-----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, FWdrr6v4HiGnxTAJcVdF0I8uBGEf2Gr8TT1OEQIdEnfolan46RKjApA5lVuuU6UJ l96s0vlDtI/huKm2PcL4OA== 0000950134-03-012461.txt : 20030904 0000950134-03-012461.hdr.sgml : 20030904 20030904171945 ACCESSION NUMBER: 0000950134-03-012461 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 20030802 FILED AS OF DATE: 20030904 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: 03882100 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 d08885e10vq.txt FORM 10-Q 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 2, 2003 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 ( ) Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes ( ) No (X) As of September 4, 2003, the number of shares outstanding of the registrant's common stock is 9,159,671. GADZOOKS, INC. FORM 10-Q For the Quarter Ended August 2, 2003 INDEX
PAGE ---- PART I. FINANCIAL INFORMATION Item 1. Consolidated Financial Statements Condensed Consolidated Balance Sheets as of 3 August 2, 2003 and February 1, 2003 Condensed Consolidated Statements of Operations 4 for the Second Quarter and Six Months Ended August 2, 2003 and August 3, 2002 Condensed Consolidated Statements of Cash Flows for 5 the Six Months Ended August 2, 2003 and August 3, 2002 Notes to Consolidated Financial Statements 6-8 Item 2. Management's Discussion and Analysis 9-14 of Financial Condition and Results of Operations Item 3. Quantitative and Qualitative Disclosures 14 About Market Risk Item 4. Controls and Procedures 14 PART II. OTHER INFORMATION 15 SIGNATURE PAGE 16 INDEX TO EXHIBITS 17
2 PART 1 -- FINANCIAL INFORMATION GADZOOKS, INC. CONDENSED CONSOLIDATED BALANCE SHEETS - -------------------------------------------------------------------------------- (IN THOUSANDS) (UNAUDITED)
AUGUST 2, FEBRUARY 1, 2003 2003 --------- ----------- ASSETS Current assets: Cash and cash equivalents $ 4,997 $ 20,769 Accounts receivable 1,506 1,321 Inventory 46,147 56,191 Other current assets 14,476 7,137 --------- --------- 67,126 85,418 --------- --------- Leaseholds, fixtures and equipment, net 35,962 34,824 Deferred tax assets 4,885 4,885 --------- --------- $ 107,973 $ 125,127 ========= ========= LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable $ 21,016 $ 26,953 Accrued expenses and other current liabilities 8,702 7,616 Income taxes payable -- 77 --------- --------- 29,718 34,646 --------- --------- Accrued rent 3,936 4,124 Commitments and contingencies Shareholders' equity Common stock 92 92 Additional paid-in capital 44,865 44,942 Retained earnings 29,445 41,450 Treasury stock (83) (127) --------- --------- 74,319 86,357 --------- --------- $ 107,973 $ 125,127 ========= =========
The accompanying notes are an integral part of these condensed 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 2, AUGUST 3, AUGUST 2, AUGUST 3, 2003 2002 2003 2002 --------- --------- --------- --------- Net sales $ 68,474 $ 76,697 $ 139,215 $ 154,972 Cost of goods sold including buying, distribution and occupancy costs 58,814 57,369 116,281 114,037 --------- --------- --------- --------- Gross profit 9,660 19,328 22,934 40,935 Selling, general and administrative expenses 22,409 19,162 42,437 37,948 --------- --------- --------- --------- Operating income (loss) (12,749) 166 (19,503) 2,987 Interest income (expense), net (35) 21 (17) 65 --------- --------- --------- --------- Income (loss) before income taxes (12,784) 187 (19,520) 3,052 Provision (benefit) for income taxes (4,922) 72 (7,515) 1,180 --------- --------- --------- --------- Net income (loss) $ (7,862) $ 115 $ (12,005) $ 1,872 ========= ========= ========= ========= Net income (loss) per share Basic $ (0.86) $ 0.01 $ (1.31) $ 0.21 ========= ========= ========= ========= Diluted $ (0.86) $ 0.01 $ (1.31) $ 0.20 ========= ========= ========= ========= Weighted average shares outstanding Basic 9,127 9,135 9,137 9,115 ========= ========= ========= ========= Diluted 9,127 9,274 9,137 9,312 ========= ========= ========= =========
The accompanying notes are an integral part of these condensed consolidated financial statements. 4 GADZOOKS, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS - -------------------------------------------------------------------------------- (IN THOUSANDS) (UNAUDITED)
