- ----------- SELLING, GENERAL AND ADMINISTRATIVE EXPENSES: Operations excluding exiting categories and closed facilities 73,674 94,612 244,899 306,385 Exiting categories and closed facilities 20,826 8,941 78,355 103,583 --------- ----------- ----------- ----------- 94,500 103,553 323,254 409,968 --------- ----------- ----------- ----------- Other income, net (774) (39,726) (14,791) (47,192) Restructuring charge (income) (777) (14,153) (2,524) 83,407 Depreciation and amortization: Operations excluding exiting categories and closed facilities 9,469 9,307 28,751 28,665 Exiting categories and closed facilities 126 502 600 4,247 --------- ----------- ----------- ----------- 9,595 9,809 29,351 32,912 --------- ----------- ----------- ----------- Reorganization items (income) 5,527 4,391 37,188 (7,981) --------- ----------- ----------- ----------- Earnings (loss) before interest, income tax, extraordinary item and cumulative effect of change in accounting principle (62,100) 15,686 (158,030) (206,876) Interest expense (contractual interest $16,127, $50,731, $19,577 and $65,923 for the three and nine periods ended October 1, 2000 and October 3, 1999, respectively) 9,088 12,558 29,614 50,419 --------- ----------- ----------- ----------- Earnings (loss) before income tax, extraordinary item and cumulative effect of change in accounting principle (71,188) 3,128 (187,644) (257,295) Income tax -- -- -- -- --------- ----------- ----------- ----------- Earnings (loss) before extraordinary item and cumulative effect of change in accounting principle (71,188) 3,128 (187,644) (257,295) Extraordinary loss from early extinguishment of debt -- -- -- (7,851) Cumulative effect of a change in recording layaway sales -- -- -- (6,566) --------- ----------- ----------- ----------- NET EARNINGS (LOSS) $ (71,188) $ 3,128 $ (187,644) $ (271,712) ========= =========== =========== =========== WEIGHTED AVERAGE COMMON SHARES - BASIC AND DILUTED 99,723 99,724 99,723 99,720 ========= =========== =========== =========== EARNINGS (LOSS) PER COMMON SHARE - BASIC AND DILUTED: Earnings (loss) before extraordinary item and cumulative effect of change in accounting principle $ (0.71) $ 0.03 $ (1.88) $ (2.58) Extraordinary loss from early extinguishment of debt -- -- -- (0.08) Cumulative effect of a change in recording layaway sales -- -- -- (0.07) --------- ----------- ----------- ----------- Net earnings (loss) $ (0.71) $ 0.03 $ (1.88) $ (2.73) ========= =========== =========== ===========
The accompanying notes are an integral part of these consolidated financial statements. 3 4 SERVICE MERCHANDISE COMPANY, INC. AND SUBSIDIARIES Consolidated Balance Sheets (Debtor-In-Possession) (in thousands, except per share data)
(UNAUDITED) ------------------------- RESTATED OCTOBER 1, OCTOBER 3, JANUARY 2, 2000 1999 2000 ----------- ----------- ----------- ASSETS CURRENT ASSETS: Cash and cash equivalents $ 22,376 $ 36,923 $ 61,591 Accounts receivable, net of allowance of $17,545, $17,752 and $19,474 respectively 7,906 6,611 13,171 Inventories 523,968 780,203 642,997 Prepaid expenses and other assets 22,641 78,666 29,135 ----------- ----------- ----------- TOTAL CURRENT ASSETS 576,891 902,403 746,894 ----------- ----------- ----------- PROPERTY AND EQUIPMENT: Net property and equipment - owned 347,253 359,057 353,078 Net property and equipment - leased 12,921 14,012 14,636 Other assets and deferred charges 48,865 62,281 47,336 ----------- ----------- ----------- TOTAL ASSETS $ 985,930 $ 1,337,753 $ 1,161,944 =========== =========== =========== LIABILITIES AND SHAREHOLDERS' (DEFICIT) EQUITY LIABILITIES NOT SUBJECT TO COMPROMISE: CURRENT LIABILITIES: Notes payable $ 139,485 $ 203,633 $ 42,977 Accounts payable 77,873 112,833 67,318 Accrued expenses 148,053 168,924 181,860 State and local sales taxes 10,423 16,008 28,737 Accrued restructuring costs 3,197 -- 38 Current maturities of long-term debt -- 1,000 1,000 Current maturities of capitalized lease obligations 88 -- 86 ----------- ----------- ----------- TOTAL CURRENT LIABILITIES 379,119 502,398 322,016 LONG-TERM LIABILITIES: Long-term debt 60,000 98,500 98,500 Capitalized lease obligations 2,420 -- 2,514 ----------- ----------- ----------- TOTAL LONG-TERM LIABILITIES 62,420 98,500 101,014 LIABILITIES SUBJECT TO COMPROMISE 749,174 784,371 755,975 ----------- ----------- ----------- TOTAL LIABILITIES 1,190,713 1,385,269 1,179,005 ----------- ----------- ----------- COMMITMENTS AND CONTINGENCIES 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 issue -- -- -- Common stock, $.50 par value, authorized 500,000 shares, issued and outstanding 99,906, 100,022 and 100,012 shares, respectively 49,954 50,011 50,006 Additional paid-in capital 6,017 4,965 6,424 Deferred compensation (327) (800) (708) Accumulated other comprehensive loss -- (869) -- Retained (deficit) earnings (260,427) (100,823) (72,783) ----------- ----------- ----------- TOTAL SHAREHOLDERS' (DEFICIT) EQUITY (204,783) (47,516) (17,061) ----------- ----------- ----------- TOTAL LIABILITIES AND SHAREHOLDERS' (DEFICIT) EQUITY $ 985,930 $ 1,337,753 $ 1,161,944 =========== =========== ===========
The accompanying notes are an integral part of these consolidated financial statements. 4 5 SERVICE MERCHANDISE COMPANY, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows (Unaudited) (Debtor-In-Possession) (in thousands)
NINE PERIODS ENDED ---------------------- RESTATED OCTOBER 1, OCTOBER 3, 2000 1999 --------- --------- CASH FLOWS FROM OPERATING ACTIVITIES: Net loss $(187,644) $(271,712) Adjustments to reconcile net loss to net cash provided (used) by operating activities: Extraordinary items -- 7,851 Cumulative effect of a change in accounting principle - layaway sales -- 6,566 Depreciation and amortization 34,317 41,777 Net gain on sale of property and equipment (4,423) (28,357) Provision for restricted cash -- 8,819 Write-down of property and equipment due to restructuring -- 16,809 Reorganization items 37,188 (7,981) Changes in assets and liabilities: Accounts receivable 5,265 16,885 Inventories 119,029 119,594 Prepaid expenses and other assets (2,707) (46,349) Accounts payable 17,465 75,209 Accrued expenses and state and local sales taxes (73,369) (4,105) Accrued restructuring costs (10,967) 48,175 Income taxes -- 10,769 --------- --------- NET CASH USED BY OPERATING ACTIVITIES (65,846) (6,050) --------- --------- CASH FLOWS FROM INVESTING ACTIVITIES: Additions to property and equipment - owned (44,559) (10,540) Proceeds from sale of property and equipment 8,723 47,978 Proceeds from sale of property and equipment - reorganization 27,307 4,592 Restricted cash and other assets, net (8,451) (2,709) --------- --------- NET CASH PROVIDED (USED) BY INVESTING ACTIVITIES (16,980) 39,321 --------- --------- CASH FLOWS FROM FINANCING ACTIVITIES: Short-term borrowings, net 96,508 47,633 Repayment of long-term debt (49,542) (148,175) Repayment of capitalized lease obligations (3,199) (5,244) Debt issuance costs -- (18,574) Debt issuance costs - reorganization -- (3,750) Exercise of stock options (forfeiture of restricted stock), net (156) (1,987) --------- --------- NET CASH PROVIDED (USED) BY FINANCING ACTIVITIES 43,611 (130,097) --------- --------- NET DECREASE IN CASH AND CASH EQUIVALENTS (39,215) (96,826) CASH AND CASH EQUIVALENTS - BEGINNING OF PERIOD 61,591 133,749 --------- --------- CASH AND CASH EQUIVALENTS - END OF PERIOD $ 22,376 $ 36,923 ========= ========= SUPPLEMENTAL DATA: Cash paid (received) during the period for: Interest $ 15,369 $ 38,687 Income taxes $ (270) $ (18,903) Reorganization items $ 21,016 $ 14,970
