-----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, SnHqKty69yqHgj/YDE/zAIpGJKoAI1uoB86JKJ/Ft4HocxtciRyuopKhzbUsQm2E xL87JBTku/X8NlCfUFcxtQ== 0000950134-02-011111.txt : 20020910 0000950134-02-011111.hdr.sgml : 20020910 20020910162643 ACCESSION NUMBER: 0000950134-02-011111 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 20020803 FILED AS OF DATE: 20020910 FILER: COMPANY DATA: COMPANY CONFORMED NAME: GADZOOKS INC CENTRAL INDEX KEY: 0000924140 STANDARD INDUSTRIAL CLASSIFICATION: RETAIL-FAMILY CLOTHING STORES [5651] IRS NUMBER: 742261048 STATE OF INCORPORATION: TX FISCAL YEAR END: 0127 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-26732 FILM NUMBER: 02760843 BUSINESS ADDRESS: STREET 1: 4121 INTERNATIONAL PKWY CITY: CARROLLTON STATE: TX ZIP: 75007 BUSINESS PHONE: 9723075555 MAIL ADDRESS: STREET 1: 4121 INTERNTIONAL PKWY CITY: CARROLLTON STATE: TX ZIP: 75007 10-Q 1 d99692e10vq.txt FORM 10-Q FOR QUARTER ENDED AUGUST 3, 2002 UNITED STATES 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 AUGUST 3, 2002 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 COMMISSION FILE NUMBER 0-26732 ------- GADZOOKS, INC. - -------------------------------------------------------------------------------- (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) TEXAS 74-2261048 - -------------------------------------------------------------------------------- STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER IDENTIFICATION NUMBER) INCORPORATION OR ORGANIZATION) 4121 INTERNATIONAL PARKWAY CARROLLTON, TX 75007 - -------------------------------------------------------------------------------- (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE) REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: 972-307-5555 ----------------------------- - -------------------------------------------------------------------------------- (FORMER NAME, FORMER ADDRESS AND FISCAL YEAR, IF CHANGED SINCE LAST REPORT.) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] As of September 10, 2002, the number of shares outstanding of the registrant's common stock is 9,158,466. GADZOOKS, INC. FORM 10-Q For the Quarter Ended August 3, 2002 INDEX
PAGE ---- PART I. FINANCIAL INFORMATION Item 1. Consolidated Financial Statements Condensed Consolidated Balance Sheets as of 3 August 3, 2002 and February 2, 2002 Condensed Consolidated Statements of Operations 4 for the Second Quarter and Six Months Ended August 3, 2002 and August 4, 2001 Condensed Consolidated Statements of Cash Flow for 5 the Six Months Ended August 3, 2002 and August 4, 2001 Notes to Consolidated Financial Statements 6-8 Item 2. Management's Discussion and Analysis 9-12 of Financial Condition and Results of Operations Item 3. Quantitative and Qualitative Disclosures 12 About Market Risk PART II. OTHER INFORMATION 14 SIGNATURE PAGE 15 CERTIFICATIONS PURSUANT TO SECTION 302 16-17 INDEX TO EXHIBITS 18
2 PART I -- FINANCIAL INFORMATION GADZOOKS, INC. CONDENSED CONSOLIDATED BALANCE SHEETS - -------------------------------------------------------------------------------- (IN THOUSANDS) (UNAUDITED)
August 3, February 2, 2002 2002 ------------ ------------ ASSETS Current assets: Cash and cash equivalents $ 7,776 $ 14,868 Short-term investments 3,969 -- Accounts receivable 2,235 1,682 Inventory 59,658 63,660 Other current assets 2,643 1,931 ------------ ------------ 76,281 82,141 ------------ ------------ Leaseholds, fixtures and equipment, net 40,965 41,009 Deferred tax assets 2,458 2,530 ------------ ------------ $ 119,704 $ 125,680 ============ ============ LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable $ 20,235 $ 27,091 Accrued expenses and other current liabilities 6,174 6,277 Income taxes payable -- 1,733 ------------ ------------ 26,409 35,101 ------------ ------------ Accrued rent 3,975 3,726 Shareholders' equity: Common stock 92 91 Additional paid-in capital 44,903 44,385 Retained earnings 44,580 42,708 Treasury stock (255) (331) ------------ ------------ 89,320 86,853 ------------ ------------ $ 119,704 $ 125,680 ============ ============
The accompanying notes are an integral part of these consolidated financial statements. 3 GADZOOKS, INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS - -------------------------------------------------------------------------------- (IN THOUSANDS, EXCEPT PER SHARE DATA) (UNAUDITED)
Second Quarter Ended Six Months Ended ------------------------- ------------------------- August 3, August 4, August 3, August 4, 2002 2001 2002 2001 ---------- ---------- ---------- ---------- Net sales $ 76,697 $ 72,553 $ 154,972 $ 143,390 Cost of goods sold including buying, distribution and occupancy costs 57,369 58,268 114,037 109,180 ---------- ---------- ---------- ---------- Gross profit 19,328 14,285 40,935 34,210 Selling, general and administrative expenses 19,162 16,414 37,948 32,804 ---------- ---------- ---------- ---------- Operating income (loss) 166 (2,129) 2,987 1,406 Interest income, net 21 60 65 279 ---------- ---------- ---------- ---------- Income (loss) before income taxes 187 (2,069) 3,052 1,685 Provision (benefit) for income taxes 72 (767) 1,180 622 ---------- ---------- ---------- ---------- Net income (loss) $ 115 $ (1,302) $ 1,872 $ 1,063 ========== ========== ========== ========== Net income (loss) per share Basic $ 0.01 $ (0.14) $ 0.21 $ 0.12 ========== ========== ========== ========== Diluted $ 0.01 $ (0.14) $ 0.20 $ 0.11 ========== ========== ========== ========== Weighted average shares outstanding Basic 9,135 9,057 9,115 9,007 ========== ========== ========== ========== Diluted 9,274 9,057 9,312 9,357 ========== ========== ========== ==========
The accompanying notes are an integral part of these consolidated financial statements 4 GADZOOKS, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOW - -------------------------------------------------------------------------------- (IN THOUSANDS) (UNAUDITED)
Six Months Ended -------------------------- August 3, August 4, 2002 2001 ---------- ---------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 1,872 $ 1,063 Adjustments to reconcile net income to cash provided by (used in) operating activities: Loss on disposal of assets 486 109 Depreciation 4,655 3,993 Changes in operating assets and liabilities (5,634) (6,627) ---------- ---------- NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES 1,379 (1,462) ---------- ---------- CASH FLOWS FROM INVESTING ACTIVITIES: Capital expenditures (5,097) (6,485) Purchase of short-term investments (4,964) -- Proceeds from redemption of short-term investments 995 -- ---------- ---------- NET CASH USED IN INVESTING ACTIVITIES (9,066) (6,485) ---------- ---------- CASH FLOWS FROM FINANCING ACTIVITIES: Issuance of common stock 460 910 Sale of treasury stock under employee benefit plans 135 100 ---------- ---------- NET CASH PROVIDED BY FINANCING ACTIVITIES 595 1,010 ---------- ---------- Net decrease in cash and cash equivalents (7,092) (6,937) Cash and cash equivalents at beginning of period 14,868 20,284 ---------- ---------- CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 7,776 $ 13,347 ========== ==========