SIX MONTHS ENDED ----------------------- AUGUST 2, AUGUST 3, 2003 2002 --------- --------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss) $(12,005) $ 1,872 Adjustments to reconcile net income (loss) to cash provided by (used in) operating activities: Loss (gain) on disposal of assets (49) 486 Depreciation 4,939 4,655 Changes in operating assets and liabilities (5,940) (5,634) -------- -------- NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES (13,055) 1,379 -------- -------- CASH FLOWS FROM INVESTING ACTIVITIES: Capital expenditures (2,806) (5,097) Proceeds from the sale of fixtures 122 -- Purchase of short-term investments -- (4,964) Proceeds from redemption of short-term investments -- 995 -------- -------- NET CASH USED IN INVESTING ACTIVITIES (2,684) (9,066) -------- -------- CASH FLOWS FROM FINANCING ACTIVITIES: Issuance of common stock -- 460 Purchase of treasury stock (102) -- Sale of treasury stock under employee benefit plans 69 135 -------- -------- NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES (33) 595 -------- -------- Net decrease in cash and cash equivalents (15,772) (7,092) Cash and cash equivalents at beginning of period 20,769 14,868 -------- -------- CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 4,997 $ 7,776 ======== ======== SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING ACTIVITIES: Accrued capital expenditures for store conversions $ 3,344 $ --
The accompanying notes are an integral part of these condensed 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 of the Company as of August 2, 2003 and February 1, 2003, and the results of operations and cash flows for the second quarter and six months ended August 2, 2003 and August 3, 2002. 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 1, 2003 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 1, 2003. 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 2003" is the 52-week period ending January 31, 2004. Stock Option Plans: The following table shows Gadzooks' net income (loss) for the quarters and six months ended August 2, 2003 and August 3, 2002, as if compensation expense for Gadzooks' stock option plans applicable to the Company's employees had been determined based upon the fair value at the grant date for awards consistent with the methodology prescribed by SFAS 123 (these pro forma effects may not be representative of expense in future periods since the estimated fair value of stock options on the date of grant is amortized to expense over the vesting period, and additional options may be granted or cancelled in future years):
QUARTER ENDED SIX MONTHS ENDED -------------------------- -------------------------- AUGUST 2, AUGUST 3, AUGUST 2, AUGUST 3, 2003 2002 2003 2002 ---------- ---------- ---------- ---------- PRO FORMA NET INCOME (LOSS): (in thousands) Reported net income (loss) $ (7,862) $ 115 $ (12,005) $ 1,872 Less: Total stock-based employee compensation expense determined under fair value based methods for all awards, net of related tax effects 356 542 696 767 ---------- ---------- ---------- ---------- Pro forma net income (loss) $ (8,218) $ (427) $ (12,701) $ 1,105 ========== ========== ========== ========== NET INCOME (LOSS) PER SHARE: Basic $ (0.86) $ 0.01 $ (1.31) $ 0.21 ========== ========== ========== ========== Basic - pro forma $ (0.90) $ (0.05) $ (1.39) $ 0.12 ========== ========== ========== ========== Diluted $ (0.86) $ 0.01 $ (1.31) $ 0.20 ========== ========== ========== ========== Diluted - pro forma $ (0.90) $ (0.05) $ (1.39) $ 0.12 ========== ========== ========== ==========
6 2. LONG-TERM OBLIGATIONS On April 11, 2003, the Company and Wells Fargo Retail Finance LLC ("Wells Fargo") entered into a three-year $30 million revolving credit agreement (the "Facility"), which is secured by an exclusive and first priority, perfected interest in all assets of the Company. The Company's borrowings under the agreement are limited to 85% of the net recovery value of eligible inventory (as defined by the Facility) plus 85% of eligible credit card accounts receivable less certain financial reserves specified by Wells Fargo. 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 a minimum maintained excess availability requirement of $3.0 million (as defined by the Facility). Amounts borrowed under the revolving line will bear interest ranging from 1.25% to 2.00% above LIBOR, or 0.25% below to 0.50% above Wells Fargo's prime rate based on credit line utilization. As of August 2, 2003, amounts available to borrow under the new credit line, as limited as described above and by outstanding letters of credit of $5.1 million, totaled $20.9 million. 3. DEFERRED TAX ASSETS The Company does not currently have a valuation allowance recorded against its deferred tax assets of $14.3 million. The Company anticipates an operating loss during the transition phase in fiscal 2003; however, should the loss exceed projections, the Company may need to recognize a valuation allowance to significantly reduce its deferred tax assets. 4. EARNINGS PER SHARE The following table outlines the Company's calculation of weighted average shares outstanding (in thousands):