The accompanying notes are an integral part of these consolidated financial statements. 5 6 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) FOR THE NINE PERIODS ENDED OCTOBER 1, 2000 A. FINANCIAL STATEMENT PRESENTATION AND GOING CONCERN MATTERS The consolidated financial statements except for the consolidated balance sheet as of January 2, 2000, have been prepared by the Company without audit. In management's opinion, the information and amounts furnished in this report reflect all adjustments (consisting of normal recurring adjustments) considered necessary for the fair presentation of the consolidated financial position and consolidated results of operations for the interim periods presented. Certain prior period amounts have been reclassified to conform to the current period presentation. As described in Note L, a change in accounting principle regarding layaway sales was adopted during the quarter ended January 2, 2000. The consolidated financial statements as of and for the nine periods ended October 3, 1999 have been restated to reflect the effect of the retroactive application of the change to January 4, 1999. The 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 consolidated statements of operations line item "Exiting categories and closed facilities" represents activity specifically identifiable to inventory liquidations conducted in conjunction with (1) the Company's restructuring plan adopted on March 25, 1997 (the "1997 Restructuring Plan"); (2) the Company's rationalization plan adopted on March 8, 1999 (the "Rationalization Plan") and (3) the exiting of toys, juvenile, sporting goods, most consumer electronics and other merchandise categories as part of the 2000 Business Plan. All activity for these items is classified in "Exiting categories and closed facilities." Prior year amounts reflect operating results for these same facilities and merchandise classifications. Selling, general and administrative expenses for exiting categories and closed facilities do not include any allocation of corporate overhead. The Company's recent losses and the Chapter 11 Cases (as defined) 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 to exit financing agreements, (ii) the Company's ability to implement its 2000 business plan; (iii) confirmation of a plan of reorganization under the Bankruptcy Code, (iv) the Company's ability to achieve profitable operations after such confirmation, and (v) the Company's ability to generate sufficient cash from operations to meet its obligations. As described in Note B, the Company has an exclusive right to submit a plan of reorganization to the Bankruptcy Court through April 30, 2001. 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 to exit 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. 6 7 On February 21, 2000, the Company's Board of Directors approved its 2000 Business Plan, which contemplates: (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 hardline 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 anticipated 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. 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 home products categories that have performed well and which generate cross-selling opportunities with jewelry. The Company has exited certain unprofitable categories, including toys, juvenile, sporting goods and most electronics. 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 intends to reconfigure its stores to feature less overall selling square footage (approximately 18,000 square feet as compared to 27,000 square feet), but increase square footage for jewelry. The excess store space will be available for sub-leasing or other real estate transactions. Approximately 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. As of October 1, 2000, the refurbishment and preparation for subleasing of sixty-three stores was substantially complete, with an additional nine under construction. Up to an additional eighty-three stores are scheduled for refurbishment in 2001. The Company's ability to complete this program depends upon the achievement of satisfactory subleasing results and is subject to other known and unknown risks and uncertainties, including those set forth below under "Safe Harbor Statement Under the Private Securities Litigation Reform Act of 1995." Although the Company plans to continue operating substantially all of its 221 stores, it has closed its distribution centers in Montgomery, New York and intends to close in January 2001 its distribution center in Orlando, Florida. As part of the 2000 Business Plan, the Company has reduced its workforce at its corporate offices, its distribution centers and its stores resulting in the elimination of approximately 5,000 positions. The Company continues to review its business strategy, which may include additional store closings, changes in merchandise assortments, changes in distribution networks and overhead costs, and is considering various options with respect to the Restated Retirement Plan, the Executive Security Plan and the Savings and Investment Plan, which may include reinstatement, amendments, termination or substitution of such plans, among other things. The Company has historically incurred a net loss for the first three quarters of the year because of the seasonality of its business. The results of operations for the nine periods ended October 1, 2000 and October 3, 1999 are not necessarily indicative of the operating results for an entire fiscal year. These consolidated financial statements should be read in conjunction with the Company's Annual Report on Form 10-K for the fiscal year ended January 2, 2000. B. 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 7 8 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 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. 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. 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 probable that it will be cancelled, and therefore, worthless if the expected plan of reorganization is consummated. C. 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. As a result, a pre-tax charge of $129.5 million for restructuring costs was taken in the first quarter of fiscal 1997. The remaining component of the restructuring charge accrual and an analysis of the change in the accrual for the nine periods ended October 1, 2000 are outlined in the following table:
ACTIVITY -------------------------- ACCRUED ACCRUED RESTRUCTURING RESTRUCTURING COSTS AS OF COSTS AS OF JANUARY 2, RESTRUCTURING CHANGE IN OCTOBER 1, 2000 COSTS PAID ESTIMATE 2000 ---- ---------- -------- ---- (in thousands) Lease termination and other real estate $7,894 $(38) $(136) $7,720 ====== ==== ===== ======
Note: The accrued restructuring costs are included in Liabilities Subject to Compromise. 8 9 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. Lease terminations and other real estate costs primarily consist of contractual rent payments and other real estate costs. These amounts have been accrued according to the remaining leasehold obligations under Section 502(b)(6) of the Bankruptcy Code. 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, not to exceed three years of the remaining term of the lease. Any unpaid rent is included in the claim. The Company experienced lower than expected expenses in lease termination and disposition of closed stores for the nine periods ended October 1, 2000. As a result the Company reduced its estimate for these costs by $0.1 million. The leases remaining on closed locations as of October 1, 2000 vary in length with expiration dates ranging from February 2001 to February 2015. RATIONALIZATION PLAN In February 1999, the Company announced a rationalization plan to close up to 132 stores and up to four distribution centers and to reduce corporate overhead. 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 and 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 remaining components of the restructuring charge accrual and an analysis of the change in the accrual for the nine periods ended October 1, 2000 are outlined in the following table:
ACTIVITY -------------------------- ACCRUED ACCRUED RESTRUCTURING RESTRUCTURING COSTS AS OF COSTS AS OF JANUARY 2, RESTRUCTURING CHANGE IN OCTOBER 1, 2000 COSTS PAID ESTIMATE 2000 ---- ---------- -------- ---- (in thousands) Lease termination and other real estate costs $ 38,315 $(1,564) $(2,563) $34,188 Employee severance 478 (578) 175 75 -------- ------- ------- ------- Total $ 38,793 $(2,142) $(2,388) $34,263 ======== ======= ======= =======