The accompanying notes are an integral part of these consolidated financial statements 5 GADZOOKS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- 1. BASIS OF PRESENTATION The accompanying condensed consolidated financial statements contain all adjustments (consisting of only normal recurring accruals) necessary to present fairly the financial position as of August 3, 2002 and February 2, 2002, and the results of operations and cash flows for the second quarter and six months ended August 3, 2002 and August 4, 2001. The results of operations for the second quarter and six months then ended are not necessarily indicative of the results to be expected for the full fiscal year. The condensed consolidated balance sheet as of February 2, 2002 is derived from audited financial statements. The condensed consolidated financial statements should be read in conjunction with the financial statement disclosures contained in the Company's Annual Report on Form 10-K for the fiscal year ended February 2, 2002. Fiscal year: The Company's fiscal year is the 52- or 53-week period that ends on the Saturday closest to the end of January. "Fiscal 2002" is the 52-week period ending February 1, 2003. 2. LONG-TERM OBLIGATIONS On June 1, 2002, the Company entered into a restated and amended credit facility with Wells Fargo Bank. The restated facility provides an unsecured revolving line of credit totaling $15 million. The total amount available to borrow pursuant to the credit agreement is limited to 140% of cash flow (as defined in the credit agreement) for the trailing 12-month period. Amounts borrowed under the revolving line bear interest at the lesser of either the bank's prime rate, or 195 basis points above LIBOR. The credit agreement also provides for the issuance of letters of credit that are generally used in connection with international merchandise purchases. Outstanding letters of credit issued by the bank reduce amounts otherwise available for borrowing under the revolving line of credit. The credit facility subjects the Company to various restrictions on the incurrence of additional indebtedness, acquisitions, loans to officers and stock repurchases, and includes various financial covenants. Amounts available to borrow under the line of credit, as limited by the cash flow multiple and/or outstanding letters of credit, totaled $13.5 million at August 3, 2002. No borrowings (other than letters of credit, totaling $1.5 million) were outstanding under the revolving line at August 3, 2002. Any amount borrowed under the revolving line of credit will become due on June 1, 2003, the date the credit agreement matures. 3. EARNINGS PER SHARE The following table outlines the Company's calculation of weighted average shares outstanding (in thousands):
Quarter Ended Six Months Ended ------------------------- ------------------------- August 3, August 4, August 3, August 4, 2002 2001 2002 2001 ---------- ---------- ---------- ---------- Weighted average common shares outstanding (basic) 9,135 9,057 9,115 9,007 Effect of dilutive options 139 -- 197 350 ---------- ---------- ---------- ---------- Weighted average common shares outstanding (diluted) 9,274 9,057 9,312 9,357 ========== ========== ========== ==========
The treasury stock method is used to determine dilutive potential common shares outstanding related to stock options. Options which, based on their exercise price, would be antidilutive are not considered in the treasury stock method calculation. Options excluded from the earnings per share calculation due to their antidilutive nature totaled 588,825 and 1,288,930 for the quarters ended August 3, 2002 and August 4, 2001, and 536,174 and 327,039 for the six months ended August 3, 2002 and August 4, 2002, respectively. 6 4. IMPAIRMENT OF LONG LIVED ASSETS During the second quarter of 2002, the Company abandoned its point of sale software implementation project after learning that the software provider would offer a new point of sale software product in 2003 and would discontinue sales of the current software. As a result of the abandonment of the project, certain costs related to the original project have been written off. The total impact of the write-off was a $310,000 ($191,000 after tax, or $.02 per diluted share) loss on disposal during the second quarter of fiscal 2002. In the first quarter of fiscal 2002, the Company hired a consulting firm to review the current store base and provide recommendations on ways to update the look of more mature stores and enhance visual merchandising in all stores. The store update and visual enhancement program developed in conjunction with the consulting firm was finalized during the second quarter and will be implemented during the second and third quarters of 2002 in an attempt to increase the visual appeal, flow and shop-ability of all stores. The program includes the removal of certain leasehold improvements and fixtures prior to the end of their estimated useful life. As a result, the Company recognized accelerated depreciation and loss on disposal of assets related to the project of approximately $365,000 ($224,000 after tax, or $.02 per diluted share) for the second quarter of fiscal 2002. 5. RETIREMENT AGREEMENT Effective August 28, 2002, the Company entered into an executive retirement agreement with Gerald R. Szczepanski, Chairman of the Board and Chief Executive Officer, pursuant to which Mr. Szczepanski or his estate shall be eligible to receive certain benefits on termination of his employment with Gadzooks as a result of either death, termination without cause or retirement. Upon such termination (i) Gadzooks will continue to provide Mr. Szczepanski (and his spouse, if applicable) medical, dental and life insurance coverage, (ii) Gadzooks will enter into a consulting relationship with Mr. Szczepanski for 24 months whereby Mr. Szczepanski will receive a consulting fee of $300,000 per year to facilitate an orderly transition to Mr. Szczepanski's successor; (iii) Mr. Szczepanski will receive his pro rata bonus for the fiscal year in which he retires; (iv) all of Mr. Szczepanski's stock options will become vested in full; and (v) all of Mr. Szczepanski's stock options with an exercise price equal to or greater than $9.00 will be amended to include a term equal to the lesser of (a) three years from such