QUARTER ENDED SIX MONTHS ENDED ----------------------- ----------------------- AUGUST 2, AUGUST 3, AUGUST 2, AUGUST 3, 2003 2002 2003 2002 --------- --------- --------- --------- Weighted average common shares outstanding (basic) 9,127 9,135 9,137 9,115 Effect of dilutive options -- 139 -- 197 --------- --------- --------- --------- Weighted average common shares outstanding (diluted) 9,127 9,274 9,137 9,312 ========= ========= ========= =========
The treasury stock method is used to determine dilutive potential common shares outstanding related to stock options. Options, that are antidilutive, are not considered in the treasury stock method calculation. Options excluded from the earnings per share calculation due to their antidilutive nature totaled 1,590,028 and 588,825 for the quarters ended August 2, 2003 and August 3, 2002, and 1,590,028 and 536,174 for the six months ended August 2, 2003 and August 3, 2002, respectively. 5. STORE CLOSING COSTS During the second quarter of fiscal 2003, the Company closed four stores that had been identified as under-performing, for a total of 13 stores closed during the six months ended August 2, 2003. Additionally, the Company has entered into agreements to close 12 more stores. The total costs incurred as a result of the store closings and termination agreements, totaled $1.4 million and $2.7 million for the quarter and six months ended August 2, 2003, respectively. These costs, primarily composed of lease termination costs, are included in selling, general and administrative expenses. 7 6. INVENTORY LIQUIDATION COSTS The Company entered into an agreement with a consulting firm to help with the complete liquidation of its men's inventory. Under the terms of the agreement, the Company reimbursed the firm for certain operating costs and paid the firm a portion of the sales proceeds based on certain specified levels of sales performance as defined in the contract. All amounts paid to the firm or accrued under the contract were contingent upon the firm's ability to meet certain minimum levels of sales performance. A total of $2.6 million and $3.0 million has been recorded as selling, general and administrative expenses during the quarter and six months ended August 2, 2003, respectively, pursuant to this agreement. As of August 2, 2003, the men's inventory liquidation has been completed; therefore, no additional costs will be incurred pursuant to the agreement. 8 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GENERAL Gadzooks is a mall-based specialty retailer of clothing, accessories, shoes, fragrances and cosmetics for young women, principally between the ages of 16 and 22. Historically, the Company has catered to the clothing needs of both young men and women. The conversion of the Gadzooks stores to an all-female merchandise assortment took place in July 2003. In the second half of fiscal 2001, the Company began testing a new retail concept with the opening of four Orchid stores. The Orchid concept caters to the unique innerwear and sleepwear needs of females between the ages of 14 and 22. As of August 2, 2003, the Company had closed 13 Gadzooks stores since the beginning of the fiscal year and operated 423 Gadzooks stores and four Orchid stores for a total of 427 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 financial statements and the notes related thereto. CRITICAL ACCOUNTING POLICIES The preparation of Gadzooks' consolidated financial statements in conformity with accounting principles generally accepted in the United States of America 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; however, the following issues 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. Cost is determined using the weighted-average method. Markdown allowances received from vendors are recorded as a reduction of inventory cost and therefore as a reduction of cost of goods sold in the period in which the related merchandise is sold. 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, aged 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. Gadzooks has not experienced significant fluctuations in historical shrink rates. 