Note: The accrued restructuring costs are included in Liabilities Subject to Compromise. Lease terminations and other real estate costs primarily consists of contractual rent payments. These amounts have been accrued according to the remaining leasehold obligations under Section 502(b)(6) of the Bankruptcy Code. Section 502(b)(6) limits a lessor's claim to the rent reserved by such lease, without 9 10 acceleration for the greater of one year, or 15 percent, not to exceed three years of the remaining term of the lease. Any unpaid rent is included in the claim. The Company experienced lower than expected expenses in lease termination and disposition of closed stores for the nine periods ended October 1, 2000. As a result the Company reduced its estimate for these costs by $2.4 million. 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. D. LIABILITIES SUBJECT TO COMPROMISE "Liabilities subject to compromise" refers to 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 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. Payment terms for these amounts, which are considered long-term liabilities at this time, will be established in connection with the Chapter 11 Cases. Pursuant to order of the Bankruptcy Court, on or about March 15, 2000, the Company mailed notices to all known creditors that the deadline for filing proofs of claim with the Bankruptcy Court was May 15, 2000. Differences between amounts recorded by the Company and claims filed by creditors are continuing to be investigated and resolved. 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 received approval from the Bankruptcy Court 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 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. 10 11
OCTOBER 1, OCTOBER 3, 2000 1999 -------- -------- (in thousands) Accounts payable $196,787 $190,749 Accrued expenses 67,710 67,376 Accrued restructuring costs: 1997 Restructuring Plan 7,720 8,109 1999 Rationalization Plan 34,263 47,246 Long-term debt 419,465 439,558 Capitalized lease obligations 23,229 31,333 -------- -------- $749,174 $784,371 ======== ========
Contractual interest expense not accrued or recorded on certain pre-petition debt totaled $21.1 million and $15.5 million for the nine periods ended October 1, 2000 and October 3, 1999, respectively, and $7.0 million and $7.0 million for the three periods ended October 1, 2000 and October 3, 1999, respectively. E. 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:
THREE PERIODS THREE PERIODS ENDED ENDED OCTOBER 1, OCTOBER 3, (in thousands) 2000 1999 -------- -------- Professional fees and administrative items $ 9,375 $ 7,197 Gain on disposal of assets (4,321) (270) Store closing costs 473 (2,536) -------- -------- Total reorganization items expense $ 5,527 $ 4,391 ======== ========
NINE PERIODS NINE PERIODS ENDED ENDED OCTOBER 1, OCTOBER 3, (in thousands) 2000 1999 -------- -------- Reduction of accrued rent for rejected leases $ -- $(45,981) Professional fees and administrative items 25,889 16,494 (Gain) loss on disposal of assets (2,361) 10,019 Store closing costs 4,237 11,487 Severance 9,423 -- -------- -------- Total reorganization items expense (income) $ 37,188 $ (7,981) ======== ========
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 leases, without acceleration, for the greater of one year, or 15 percent, not to exceed three years, of the remaining term of such leases, plus any unpaid rent. PROFESSIONAL FEES AND OTHER ADMINISTRATIVE ITEMS: Professional fees and administrative items relate to legal, accounting and other professional costs directly attributable to the Chapter 11 Cases. 11 12 (GAIN) LOSS ON DISPOSAL OF ASSETS: (Gain) loss on disposal of assets consists of gains and losses associated with the sale of four parcels of real property, sale of a distribution center, sale of certain assets of one of the Company's subsidiaries, B.A. Pargh Co., Inc. and disposition of displaced fixtures and equipment from remodeled stores under the 2000 Business Plan. STORE CLOSING COSTS: Store closing costs include rent, common area maintenance, utilities, asset write-downs and real estate taxes offset by other income resulting from store dispositions. Rent amounts have been adjusted to reflect the reduction allowed under Section 502(b)(6) of the Bankruptcy Code. SEVERANCE: Severance costs arise from workforce reductions at the corporate offices, distribution centers and stores as a part of the 2000 Business Plan. F. BORROWINGS This note contains information regarding the Company's short-term borrowings and long-term debt as of October 1, 2000. 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. 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 included $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 were 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 $203.6 million as of October 3, 1999. Outstanding borrowings under the term loan of the DIP Facility were $99.5 million as of October 3, 1999. There was a commitment fee of 0.375% on the undrawn portion of the revolving loans under the DIP Facility. 12 13 The DIP Facility was secured by all material unencumbered assets of the Company and its subsidiaries, including inventory, but excluding previously mortgaged property. Borrowings under the DIP Facility were limited based on a borrowing base formula which considered eligible inventories, eligible accounts receivable, mortgage values on eligible real properties, eligible leasehold interests, available cash equivalents and in-transit cash. On April 14, 2000, the Company entered into a four year, $600.0 million fully committed asset-based debtor-in-possession and emergence credit facility (the "DIP to Exit Facility") which replaced the DIP Facility. The Bankruptcy Court approved the DIP to Exit Facility on April 4, 2000. The DIP to Exit Facility matures on April 14, 2004, and includes $60.0 million in term loans and up to a maximum of $540.0 million in revolving loans including a $150.0 million sub-facility for letters of credit. Interest rate spreads on the DIP to Exit Facility are initially LIBOR + 2.50% on Eurodollar loans and Prime Rate + 0.75% on Alternate Base Rate loans. After the first quarter of 2001, these spreads are subject to quarterly adjustment pursuant to a pricing grid based on availability and financial performance, with ranges of 200 to 275 basis points over LIBOR and 25 to 100 basis points over prime rate. Short-term borrowings under the revolver of the DIP to Exit Facility were $139.5 million as of October 1, 2000. Outstanding borrowings under the term loan of the DIP to Exit Facility were $60.0 million as of October 1, 2000. There is a commitment fee of 0.375% on the undrawn portion of the revolving loans under the DIP to Exit Facility. Borrowings under the DIP to Exit Facility are secured by all material unencumbered assets of the Company and its subsidiaries, including inventory, but excluding previously mortgaged property. Borrowings under the DIP to Exit 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. Availability under the facility continues unless the Company breaches the financial covenants for the DIP to Exit facility. As of October 1, 2000, the Company was in compliance with its financial covenants. G. EARNINGS PER SHARE Basic earnings (loss) per common share is computed by dividing net earnings (loss) by the weighted-average number of common shares outstanding during the reported period. 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 period plus incremental shares that would have been outstanding upon the assumed vesting of dilutive restricted stock and the assumed exercise of dilutive stock options. As of October 1, 2000, all outstanding restricted stock and stock options are considered anti-dilutive. For the nine periods ended October 3, 1999 all outstanding restricted stock and stock options are considered anti-dilutive. For the three periods ended October 3, 1999 certain restricted stock and stock options were dilutive, but were not considered material. H. PREPAID EXPENSES AND OTHER ASSETS Prepaid expenses and other assets for the Company were $22.6 million as of October 1, 2000 compared to $78.7 million as of October 3, 1999. The decrease was primarily due to the reduction of cash in advance payments to purchase inventory and a reduction in assets held for sale. I. BENEFIT PLANS On August 31, 1999, the Bankruptcy Court approved a motion by the Company to amend the Restated Retirement Plan and the Executive Security Plan. 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 Executive Security Plan, covering approximately 165 former and current management associates, ceased the accrual of benefits and suspended payments effective September 30, 1999. 13 14 J. 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 had projected that such portfolio losses and negative spreads would 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 an amended complaint. On April 24, 2000, WFNNB filed a motion to dismiss this amended complaint. The Company responded to the motion to dismiss and filed a cross-motion seeking to treat its amended complaint as an objection to WFNNB's proof of claim. On October 24, 2000, the Bankruptcy Court heard oral arguments on WFNNB's motion to dismiss and the Company's cross-motion. The court has taken the motions under advisement. The Company was involved in litigation, investigations and various legal matters during the nine periods ended October 1, 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. 14 15 K. SEGMENT REPORTING The Company manages its business on the basis of one reportable segment. As of October 1, 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.