termination or (b) the original expiration date of such stock options. In addition, Mr. Szczepanski agrees that upon termination of his employment with Gadzooks, he will not disclose any confidential information relating to Gadzooks and he will not solicit, interfere or compete with Gadzooks, its business, its clients or its customers for a period of two years In accordance with the Statement of Financial Accounting Standards ("SFAS") No. 106, "Employers' Accounting for Postretirement Benefits Other than Pensions", the Company will expense postretirement benefit costs during the third quarter of fiscal 2002. The estimated postretirement benefit costs have not yet been determined. In accordance with APB Opinion No. 25, "Accounting for Stock Issued to Employees" and FIN 44, "Accounting for Certain Transactions Involving Stock Compensation", the Company will not record any compensation expense related to the potential stock option amendments due to the exercise price of the options, potentially amended by the modification, being more than the stock price at the execution date of the agreement. 6. NEW ACCOUNTING PRONOUNCEMENTS In June 2001, the Financial Accounting Standards Board ("FASB") issued SFAS No. 141, "Business Combinations," and SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS 141 supersedes Accounting Principles Board Opinion ("APB") No. 16, "Business Combinations." The provisions of SFAS 141 (1) require that the purchase method of accounting be used for all business combinations initiated after June 30, 2001, (2) provide specific criteria for the initial recognition and measurement of intangible assets apart from goodwill and (3) require that unamortized negative goodwill be written off immediately as an extraordinary gain instead of being deferred and amortized. SFAS 142 supersedes APB 17, "Intangible Assets," and changes the accounting for goodwill from an amortization method to an impairment-only approach. The Company's consolidated financial statements were not impacted by the adoptions of SFAS 141 and SFAS 142. 7 In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" effective for fiscal years beginning after December 15, 2001 and replacing SFAS 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." SFAS 144 establishes an accounting model for long-lived assets to be disposed of by sale, including discontinued operations, and replaces the provisions of APB Opinion No. 30 for the disposal of segments of a business. SFAS 144 retains the fundamental provisions of SFAS 121 concerning the recognition and measurement of long-lived assets to be held and used and the measurement of long-lived assets to be disposed of by sale. However, SFAS 144 provides additional guidance with regard to discontinued operations and assets to be disposed of. In addition, SFAS 144 excludes goodwill from its scope. The adoption of SFAS 144 did not have a material impact on the Company, but could result in future store closures being classified as discontinued operations in the consolidated financial statements. SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities" was issued on July 30, 2002 and replaces emerging Issues Task Force Issue 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity." SFAS 146 requires companies to recognize certain costs associated with exit or disposal activities when they are incurred rather than at the date of a commitment to an exit or disposal plan. SFAS 146 will be effective for exit or disposal activities that are initiated after December 31, 2002. 8 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GENERAL Gadzooks is a mall-based specialty retailer of casual apparel and related accessories for young men and women principally between the ages of 14 and 18. As of August 3, 2002, the Company had opened nine new Gadzooks stores and closed one since the beginning of the fiscal year and operated 435 Gadzooks stores and four Orchid stores for a total of 439 stores in 41 states. The Company's business is subject to seasonal influences with higher sales during the Christmas holiday, back-to-school and spring break seasons. Management's discussion and analysis should be read in conjunction with the Company's consolidated financial statements and related notes. CRITICAL ACCOUNTING POLICIES The preparation of Gadzooks' consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the balance sheet date, as well as the reported amounts of revenues and expenses during the reporting period. On an ongoing basis, management evaluates such estimates including sales return rates, inventory reserves, impairment of long-lived assets, income taxes and accrued expenses. Actual results may differ from estimates. Gadzooks accounting policies are generally straightforward, but the following items require more significant management judgments and estimates. REVENUE RECOGNITION. Retail merchandise sales are recognized at the point of sale less sales returns and employee discounts. Management records a provision for estimated sales returns based on historical return rates. If sales return rates change, an additional allowance may be required. INVENTORY VALUATION. Inventories are valued at the lower of average cost or market. In addition, inventories include an allocation of buying and distribution costs to prepare product for the stores. This inventory valuation method requires certain management estimates and judgments, including estimates of merchandise markdowns, which could significantly affect gross margin. Management estimates the markdown reserve based on several factors, including but not limited to, merchandise quantities, historical markdown percentages, and seasonal merchandise and future merchandise plans. If future demand or merchandise markdowns are less favorable than those projected by management, additional inventory adjustments may be required. On a monthly basis, management estimates shrink based on historical shrink rates. These estimates are compared to actual results as inventory counts are taken and reconciled to the general ledger during the second and fourth quarter of each year. LONG-TERM ASSET IMPAIRMENT. Management periodically reviews its long-lived assets for impairment and records a provision whenever events or circumstances indicate that the net book value of the asset may not be recoverable. Impairment is determined based on several factors, including but not limited to, current year operating loss or cash flow loss combined with a history and forecast of operating or cash flow losses and significant negative industry or economic trends. If management determines that an impairment exists, an impairment loss is recognized if the sum of the expected future cash flows (undiscounted and before