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, significant negative industry or economic trends and a current expectation, that more likely than not, the asset will be disposed of significantly before the end of its previously estimated useful life. If management determines that 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 the net book value of the assets. The amount of the impairment loss is measured as the difference between the net book value of the assets and the estimated fair market value of the related assets. 9 DEFERRED TAX ASSETS. The Company does not currently have a valuation allowance recorded against its deferred tax assets of $14.3 million. 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. The Company anticipates an operating loss during the transition phase in fiscal 2003 and expects to return to profitability in fiscal 2004; however, should the loss for fiscal 2003 exceed projections, the Company may need to recognize a valuation allowance to significantly reduce its deferred tax assets. The Company will perform a review of its financial performance at the end of each quarter during 2003 to evaluate the likelihood of realizing its deferred tax assets. 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 level. Property and casualty claims at a store level are estimated and recognized 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. CONVERSION TO ALL-FEMALE MERCHANDISE ASSORTMENT The conversion of all Gadzooks stores to an all-female merchandise assortment took place in July 2003. The Company anticipates an operating loss during the transition phase in fiscal 2003 and expects to return to profitability in fiscal 2004. Although it is not possible to predict all of the costs associated with the transition, the Company does plan to spend at least $1.5 million to $2.5 million in fiscal 2003 to market the new concept, of which $906,000 has been spent through August 2, 2003. The Company hired a consulting firm to help with the liquidation of its men's inventory. Under the terms of the agreement, the Company reimbursed the firm for certain operating costs and paid the firm a portion of the sales proceeds based on certain specified levels of sales performance as defined in the contract. A total of $3.0 million has been recorded as selling, general and administrative expenses during the six months ended August 2, 2003 pursuant to this agreement. No assurance can be given that the conversion will be successful, or that the Company will return to profitability. STORE CLOSINGS The Company has closed 13 Gadzooks stores and contracted to close 12 additional stores in fiscal 2003. The Company is also pursuing the closure of up to 10 more under-performing stores during the remainder of fiscal 2003. The costs associated with closing these stores, including, but not limited to, lease termination costs and employee severance, is expected to be between $2.7 million and $3.5 million in the aggregate, of which $2.7 million has been spent through August 2, 2003. Costs and expenses associated with store closures will be recognized at the time the liability is incurred. In addition to the Gadzooks' closings, the Company intends to close one Orchid store during the third quarter and replace it with a more suitably sized location in another mall. No assurance can be given, however, that these stores will be closed during fiscal 2003, that additional stores will not be closed during fiscal 2003 or that the costs related to closing stores will not exceed the range provided. RESULTS OF OPERATIONS The second quarter ended August 2, 2003 compared to the second quarter ended August 3, 2002 Net Sales Net sales decreased approximately $8.2 million, or 10.7 percent, to $68.5 million during the second quarter of fiscal 2003 from $76.7 million during the comparable quarter of fiscal 2002. The total Company sales decrease was due to a comparable store sales decrease of $7.4 million and a sales decrease of $1.4 million due to closed stores, partially offset by $600,000 of sales from the 11 new stores not yet included in the comparable store sales base. Comparable store sales decreased 9.9 percent for the second quarter of fiscal 2003. Sales by category in the average store changed as follows versus the prior year quarter: junior shoes - increased by 28 percent; junior accessories - increased by 24 percent; junior apparel - increased by 10 percent; and men's merchandise - 10 decreased by 35 percent. The decrease in comparable store sales is attributed to the conversion to an all-female merchandise assortment and a difficult retail environment. The Company's average transaction size decreased 