CLASSES OF SIMILAR PRODUCTS: THREE PERIODS ENDED NINE PERIODS ENDED ----------------------- ------------------------- OCTOBER 1, OCTOBER 3, OCTOBER 1, OCTOBER 3, 2000 1999 2000 1999 -------- -------- ---------- ---------- Net Sales (in thousands): Home products $165,782 $242,546 $ 652,636 $ 930,930 Jewelry 108,556 121,918 382,279 463,907 -------- -------- ---------- ---------- Total Net Sales $274,338 $364,464 $1,034,915 $1,394,837 ======== ======== ========== ==========
L. LAYAWAY SALES The Company adopted the Securities and Exchange Commission's Staff Accounting Bulletin: No. 101 Revenue Recognition in Financial Statements during fiscal 1999. As a result, the Company changed its method of accounting for layaway sales to recognize layaway sales upon delivery of merchandise to the customer. Layaway sales in prior periods were recognized when the initial deposit was received. 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 $6.6 million or ($0.07) per share. The restated amounts below reflect the effect of the retroactive application of the accounting change on the Consolidated Financial Statements as of and for the three and nine periods ended October 3, 1999.
THREE PERIODS NINE PERIODS ENDED ENDED OCTOBER 3, OCTOBER 3, (in thousands, except per share data) 1999 1999 --------- ----------- Net sales as originally reported $ 366,485 $ 1,395,258 Effect of change in accounting for layaway sales (2,021) (421) --------- ----------- Net sales as restated $ 364,464 $ 1,394,837 ========= =========== Gross margin as originally reported(a) $ 80,399 $ 264,419 Effect of change in accounting for layaway sales (839) (181) --------- ----------- Gross margin as restated $ 79,560 $ 264,238 ========= =========== Net income/(loss) as originally reported $ 3,967 $ (264,965) Effect of change in accounting for layaway sales (839) (181) Extraordinary loss -- 7,851 --------- ----------- Income/(loss) before cumulative effect of change in accounting principle and extraordinary loss as restated 3,128 (257,295) Extraordinary loss -- (7,851) Cumulative effect of change in accounting for layaway sales -- (6,566) --------- ----------- Net income/(loss) as restated $ 3,128 $ (271,712) ========= ===========
15 16 Per common share - basic and diluted Net loss as originally reported $ 0.04 $ (2.66) Effect of change in accounting for layaway sales (0.01) (0.00) Extraordinary loss -- 0.08 --------- ----------- Loss before cumulative effect and extraordinary loss as restated 0.03 (2.58) Extraordinary loss -- (0.08) Cumulative effect of change in accounting for layaway sales -- (0.07) --------- ----------- Net loss as restated $ 0.03 $ (2.73) ========= ===========
(a) Gross margin after costs and expenses
OCTOBER 3, 1999 --------- Accounts receivable as originally reported $ 18,742 Effect of change in accounting for layaway sales (12,131) --------- Accounts receivable as restated $ 6,611 ========= Inventories as originally reported $ 772,299 Effect of change in accounting for layaway sales 7,904 --------- Inventories as restated $ 780,203 ========= Accrued expenses as originally reported $ 166,404 Effect of change in accounting for layaway sales 2,520 --------- Accrued expenses as restated $ 168,924 =========
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS For comparative purposes, interim balance sheets are more meaningful when compared to the balance sheets at the same point in time of the prior year. Comparisons to balance sheets of the most recent fiscal year end may not be meaningful due to the seasonal nature of the Company's business. SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 This report includes certain forward-looking statements (statements other than solely with respect to historical fact, including statements relating to the Company's 2000 Business Plan, its expected plan of reorganization and anticipated availability under the 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: the ability of the Company to continue as a going concern; the ability of the Company to operate pursuant to the terms of the DIP to Exit Facility; 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 negotiate non-disturbance agreements with its landlords; the ability of the Company to complete its store refurbishment program within cost, time and size expectations; the successful implementation of the consolidation of its distribution centers; the ability of the Company to operate successfully under a Chapter 11 proceeding, achieve planned sales and margin, and create and have 16 17 approved a reorganization plan in the Chapter 11 Cases; potential adverse developments with respect to the Company's liquidity or results of operations; 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 conduct successful clearance sales in connection with the 2000 Business Plan; 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 trustee or to convert the Company's reorganization cases to liquidations cases; 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; 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 Company, with 221 stores in 32 states at October 1, 2000, is one of the nation's largest retailers of jewelry and offers a selection of brand-name home products 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 home 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 hardlines categories, including toys, juvenile, sporting goods, most consumer electronics and most indoor furniture. As part of the 2000 Business Plan, the Company has eliminated approximately 5,000 positions 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. The Company's strategy also contemplates 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. 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 17 18 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. 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 in accordance with the Bankruptcy Code. 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 Debtors 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 Debtors 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, for a debtor-in-possession credit facility (the "DIP Facility") under which the Company could 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 included $100.0 million in term loans and a maximum of $650.0 million in revolving loans. The DIP Facility included a $200.0 million sub-facility for standby and trade letters of credit. Interest rates on the DIP Facility were based on either the Citibank N.A. Alternative Base Rate ("ABR") plus 1.25% for ABR Loans or 2.25% over LIBOR for Eurodollar Loans. The DIP Facility was 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 14, 2000, the Company entered into a four year, $600.0 million fully committed asset-based debtor-in-possession and emergence credit facility (the "DIP to Exit Facility") which replaced the DIP Facility. 