interest) from the use of the assets is less than net book value of the assets. The amount of the impairment is measured as the difference between the net book value of the assets and the estimated fair market value of the related assets. DEFERRED TAX ASSETS. The Company does not currently have a valuation allowance recorded against its deferred tax assets. If management determines it is more likely than not that its deferred tax assets would not be realizable in the future, a valuation allowance would be recorded to reduce the deferred tax asset to its net realizable value. ACCRUED EXPENSES. On a monthly basis, certain expenses are estimated in an effort to reflect these expenses in the proper period. Gadzooks' most material estimates relate to self-insurance reserves, store level operating expenses and bonuses. The self-insurance reserves for medical and worker's compensation claims are recorded based on historical claim levels adjusted for growth in the employee base. If the historical claims used to calculate these estimates are not reflective of actual results, additional expenses may be incurred up to the point that the Company's stop loss insurance begins. The Company is self-insured for property and casualty claims at the store 9 level. Property and casualty claims at a store level are recorded as incurred. Accrued store level operating expenses are estimated based on current activity and historical results. Bonuses are based on performance and projected performance for the remainder of the bonus period. If actual results are significantly different from Gadzooks' expectations, an adjustment to expenses may be required. RESULTS OF OPERATIONS The second quarter ended August 3, 2002 compared to the second quarter ended August 4, 2001. Net Sales Net sales increased approximately $4.1 million, or 5.6 percent, to $76.7 million during the second quarter of fiscal 2002 from $72.6 million during the comparable quarter of fiscal 2001. The total Company sales increase was due to $6.4 million of sales from the 48 new stores not yet included in the comparable store sales base partially offset by a comparable store sales decrease of $2.3 million. Comparable store sales decreased 3.3 percent for the second quarter of fiscal 2002. Sales by category in the average store changed as follows versus the prior year quarter: shoes - increased a mid single digit percentage; junior apparel - increased a low single digit percentage; accessories - decreased a mid single digit percentage; and men's apparel - decreased a high single digit percentage. The number of transactions in the average store declined by 6.1 percent, and the average transaction size increased 3.2 percent. A store becomes comparable after it has been open for 14 full fiscal months. Gross profit Gross profit increased approximately $5.0 million to $19.3 million during the second quarter of fiscal 2002 from $14.3 million during the comparable quarter of fiscal 2001. As a percentage of net sales, gross profit increased by 5.5 percentage points to 25.2 percent from 19.7 percent for the comparable quarter of last year. Merchandise margins as a percentage of sales were 7.1 percent higher than the prior year. This increase is primarily attributable to a significant reduction in retail markdowns taken during the period and a considerable reduction in inventory shrinkage. The reduction in inventory shrinkage is the result of a number of initiatives used by the Company to raise awareness of loss prevention issues, train associates in loss prevention techniques, identify and resolve associate integrity issues, and measure our effectiveness at preventing external theft on a more real-time basis. Partially offsetting the improvement in merchandise margin was a 1.5 percent increase in occupancy costs as a percentage of sales. The increase in occupancy costs (which are relatively fixed in nature) as a percentage of sales was due to the negative leverage effect of the comparable store sales decrease, as well as higher costs related to new stores. Selling, general and administrative expenses Selling, general and administrative expenses ("SG&A") increased approximately $2.8 million to $19.2 million during the second quarter of 2002 from $16.4 million during the comparable quarter of fiscal 2001. The aggregate increase in SG&A is primarily attributable to additional store expenses as a result of the Company's expanded store base during the past year and an increase in administrative costs to support the larger store chain. As a percentage of net sales, SG&A increased by 2.4 percentage points to 25.0 percent during the second quarter of fiscal 2002 from 22.6 percent during the second quarter of last year. The increase in the SG&A percentage is a result of negative leverage from the comparable store sales decrease, an increase in store payroll expense, increased advertising and visual marketing costs and the write-off of certain project costs related to an abandoned information systems project. Interest The Company's net interest income decreased $39,000 to $21,000 during the second quarter of fiscal 2002 from $60,000 in the comparable period of last year due primarily to lower average cash balances and lower market interest rates. 10 The six months ended August 3, 2002 compared to the six months ended August 4, 2001. Net sales Net sales increased approximately $11.6 million, or 8.1 percent, to $155.0 million during the first six months of fiscal 2002 from $143.4 million during fiscal 2001. The total Company sales increase was attributable to new store sales of $15.4 million, net of a comparable store sales decrease of $3.8 million, or 2.8 percent for the first six months of fiscal 2002. The Company experienced comparable store sales decreases in all its major categories except footwear. The Company's average transaction size increased by 4.8 percent, and the number of transactions per average store decreased by 7.2 percent. Gross profit Gross profit increased approximately $6.7 million to $40.9 million during the first six months of fiscal 2002 from $34.2 million during the comparable six months of fiscal 2001. As a percentage of net sales, gross profit increased 2.5 percentage points to 26.4 percent from 23.9 percent for the comparable six months of last year. Merchandise margins as a percentage of sales were 4.0 percent higher than the prior year. This increase is primarily attributable to a significant reduction in retail markdowns taken during the period as well as considerably improved inventory shrinkage results. Partially offsetting the improvement in merchandise margin was a 1.5 percent increase in occupancy costs as a percentage of sales. The increase in occupancy costs as a percentage of