18 19 The Bankruptcy Court approved the DIP to Exit Facility on April 4, 2000. The DIP to Exit Facility matures on April 14, 2004, and includes $60.0 million in term loans and up to a maximum of $540.0 million in revolving loans including a $150.0 million sub-facility for letters of credit. Interest rate spreads on the DIP to Exit Facility are initially LIBOR + 2.50% on Eurodollar loans and Prime Rate + 0.75% on Alternate Base Rate loans. After the first quarter of 2001, these spreads are subject to quarterly adjustment pursuant to a pricing grid based on availability and financial performance, with ranges of 200 to 275 basis points over LIBOR and 25 to 100 basis points over Prime Rate. Short-term borrowings under the revolver of the the DIP to Exit Facility were $139.5 million as of October 1, 2000. Outstanding borrowings under the term loan of the DIP to Exit Facility were $60 million as of October 1, 2000. There is a commitment fee of 0.375% on the undrawn portion of the revolving loans under the DIP to Exit 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 affairs are subject to further amendment or modification. Pursuant to order of the Bankruptcy Court, on or about March 15, 2000, the Company mailed notices to all known creditors that the deadline for filing proofs of claim with the Bankruptcy Court was May 15, 2000. Differences between amounts scheduled by the Company and claims by creditors are continuing to be investigated and resolved. 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. During the nine-month period ended October 1, 2000, these motions pertained to, among other things, (i) implementation of employee retention and incentive programs, (ii) provision of adequate protection to certain secured creditors, (iii) approval of a new debtor-in-possession financing facility which may be converted to an exit financing facility, (iv) authorizing the Company to pay certain prepetition oversecured tax obligations, (v) establishing notification procedures with respect to the trading of claims against the Company, (vi) authorizing the wind-up of Ser-Plus, a non-debtor affiliate of the Company, (vii) and approving various leasing and subleasing transactions related to the Company's real estate initiatives. 2000 BUSINESS PLAN On February 21, 2000, the Company's Board of Directors approved its 2000 Business Plan, which contemplates: (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 home products 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. 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 home products categories that have performed well and which generate cross-selling opportunities with jewelry. The Company has exited 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. 19 20 The Company intends to reconfigure its stores to feature less overall selling square footage (approximately 18,000 square feet as compared to 27,000 square feet), but increase square footage for jewelry. The excess store space will be available for sub-leasing or other real estate transactions. Approximately 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. As of October 1, 2000, the refurbishment and preparation for subleasing of sixty-three stores was substantially complete, with an additional nine under construction. Up to an additional eighty-three stores are scheduled for refurbishment in 2001. The Company's ability to complete this program depends upon the achievement of satisfactory subleasing results and is subject to other known and unknown risks and uncertainties, including those set forth above under "Safe Harbor Statement Under the Private Securities Litigation Reform Act of 1995." Although the Company plans to continue operating substantially all of its 221 stores, it has closed its distribution centers in Montgomery, New York and intends to close in January 2001 its distribution center in Orlando, Florida. As part of the 2000 Business Plan, the Company has reduced its workforce at its corporate offices, its distribution centers and its stores resulting in the elimination of approximately 5,000 positions. The Company's ability to successfully complete the sub-leasing or other real estate transactions according to the 2000 Business Plan is subject to known and unknown risk factors as listed above under "Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995." To support the 2000 Business Plan, on April 14, 2000, the Company entered into the DIP to Exit Facility which replaced the DIP Facility. See Note F of the Notes to the Consolidated Financial Statements. At this time, it is not possible to predict the outcome of the Chapter 11 Cases or their effect on the Company's business. 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% of their face value and the equity interests of the Company's shareholders may have no value. The Company believes that results from operations and 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 THREE PERIODS ENDED OCTOBER 1, 2000 COMPARED TO THREE PERIODS ENDED OCTOBER 3, 1999 The consolidated statements of operations line item "Exiting categories and closed facilities" represents activity specifically identifiable to inventory liquidations conducted in conjunction with (1) the Company's Restructuring Plan; (2) the Company's Rationalization Plan and (3) the exiting of toys, juvenile, sporting goods, most consumer electronics, most indoor furniture and other merchandise categories as part of the 2000 Business Plan. All activity for these items is classified in "Exiting categories and closed facilities." Prior year amounts reflect operating results for these same facilities and merchandise classifications. Selling, general and administrative expenses for exiting categories and 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 37.5% and 40.6% of total net sales in fiscal 1999 and 1998, respectively. NET SALES Net sales for the Company were $274.3 million for the three periods ended October 1, 2000 compared to $364.5 million for the three periods ended October 3, 1999. The decline in net sales was primarily due to the closure of 127 stores as a result of the restructuring and remerchandising activities in fiscal 1999. 20 21 Net sales from operations excluding exiting categories and closed facilities were $225.4 million for the three periods ended October 1, 2000 compared to $250.1 million for the three periods ended October 3, 1999. Comparable store sales for home products were down 8.9% compared to the three periods ended October 3, 1999, and jewelry comparable store sales were down 12.4%. The jewelry comparable sales decrease was led by declines in watches/accessories and diamonds. The home products comparable sales performance was driven by declines in photo, floor care and appliances. Net sales from exiting categories and closed facilities were $48.9 million for the three periods ended October 1, 2000 compared to $114.4 million for the three periods ended October 3, 1999. Sales from exiting categories and closed facilities decreased primarily due to the fact that the three periods ended October 3, 1999 reflects the sales of 127 stores that were closed by July 31, 1999. The three periods ended October 1, 2000 sales reflect primarily the discontinued merchandise categories of toys, juvenile, sporting goods and most consumer electronics. GROSS MARGIN Gross margin was $46.0 million for the three periods ended October 1, 2000 as compared to $79.6 million in the three periods ended October 3, 1999. The decrease in gross margin was primarily due to a decrease in sales. Gross margin after costs and expenses and excluding exiting categories and closed facilities was $57.4 million or 25.5% of net sales for the three periods ended October 1, 2000, compared to $58.0 million or 23.2% of net sales for the three periods ended October 3, 1999. The margin increase was primarily due to a shift to higher margin merchandise assortments. Gross margin (loss) after costs and expenses for exiting categories and closed facilities was $(11.4) million, or (23.3%) of net sales for the three periods ended October 1, 2000 compared to $21.6 million, or 18.9% of net sales for the three periods ended October 3, 1999. The margin decrease was primarily the result of sales and margin declines associated with the discontinued merchandise categories of toys, juvenile, sporting