sales was due to the negative leverage effect of the comparable store sales decrease, as well as higher costs related to new stores. Selling, general and administrative expenses Selling, general and administrative expenses increased approximately $5.2 million to $38.0 million during the first six months of 2002 from $32.8 million during the comparable six months of fiscal 2001. The aggregate increase in SG&A is primarily attributable to additional store expenses as a result of the Company's expanded store base during the past year and an increase in administrative costs to support the larger store chain. As a percentage of net sales, SG&A increased 1.6 percent to 24.5 percent during the first six months of fiscal 2002 from 22.9 percent during the comparable six months of last year. The increase in the SG&A percentage is a result of the negative leverage effect of the comparable store sales decrease, an increase in store payroll expense, increased advertising and visual marketing costs and the write-off of certain project costs related to an abandoned information systems project. Interest The Company's net interest income decreased $214,000 to $65,000 during the first six months of fiscal 2002 from $279,000 in the comparable period of last year due primarily to lower average cash balances and lower market interest rates. LIQUIDITY AND CAPITAL RESOURCES General The Company's primary uses of cash are financing new store openings and store refurbishments, and purchasing merchandise inventories. The Company is currently meeting its cash requirements through cash flow from operations and cash and cash equivalents on-hand. Cash Flows At August 3, 2002, cash and cash equivalents were $7.8 million, a decrease of $7.1 million since February 2, 2002. The primary uses of cash were capital expenditures of $5.1 million for new stores, store refurbishments and information systems, net short-term investment purchases of $4.0 million and a decrease in accounts payable of $6.9 million, which were slightly offset by a decrease in inventory of $4.0 million. 11 Credit Facility On June 1, 2002, the Company entered into a restated and amended credit facility with Wells Fargo Bank. The restated facility provides an unsecured revolving line of credit totaling $15 million. The total amount available to borrow pursuant to the credit agreement is limited to 140% of cash flow (as defined in the credit agreement) for the trailing 12-month period. Amounts borrowed under the revolving line bear interest at the lesser of either the bank's prime rate, or 195 basis points above LIBOR. The credit agreement also provides for the issuance of letters of credit that are generally used in connection with international merchandise purchases. Outstanding letters of credit issued by the bank reduce amounts otherwise available for borrowing under the revolving line of credit. The credit facility subjects the Company to various restrictions on the incurrence of additional indebtedness, acquisitions, loans to officers and stock repurchases, and includes various financial covenants. Amounts available to borrow under the line of credit, as limited by the cash flow multiple and/or outstanding letters of credit, totaled $13.5 million at August 3, 2002. No borrowings (other than letters of credit totaling $1.5 million) were outstanding under the revolving line at August 3, 2002. Any amount borrowed under the revolving line of credit will become due on June 1, 2003, the date the credit agreement matures. Capital Expenditures The Company began its fiscal 2002 store expansion program with the opening of nine new stores during the first half, and anticipates opening an additional two stores during the remainder of the year. The Company expects capital expenditures for the remainder of the year of between $2.5 million and $4.5 million to open the remaining stores, update the look of selected existing stores and purchase and/or upgrade information systems. The Company hired a consulting firm to review the current store base and provide recommendations on ways to update the look of more mature stores and enhance visual merchandising in all stores. The store update and visual enhancement program developed in conjunction with the consulting firm was finalized during the second quarter and will be implemented during the second and third quarters of 2002 in an attempt to increase the visual appeal, flow and shop-ability of all stores. Accelerated depreciation and loss on disposal of assets related to the project was approximately $365,000 for the second quarter of fiscal 2002, and management estimates that accelerated depreciation will be approximately $100,000 in the third quarter of fiscal 2002. Management believes that the Company's working capital, credit facility and cash flows from operating activities will be sufficient to meet the Company's operating and capital requirements through the end of fiscal 2002. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company does not engage in trading market risk sensitive instruments and does not purchase as investments, as hedges, or for purposes "other than trading" instruments that are likely to expose the Company to market risk, whether it be from interest rate, foreign currency exchange, commodity price or equity price risk. The Company has issued no debt instruments, entered into no forward or futures contracts, purchased no options and entered into no swaps. The Company's primary market risk exposure is that of interest rate risk. A change in LIBOR, or the Prime Rate as set by Wells Fargo Bank, would affect the rate at which the Company could borrow funds under its credit facility. RELATED PARTY TRANSACTIONS Gadzooks has entered into an executive retirement agreement with Gerald R. Szczepanski, Chairman of the Board and Chief Executive Officer, pursuant to which Mr. Szczepanski or his estate shall be eligible to receive certain benefits on termination of his employment with Gadzooks as a result of either death, termination without cause or retirement. Upon such termination (i) Gadzooks will continue to provide Mr. Szczepanski (and his spouse, if applicable) medical, dental and life insurance coverage, (ii) Gadzooks will enter into a consulting relationship with Mr. Szczepanski for 24 months whereby Mr. Szczepanski will receive a consulting fee of $300,000 per year to facilitate an orderly transition to Mr. Szczepanski's successor; (iii) Mr. Szczepanski will receive his pro rata bonus for the fiscal year in which he retires; (iv) all of Mr. Szczepanski's stock options will become vested in full; and (v) all of Mr. Szczepanski's stock options with an exercise price equal to or greater than $9.00 will be amended to include a term equal to the lesser of (a) three years from such termination or (b) the original expiration date of such stock options. In addition, Mr. Szczepanski agrees that upon termination of his employment with Gadzooks, he will not disclose any confidential information relating to Gadzooks and he will not solicit, interfere or compete with Gadzooks, its business, its clients or its customers for a period of two years. 12 STATEMENT REGARDING FORWARD-LOOKING DISCLOSURE Certain sections of this Quarterly Report on Form 10-Q, including the preceding "Management's Discussion and Analysis of Financial Condition and Results of Operations," contain various forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934. When used in this report, words such an "anticipate," "believe," "estimate," "expect," "intend," "predict," "project," and similar expressions, as they relate to us or our management, identify forward-looking statements. These forward-looking statements are based on information currently available to our management. Actual results could differ materially from those contemplated by the forward-looking statements as a result of certain factors, including fluctuations in store sales results, changes in economic conditions, fluctuations in quarterly results and other factors described under the "Risk Factors" section of the Company's Annual Report on Form 10-K for the fiscal year ended February 2, 2002. Such statements reflect the current views of our management with respect to future events and are subject to these and other risks, uncertainties and assumptions relating to our operations, results of operations, growth strategy and liquidity. All subsequent written and oral forward-looking statements attributable to us, or persons acting on our behalf, are expressly qualified in their entirety by this paragraph. 13 PART II - OTHER INFORMATION Items 1-3 - None Item 4 - Submission of Matters to a Vote of Security Holders (a) The Annual Meeting of Shareholders of the Company was held on June 13, 2002. (b) Information regarding the Company's directors is contained in the Company's Definitive Proxy Statement, which was filed with the Commission on May 5, 2002. (c) William C. Bousquette was elected to serve as director until the Company's 2004 annual meeting of shareholders, and G. Michael Machens and Lawrence H. Titus, Jr. were elected to serve as directors until the Company's 2005 annual meeting of shareholders according to the following vote:
For Against or Withheld --- ------------------- William C. Bousquette 8,389,223 86,507 G. Michael Machens 8,389,869 85,861 Lawrence H. Titus, Jr. 8,372,076 103,654
The 1992 Incentive and Nonstatutory Stock Option Plan (the "Plan") was amended to extend the term of the Plan to February 26, 2012. For: 5,483,281 Against or Withheld: 611,737 Abstention: 465,484 Broker Non-votes: 1,915,228
The Employee Stock Purchase Plan (the "Stock Purchase Plan") was amended to increase the number of monthly offerings to 180 and extend the term of the Stock Purchase Plan to March 31, 2013. For: 6,057,352 Against or Withheld: 36,884 Abstention: 466,266 Broker Non-votes: 1,915,228
The selection of PricewaterhouseCoopers LLP as the Company's independent accountants for the fiscal year ending February 1, 2003 was ratified by the shareholders according to the following vote: For: 8,396,601 Against or Withheld: 78,644 Abstention: 485 Broker Non-votes: --
(d) None Item 5 - None Item 6 - Exhibits and Reports on Form 8-K. (a) See Index of Exhibits. (b) None. 14 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. GADZOOKS, INC. (Registrant) DATE: September 10, 2002 By: /s/ James A. Motley ------------------------------------------ James A. Motley Vice President / Chief Financial Officer (Chief Accounting Officer and Duly Authorized Officer of the Registrant) 15 CERTIFICATION I, James A. Motley, Vice President, Chief Financial Officer and Secretary of Gadzooks, Inc., certify that: 1. I have reviewed this quarterly report on Form 10-Q of Gadzooks, Inc.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; and 3. Based on my knowledge, the financial statements and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report. DATE: September 10, 2002 By: /s/ James A. Motley -------------------------------------- James A. Motley Vice President, Chief Financial Officer and Secretary 16 CERTIFICATION I, Gerald R. Szczepanski, Chairman of the Board and Chief Executive Officer of Gadzooks, Inc., certify that: 1. I have reviewed this quarterly report on Form 10-Q of Gadzooks, Inc.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; and 3. Based on my knowledge, the financial statements and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report. DATE: September 10, 2002 By: /s/ Gerald R. Szczepanski -------------------------------------- Gerald R. Szczepanski Chairman of the Board and Chief Executive Officer 17 INDEX TO EXHIBITS
EXHIBIT NO. DESCRIPTION OF DOCUMENTS - ------- ------------------------ 3.1 -- Third Restated Articles of Incorporation of the Company (filed as Exhibit 4.1 to the Company's Form S-8 (No. 33-98038) filed with the Commission on October 12, 1995 and incorporated herein by reference). 3.2 -- Amended and Restated Bylaws of the Company (filed as Exhibit 4.2 to the Company's Form S-8 (No. 33-98038) filed with the Commission on October 12, 1995 and incorporated herein by reference). 3.3 -- First Amendment to the Amended and Restated Bylaws of the Company (filed as Exhibit 3.3 of the Company's Quarterly Report on Form 10-Q for the quarter ended August 2, 1997 filed with the Commission on September 16, 1997 and incorporated herein by reference). 4.1 -- Specimen Certificate for shares of Common Stock, $.01 par value, of the Company (filed as Exhibit 4.1 to the Company's Amendment No. 2 to Form S-1 (No. 33-95090) filed with the Commission on September 8, 1995 and incorporated herein by reference). 4.2 -- Rights Agreement dated as of September 3, 1998 between the Company and Mellon Investor Services, L.L.C. (filed as Exhibit 1 to the Company's Form 8-A filed with the Commission on September 4, 1998 and incorporated herein by reference). 10.1 -- Credit Agreement dated May 31, 2002 between the Company and Wells Fargo Bank (Texas), National Association (filed as Exhibit 10.1 of the Company's Quarterly Report as Form 10-Q for the quarter ended May 4, 2002 filed with the Commission on June 14, 2002 and incorporated herein by reference). 10.2* -- Executive Retirement Agreement dated August 28, 2002 between Gadzooks Management L.P. and Gerald R. Szczepanski. 99.1* -- Certification of Chief Executive Officer pursuant to Sarbanes-Oxley Act of 2002. 99.2* -- Certification of Chief Financial Officer pursuant to Sarbanes-Oxley Act of 2002.