goods and most consumer electronics. SELLING, GENERAL AND ADMINISTRATIVE EXPENSES Selling, general and administrative expenses declined $9.1 million in the three periods ended October 1, 2000 to $94.5 million from $103.6 million in the three periods ended October 3, 1999. The decline was primarily due to store closures, corporate downsizing and overhead reduction efforts. Selling, general and administrative expenses were $73.7 million or 32.7% of net sales from operations excluding exiting categories and closed facilities for the three periods ended October 1, 2000 compared to $94.6 million or 37.8% of net sales from operations excluding exiting categories and closed facilities for the three periods ended October 3, 1999. The decrease was attributable to a decrease in employment costs and other selling, general and administrative expenses primarily due to corporate downsizing and overhead reduction efforts. Selling, general and administrative expenses for exiting categories and closed facilities were $20.8 million or 42.6% of net sales from operations for exiting categories and closed facilities for the three periods ended October 1, 2000 compared to $8.9 million or 7.8% of net sales from operations for exiting categories and closed facilities for the three periods ended October 3, 1999. The increase was attributable to increases in other selling, general and administrative expenses primarily due to inventory clearance sales and remerchandising activities. 21 22 OTHER INCOME, NET The net gain on dispositions of property and leases recorded for the three periods ended October 1, 2000 was $0.7 million, as compared to $39.7 million for the three periods ended October 3, 1999. The gain for the three periods ended October 1, 2000 included amounts realized from the completion of one leased auction property compared to 16 owned and 33 leased auction properties for the three periods ended October 3, 1999. DEPRECIATION AND AMORTIZATION Depreciation and amortization on owned and leased property and equipment was $9.6 million for the three periods ended October 1, 2000 as compared to $9.8 million for the three periods ended October 3, 1999. The decrease of 2.1% was primarily attributable to store closures. INTEREST EXPENSE Interest expense for the three periods ended October 1, 2000 was $9.1 million as compared to $12.6 million for the three periods ended October 3, 1999. The decline in interest expense primarily relates to lower average borrowings offset in part by higher average interest rates. INCOME TAXES The Company did not recognize an income tax benefit due to the recording of a deferred tax asset valuation allowance. Deferred taxes are recognized to reflect the estimated future utilization of temporary book/tax differences. The Company has recorded a full valuation allowance on net deferred tax assets as realization of such assets in future years is uncertain. Management does not believe it is more likely than not the Company will realize the deferred tax asset. NINE PERIODS ENDED OCTOBER 1, 2000 COMPARED TO NINE PERIODS ENDED OCTOBER 3, 1999 NET SALES Net sales for the Company were $1,034.9 million for the first nine periods of 2000 compared to $1,394.8 million for the first nine periods of 1999. The decline in net sales was primarily due to the closure of 127 stores as a result of the restructuring and remerchandising activities in fiscal 1999. Net sales from operations excluding exiting categories and closed facilities were $780.8 million for the first nine periods of 2000 compared to $794.6 million for the first nine periods of 1999. Comparable store sales for home products were down 5.1% as compared to the first nine periods of 1999, and jewelry comparable sales were up 1.7%. The jewelry comparable sales increase was driven by strong performance in Jewelry Special Events which offset declines in watches/accessories and gold. Home products comparable sales performance was driven by declines in photo, floor care and tabletop/gifts. Net sales from exiting categories and closed facilities were $254.1 million for the first nine periods of 2000 compared to $600.2 million for the first nine periods of 1999. Sales from exiting categories and closed facilities decreased primarily due to the fact that first quarter 1999 reflects the sales of 127 stores that were closed by July 31, 1999 and were not reflected in the first nine periods of 2000. The first nine periods of 2000 sales reflect primarily the discontinued merchandise categories of toys, juvenile, sporting goods, most consumer electronics and other merchandising categories. GROSS MARGIN Gross margin was $214.5 million for the first nine periods of 2000 compared to $264.2 million for the 22 23 first nine periods of 1999. The decrease was primarily due to a $359.9 million decline in sales, partially offset by a $310.1 million decrease in cost of goods sold. Gross margin after costs and expenses and excluding exiting categories and closed facilities was $219.7 million or 28.1% of net sales for the first nine periods of 2000, compared to $193.4 million or 24.3% of net sales for the first nine periods of 1999. The margin increase was primarily due to increased jewelry sales and a shift to higher margin merchandise assortments. Gross margin (loss) after costs and expenses for exiting categories and closed facilities was $(5.3) million, or (2.1%) of net sales for the first nine periods of 2000, compared to $70.8 million, or 11.8% of net sales for the first nine periods of 1999. The margin decrease was primarily a result of decreased sales. The decrease in the rate was attributable to inventory clearance sales. SELLING, GENERAL AND ADMINISTRATIVE Selling, general and administrative expenses decreased $86.7 million in the first nine periods of 2000 to $323.3 million from $410.0 million in the first nine periods of 1999. The decline was primarily due to store closures, corporate downsizing and overhead reduction efforts. Selling, general and administrative expenses were $244.9 million or 31.4% of net sales from operations excluding exiting categories and closed facilities for the first nine periods of 2000 compared to $306.4 million or 38.6% of net sales from operations excluding exiting categories and closed facilities for the first nine periods of 1999. The decrease was attributable to a decrease in employment costs and other selling, general and administrative expenses primarily due to corporate downsizing and overhead reduction efforts. Selling, general and administrative expenses for exiting categories and closed facilities were $78.4 million or 30.8% of net sales from operations for exiting categories and closed facilities for the first nine periods of 2000 compared to $103.6 million or 17.3% of net sales from operations for exiting categories and closed facilities for the first nine periods of 1999. The decrease was attributable to decreases in employment costs and other selling, general and administrative expenses primarily due to store closures. OTHER INCOME, NET The net gain on dispositions of property and leases recorded for the first nine periods of 2000 was $14.8 million, as compared to $47.2 million for the first nine periods in 1999. The gain for the first nine periods of 2000 includes amounts realized from the completion of the auction property sale of 10 owned and 14 leased properties compared to 16 owned and 33 leased auction properties for the first nine periods of 1999. DEPRECIATION AND AMORTIZATION Depreciation and amortization on owned and leased property and equipment was $29.4 million for the first nine periods of 2000 as compared to $32.9 million for the first nine periods of 1999. The decrease of 10.6% was primarily attributable to store closures. INTEREST EXPENSE Interest expense for the first nine periods of 2000 was $29.6 million as compared to $50.4 million for the first nine periods of 1999. Interest expense decreased due to lower average borrowings offset in part by higher average interest rates, and, 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 15, 1999. 