- ---------- *Filed herewith (unless otherwise indicated, exhibits are previously filed). 18 EX-10.2 3 d99692exv10w2.txt EXECUTIVE RETIREMENT AGREEMENT - G. SZCZEPANSKI EXHIBIT 10.2 EXECUTIVE RETIREMENT AGREEMENT This Executive Retirement Agreement (the "AGREEMENT") dated as of August 28, 2002, is made by and between Gadzooks Management, L.P., a Texas limited partnership (the "COMPANY"), and Gerald R. Szczepanski ("EXECUTIVE"). RECITALS A. Executive is currently employed by the Company. B. The Company and Executive desire to enter into certain agreements providing for certain events upon Executive's retirement from the Company. NOW, THEREFORE, in consideration of the premises and mutual covenants herein contained and other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereto agree as follows: 1. Eligibility. Executive or his estate, devisees or heirs, as the case may be, shall be eligible to receive the benefits provided for in this Agreement so long as he is an officer of the Company at or above the level of vice president (an "EXECUTIVE OFFICER") on the termination date of Executive's employment with the Company as a result of either (i) Executive's death, (ii) the Company's termination, without Cause (as defined herein), of Executive's employment with the Company (solely with respect to the benefits set forth in Sections 6 and 7 of this Agreement), or (iii) Executive's retirement from employment with the Company (each, the "RETIREMENT DATE"). Executive shall cease to be eligible for the benefits provided for in this Agreement if his employment with the Company is terminated by the Company for Cause, and this Agreement shall automatically terminate and be of no further force or effect upon the date of such termination. The Company shall have the right to terminate Executive's employment at any time for any of the following reasons, each of which is referred to herein as "Cause": (i) any act of fraud or dishonesty with respect to any aspect of the Company's or any affiliate's business; (ii) continued use of illegal drugs; (iii) as a result of Executive's gross negligence or willful misconduct, Executive shall violate, or cause the Company to violate, any applicable federal or state securities or banking law or regulation and as a result of such violation, shall become, or shall cause the Company or any affiliate to become the subject of any legal action or administrative proceeding seeking an injunction from further violations or a suspension of any right or privilege; (iv) as a result of Executive's gross negligence or willful misconduct, Executive shall commit any act that causes, or shall knowingly fail to take reasonable and appropriate action to prevent, any material injury to the financial condition or business reputation of the Company or any affiliate; (v) substantial failure of performance, repeated or continued after written notice of such failure and explanation of such failure of performance, which is reasonably determined by the Board of Directors to be materially injurious to the business or interests of the Company or any affiliate; or (vi) conviction of a felony or of a crime involving moral turpitude. 2. Notice. Executive shall provide the Company with 180 days written notice of his retirement from employment with the Company. 3. Insurance Coverage. After the Retirement Date and until the death of Executive or Executive's spouse, whichever is later, the Company will reimburse Executive (and Executive's spouse, if applicable) for all medical, dental and life insurance premiums paid on behalf of Executive (and Executive's spouse, if applicable) by the Company on the Retirement Date (the "INSURANCE COVERAGE"); provided, however, once Executive or his spouse becomes eligible for Medicare coverage, the Insurance Coverage will automatically be reduced with respect to such person by the amount of Medicare coverage, irrespective of whether Executive or his spouse actually obtains such coverage, and thereafter the Insurance Coverage with respect to such person will only be supplemental to Medicare coverage. The Insurance Coverage may be modified by the Company at any time subsequent to the Retirement Date as long as such modifications are pursuant to and to the same extent as any modifications to the Company's insurance coverage provided to the Executive Officers in office on the date of such modifications and such modifications do not result in a substantial reduction in benefits under the Insurance Coverage. 4. Consultant Arrangement. During the 24 months immediately following the Retirement Date (the "CONSULTING PERIOD"), the Company will retain the services of Executive to facilitate an orderly transition of Executive's duties and responsibilities to Executive's successor(s) (the "SERVICES"). Execute shall devote such time and attention as are necessary to faithfully and diligently complete the Services; provided that Executive shall not be required to expend over ten (10) hours per week in performing the Services over the Consulting Period. The Company shall pay Executive, and Executive shall accept as full consideration for performance of the Services, a consulting fee of $300,000 per annum (the "CONSULTING FEE"), which will be payable on a bi-weekly basis. Should Executive suffer physical or mental disability (so that Executive is not reasonably able to complete the Services) for any consecutive six month period during the Consulting Period, the Company may, at any time after such six month period, at the Company's written election and written notice to Executive, immediately terminate payment of the Consulting Fee. In the event of any termination of payment pursuant to the foregoing provisions of this paragraph, both the Company and Executive shall be released and discharged of and from all further obligations under this Section 4 except for any accrued but unpaid portion of the Consulting Fee due Executive for Services rendered prior to the date of such Termination. The Company's non-enforcement of this provision in one instance shall not be deemed to preclude it from subsequent enforcement of this provision thereafter. Should Executive die at any time during the Consulting Period, the Company shall be released and discharged of and from all further obligations under this Section 4, except for any accrued but unpaid portion of the Consulting Fee due Executive for services rendered prior to the date of such termination. 2 5. Pro Rated Bonus Payment. Within 30 days after the Retirement Date, the Company will pay to Executive or his estate, devisees, or heirs, as the case may be, an amount equal to (i) the target bonus that Executive would have received if he was still an Executive Officer at the end of the fiscal year in which the Retirement Date occurs multiplied by (ii) a fraction, the numerator of which is equal to the number of days from the first day of the fiscal year that includes the Retirement Date to the Retirement Date, and the denominator of which is equal to 365. 6. Stock Options - Acceleration of Vesting. Immediately after the Retirement Date and notwithstanding the provisions of any applicable Company stock option agreements, all of Executive's unexpired Company stock options granted pursuant to any Company stock option plan shall become vested in full. 7. Stock Options - Amendment of Term. Immediately after the Retirement Date and notwithstanding the provisions of any applicable Company stock option agreements, all of Executive's Company stock options with an exercise price equal to or greater than $9.00 shall be amended to include a term equal to the lesser of (i) three years from the Retirement Date or (ii) the original expiration date of such Company stock options. 8. Non-Competition, Non-Solicitation, Non-Interference and Confidentiality. (a) Executive agrees that for a period of two years from the Retirement Date (the "RESTRICTED PERIOD"), he will not, without the prior written consent of the Company, alone or with or for others, in whatever capacity, directly or indirectly, solicit or attempt to solicit clients or customers of the Company, or solicit or attempt to solicit employees of the Company to leave the Company's employ. (b) Executive agrees that during the Restricted Period he will not interfere with the relationship between the Company and any of its vendors. (c) Executive agrees that, during the Restricted Period, he shall not, for himself or any third party, directly or indirectly, engage in any business activity or accept employment with any entity that is or may be competitive to a material extent with the Company in the field of retail sales (including, but not limited to, internet retail sales and mail-order retail sales), of moderately priced men's and women's casual apparel and accessories targeted primarily at the 13 year old to 19 year old age group ("COMPETITOR"), without prior written consent of the Company. Executive agrees that, prior to engaging in any such activity or accepting employment with a Competitor or any entity that could reasonably be deemed a Competitor during the Restricted Period, Executive shall advise the Company in writing of Executive's intentions and seek the Company's approval. Company approval shall apply only with respect to the activity or position approved and Executive shall be obligated to obtain Company approval with respect to any subsequent change of activity or position or employment during the Restricted Period. Executive also agrees that, during the Restricted Period, Executive shall not hold any stock in a Competitor other than passive minority interests comprising less than 2% of the outstanding stock of a publicly-traded Competitor. 3 (d) Without the prior written consent of the Company, except to the extent required by an order of a court having competent jurisdiction or under subpoena from an appropriate government agency, Executive shall not disclose any trade secrets, customer lists, supplier lists, drawings, designs, information regarding product development, marketing plans, sales plans, management plans, management organization information (including data and other information relating to members of the Board and management), operating policies or manuals, business plans, financial records or any other financial, commercial, business or technical information relating to the Company or information designated as confidential or proprietary that the Company may receive belonging to suppliers, customers or others who do business with the Company (collectively, "CONFIDENTIAL INFORMATION") to any third person unless such Confidential Information has been previously disclosed to the public by the Company or is in the public domain (other than by reason of Executive's breach of this Section 8(d)). 9. Not a Contract of Employment. This Agreement shall not be deemed to constitute an express or implied obligation of the Company to continue to employ Executive. 10. Successors. The provisions of this Agreement shall be binding upon the Company and its successors and assigns. 11. Governing Law. This Agreement will be construed and enforced according to the laws of the State of Texas. 4 IN WITNESS WHEREOF, the parties have caused this Agreement to be duly executed and delivered on the day and year first above written. GADZOOKS MANAGEMENT, L.P. By: Gadzooks, Inc., its general partner By: /s/ James A. Motley ---------------------------------- Name: James A. Motley -------------------------------- Title: Chief Financial Officer ------------------------------- /s/ Gerald R. Szczepanski ------------------------------------- Gerald R. Szczepanski 5 EX-99.1 4 d99692exv99w1.txt CERTIFICATION OF CHIEF EXECUTIVE OFFICER EXHIBIT 99.1 Certification Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 In connection with the Quarterly Report of Gadzooks Inc. (the "Company") on Form 10-Q for the period ending August 3, 2002 as filed with the Securities and Exchange Commission (the "Report"), I, Gerald R. Szczepanski, certify pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: 1. the Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and 2. the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. September 10, 2002 /s/ Gerald R. Szczepanski ------------------------------- Gerald R. Szczepanski Chairman of the Board and Chief Executive Officer EX-99.2 5 d99692exv99w2.txt CERTIFICATION OF CHIEF FINANCIAL OFFICER EXHIBIT 99.2 Certification Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 In connection with the Quarterly Report of Gadzooks Inc. (the "Company") on Form 10-Q for the period ending August 3, 2002 as filed with the Securities and Exchange Commission (the "Report"), I, James A. Motley, certify pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: 1. the Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and 2. the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. September 10, 2002 /s/ James A. Motley ----------------------------- James A. Motley Vice President, Chief Financial Officer and Secretary -----END PRIVACY-ENHANCED MESSAGE-----