23 24 INCOME TAXES The Company did not recognize an income tax benefit due to the recording of a deferred tax asset valuation allowance. Deferred taxes are recognized to reflect the estimated future utilization of temporary book/tax differences. The Company has recorded a full valuation allowance on net deferred tax assets as realization of such assets in future years is uncertain. Management does not believe it is more likely than not that the Company will realize the deferred tax asset. EXTRAORDINARY ITEM An extraordinary loss on the early extinguishment of debt was recorded in the amount of $7.9 million during the first nine periods of 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 adopted the Securities and Exchange Commission's Staff Accounting Bulletin: No. 101 Revenue Recognition in Financial Statements during fiscal 1999. As a result, the Company changed its method of accounting for layaway sales. 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. See Note L of the Notes to the Consolidated Financial Statements. 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. As a result, a pre-tax charge of $129.5 million for restructuring costs was taken in the first quarter of fiscal 1997. The remaining component of the restructuring charge accrual and an analysis of the change in the accrual for the nine periods ended October 1, 2000 are outlined in the following table:
ACTIVITY -------------------------- ACCRUED ACCRUED RESTRUCTURING RESTRUCTURING COSTS AS OF COSTS AS OF JANUARY 2, RESTRUCTURING CHANGE IN OCTOBER 1, 2000 COSTS PAID ESTIMATE 2000 ---- ---------- -------- ---- (in thousands) Lease termination and other real estate costs $7,894 $ (38) $ (136) $7,720 ====== ===== ====== ======
Note: The accrued restructuring costs 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. Lease terminations and other real estate costs primarily consist of contractual rent payments and other real estate costs. These amounts have been accrued according to the remaining leasehold obligations under Section 502(b)(6) of the Bankruptcy Code. 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, not to exceed three years of the remaining term of the lease. Any unpaid rent is included in the claim. 24 25 The Company experienced lower than expected expenses in lease termination and disposition of closed stores for the nine periods ended October 1, 2000. As a result the Company reduced its estimate for these costs by $0.1 million. The leases remaining on closed locations as of October 1, 2000 vary in length with expiration dates ranging from February 2001 to February 2015. RATIONALIZATION PLAN In February 1999, the Company announced a rationalization plan to close up to 132 stores and up to four distribution centers and to reduce corporate overhead. 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 and 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 remaining components of the restructuring charge accrual and an analysis of the change in the accrual for the nine periods ended October 1, 2000 are outlined in the following table:
ACTIVITY -------------------------- ACCRUED ACCRUED RESTRUCTURING RESTRUCTURING COSTS AS OF COSTS AS OF JANUARY 2, RESTRUCTURING CHANGE IN OCTOBER 1, 2000 COSTS PAID ESTIMATE 2000 ---- ---------- -------- ---- (in thousands) Lease termination and other real estate costs $38,315 $ (1,564) $ (2,563) $34,188 Employee severance 478 (578) 175 75 ------- -------- -------- ------- Total $38,793 $ (2,142) $ (2,388) $34,263 ======= ======== ======== =======
Note: The accrued restructuring costs are included in Liabilities Subject to Compromise. Lease terminations and other real estate costs primarily consists of contractual rent payments. These amounts have been accrued according to the remaining leasehold obligations under Section 502(b)(6) of the Bankruptcy Code. 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, not to exceed three years of the remaining term of the lease. Any unpaid rent is included in the claim. The Company experienced lower than expected expenses in lease termination and disposition of closed stores for the nine periods ended October 1, 2000. As a result the Company reduced its estimate for these costs by $2.4 million. 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. LIQUIDITY AND CAPITAL RESOURCES On March 27, 1999, the Debtors filed the Chapter 11 Cases, which will affect the Company's liquidity 25 26 and capital resources in fiscal 2000. See Note B, Notes to the Financial Statements - "Proceedings Under Chapter 11 of the Bankruptcy Code." 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 scheduled 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. 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 included $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 were 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 $203.6 million as of October 3, 1999. Outstanding borrowings under the term loan of the DIP Facility were $99.5 million as of October 3, 1999. There was a commitment fee of 0.375% on the undrawn portion of the revolving loans under the DIP Facility. The DIP Facility was secured by all material unencumbered assets of the Company and its subsidiaries, including inventory, but excluding previously mortgaged property. Borrowings under the DIP Facility were limited based on a borrowing base formula which considered eligible inventories, eligible accounts receivable, mortgage values on eligible real properties, eligible leasehold interests, available cash equivalents and in-transit cash. On April 14, 2000, the Company entered into a four year, $600.0 million fully committed asset-based debtor-in-possession and emergence credit facility (the "DIP to Exit Facility") which replaced the DIP Facility. The Bankruptcy Court approved the DIP to Exit Facility on April 4, 2000. The DIP to Exit Facility matures on April 14, 2004, and includes $60.0 million in term loans and up to a maximum of $540.0 million in revolving loans including a $150.0 million sub-facility for letters of credit. Interest rate spreads on the DIP to Exit Facility are initially LIBOR + 2.50% on Eurodollar loans and Prime Rate + 0.75% on Alternate Base Rate loans. After the first quarter of 2001, these spreads are subject to quarterly adjustment pursuant to a pricing grid based on availability and financial performance, with ranges of 200 to 275 basis points over LIBOR and 25 to 100 basis points over prime rate. Short-term borrowings under the revolver of the DIP to Exit Facility were $139.5 million as of October 1, 2000. Outstanding borrowings under the term loan of the DIP to Exit Facility were $60.0 million as of October 1, 2000. There is a commitment fee of 0.375% on the undrawn portion of the revolving loans under the DIP to Exit Facility. Borrowings under the DIP to Exit Facility are secured by all material unencumbered assets of the Company and its subsidiaries, including inventory, but excluding previously mortgaged property. Borrowings under the DIP to Exit 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. Availability under the facility continues unless the Company breaches the financial covenants for the DIP to Exit Facility. As of October 1, 2000, the Company was in compliance with its financial covenants. 26 27 The following table sets forth the Company's three month borrowing base and borrowing availability projections under the DIP to Exit Facility. The forecast projects a borrowing base which ranges from $456.6 million to $563.2 million over the period from October 8, 2000 to December 31, 2000, and unused borrowing availability which ranges from $133.4 million to $249.8 million. The borrowing base and borrowing availability projections under the DIP to Exit Facility are forward-looking statements subject to various assumptions regarding the Company's business, operating performance and other factors including revenues, expenses, asset dispositions, trade terms, capital expenditures and various other known and unknown risks and uncertainties including those set forth in "Safe Harbor Statement under the Private Securities Litigation Reform Act." The Company undertakes no obligation to update such information or to disclose similar information in future reports. These projections are subject to future adjustments, if any, that could materially affect such information.
Actual Forecast Forecast Forecast October 1, October 29, November 26, December 31, 2000 2000 2000 2000 ------ ------ ------ ------ (in millions) Ending Total Revolver Balance $139.5 $218.0 $322.4 $100.9 Term Loan 60.0 60.0 60.0 60.0 Standby Letters of Credit 25.9 25.7 27.2 25.7 Trade Letters of Credit 30.7 17.8 20.2 20.2 ------ ------ ------ ------ Total Extensions of Credit 256.1 321.5 429.8 206.8 Borrowing Base 469.5 494.6 563.2 456.6 ------ ------ ------ ------ Availability $213.4 $173.1 $133.4 $249.8 ====== ====== ====== ======
CAPITAL STRUCTURE During the three periods ended October 1, 2000, the Company's principal source of liquidity was the $600 million DIP to Exit Facility (which includes a $60 million term loan and a revolving credit facility with a maximum commitment level of $540 million). At October 1, 2000, the Company had total extensions of credit of $256.1 million under the DIP to Exit Facility. At October 3, 1999, the Company had total extensions of credit of $404.0 million under the DIP Facility. EFFECT OF NEW ACCOUNTING PRONOUNCEMENTS In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standard ("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. In June 2000, the FASB issued SFAS No. 138 "Accounting For Derivative Instruments and Hedging Activities - Amendment of FASB Statement No. 133." This pronouncement amends and clarifies implementation of SFAS No. 133. The Company is currently in the process of analyzing the impact of the adoption of these Statements. 27 28 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE 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. As discussed in the Company's Annual Report on Form 10-K filed on March 16, 2000, the Company had interest rate swaps at fiscal year-end with a notional amount of $125 million. On July 5, 2000, the Company entered into interest rate swap agreements related to its interest rate exposure in 2001, as its existing interest rate swaps expire at the end of fiscal year 2000. These swaps vary in notional amount during 2001 from $85 million to $155 million, reflecting the seasonal nature of the Company's borrowings. As of October 1, 2000, the fair value of the interest rate swap agreements was ($0.3) million. 28 29 PART II - OTHER INFORMATION ITEM 1. 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 an amended complaint. On April 24, 2000 WFNNB filed a motion to dismiss this amended complaint. The Company responded to the motion to 29 30 dismiss and filed a cross-motion seeking to treat its amended complaint as an objection to WFNNB's proof of claim. On October 24, 2000, the Bankruptcy Court heard oral arguments on WFNNB's motion to dismiss and the Company's cross-motion. The court has taken the motions under advisement. 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. 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 elsewhere in this Quarterly report on Form 10-Q and in Item 1. "Business -- Proceedings Under Chapter 11 of the Bankruptcy Code," Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations," Note B of Notes to Consolidated Financial Statements (Unaudited) and the Report of Independent Auditors included in the Company's Annual Report on Form 10-K filed on March 16, 2000, 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% of their face value and the equity interests of the Company's shareholders may have no value. ITEM 2. DEFAULTS UPON SENIOR SECURITIES. The Company commenced the Chapter 11 Cases on March 27, 1999. As a result of filing the Chapter 11 Cases, no principal or interest payments will be made on certain indebtedness incurred by the Company prior to March 27, 1999, including the 9% Senior Subordinated Debentures and 8 3/8% Senior Notes, until a plan of reorganization defining the payment terms has been approved by the Bankruptcy Court. ITEM 3. EXHIBITS AND REPORTS ON FORM 8-K. (a) Exhibits filed with this Form 10-Q. 27.1 Financial Data Schedule for the Nine Periods ended October 1, 2000. 27.2 Restated Financial Data Schedule for the Nine Periods ended October 3, 1999. (b) Reports on Form 8-K. During the third quarter ended October 1, 2000, the Company filed the following current reports on Form 8-K: (i) dated August 24, 2000 announcing the filing with the Bankruptcy Court of the Company's monthly operating report for the period commencing July 3, 2000 and ending July 30, 2000; and (ii) dated September 26, 2000 announcing the filing with the Bankruptcy Court of the Company's monthly operating report for the period commencing July 31, 2000 and ending August 27, 2000. 30 31 SIGNATURES 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/ S. Cusano - --------------------------------------- S. Cusano Director and Chief Executive Officer (Principal Executive Officer) November 9, 2000 /s/ Kenneth A. Conway - --------------------------------------- Kenneth A. Conway Vice President Controller and Chief Accounting Officer (Principal Accounting Officer) November 9, 2000 31 EX-27.1 2 g65165ex27-1.txt FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE SERVICE MERCHANDISE COMPANY, INC. FORM 10-Q FOR QUARTERLY PERIOD ENDED OCTOBER 1, 2000 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS DETAILED IN PART I OF THE FORM 10-Q. 1,000 9-MOS DEC-31-2000 JAN-03-2000 OCT-01-2000 22,376 0 25,451 17,545 523,968 576,891 731,222 371,048 985,930 379,119 479,465 0 0 99,906 (254,737) 985,930 1,034,915 1,034,915 820,467 820,467 372,478 0 29,614 (187,644) 0 (187,644) 0 0 0 (187,644) (1.88) (1.88) AMOUNT REPRESENTS THE NUMBER OF SHARES OF $0.50 PAR VALUE COMMON STOCK AND OUTSTANDING. AMOUNT INCLUDES (I) DEPRECIATION AND AMORTIZATION (II) SELLING, GENERAL AND ADMINISTRATIVE EXPENSES (III) OTHER INCOME, NET (IV) RESTRUCTURING CHARGE AND (V) REORGANIZATION ITEMS.
EX-27.2 3 g65165ex27-2.txt RESTATED FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE SERVICE MERCHANDISE COMPANY, INC. FORM 10-Q FOR QUARTERLY PERIOD ENDED OCTOBER 3, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS DETAILED IN PART I OF THE FORM 10-Q. 1,000 9-MOS JAN-02-2000 JAN-04-1999 OCT-03-1999 36,923 0 24,363 17,752 780,203 902,403 833,470 460,401 1,337,753 502,398 538,058 0 0 100,022 (97,527) 1,337,753 1,394,837 1,394,837 1,130,599 1,130,599 471,114 16,901 50,419 (257,295) 0 (257,295) 0 (7,851) (6,566) (271,712) (2.73) (2.73) AMOUNT REPRESENTS THE NUMBER OF SHARES OF $0.50 PAR VALUE COMMON STOCK AND OUTSTANDING. AMOUNT INCLUDES (I) DEPRECIATION AND AMORTIZATION (II) SELLING, GENERAL AND ADMINISTRATIVE EXPENSES (III) OTHER INCOME, NET (IV) RESTRUCTURING CHARGE AND (V) REORGANIZATION ITEMS.
-----END PRIVACY-ENHANCED MESSAGE-----