9.1 percent, and the number of transactions per average store increased by 0.2 percent. Comparable store sales for fiscal August 2003 decreased by 33.6 percent from the prior year. The Company is currently making inventory level and mix adjustments that management believes will positively impact the business for the holiday season as well as the next couple of months. No assurance can be given that these inventory level and mix adjustments will positively impact future business. Gross profit Gross profit decreased approximately $9.6 million to $9.7 million during the second quarter of fiscal 2003 from $19.3 million during the comparable quarter of fiscal 2002. As a percentage of net sales, gross profit decreased 11.1 percentage points to 14.1 percent from 25.2 percent for the comparable quarter of last year. Merchandise margins as a percentage of sales declined 9.2 percent from the prior year. This decrease is primarily attributable to the completion of the men's inventory liquidation and increased markdown activity in the junior category during the period. Occupancy costs as a percentage of sales increased by 1.5 percent, and buying and distribution costs as a percentage of sales increased by 0.3 percent. 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, which was slightly offset by operating leverage achieved as a result of the closing of under performing stores and reduced depreciation expense resulting from the prior year impairment of certain under-performing stores. The increase in buying and distribution costs as a percentage of sales was due primarily to the negative leverage effect of the comparable store sales decrease. Selling, general and administrative expenses Selling, general and administrative expenses ("SG&A") increased approximately $3.2 million to $22.4 million during the second quarter of 2003 from $19.2 million during the comparable quarter of fiscal 2002. The aggregate increase in SG&A is primarily attributable to costs of $2.6 million associated with the liquidation of the men's merchandise, lease termination costs of $1.4 million and additional advertising and marketing expenses of $302,000 related to the transition. These costs were offset in part by a reduction in payroll, employee benefits and inventory service costs as well as a gain on fixtures disposed of in the second quarter of fiscal 2003 versus a loss recognized in the prior year's quarter on an abandoned information systems project. As a percentage of net sales, SG&A increased by 7.7 percentage points to 32.7 percent during the second quarter of fiscal 2003 from 25.0 percent during the second quarter of last year. The increase in the SG&A percentage was due to negative leverage from the comparable store sales decrease, costs associated with the liquidation of the men's merchandise, lease termination costs and the increase in advertising and marketing costs related to the transition. Interest The Company recorded $35,000 in net interest expense during the second quarter of fiscal 2003 compared to $21,000 in net interest income in the comparable period of last year. The change is due primarily to higher fees associated with the larger credit facility and, to a lesser extent, increased letter of credit activity, lower average cash balances and lower market interest rates. Income tax benefit The Company's income tax status changed to an income tax benefit of $4.9 million during the second quarter of fiscal 2003 from an income tax provision of $72,000 in the comparable period of last year as a result of the operating loss recorded in the second quarter of fiscal 2003. The Company anticipates an operating loss during the transition phase in fiscal 2003 and expects to return to profitability in fiscal 2004; however, should the loss for fiscal 2003 exceed projections, the Company may need to recognize a valuation allowance to significantly reduce its existing deferred tax asset balance and possibly reduce or eliminate any future tax benefits associated with the generation of net operating losses. The Company will perform a review of its financial performance at the end of each quarter during 2003 to evaluate the likelihood of realizing its deferred tax assets. 11 The six months ended August 2, 2003 compared to the six months ended August 3, 2002. Net sales Net sales decreased approximately $15.8 million, or 10.2 percent, to $139.2 million during the first six months of fiscal 2003 from $155.0 million during fiscal 2002. The total Company sales decrease for the first six months of fiscal 2003 was attributable to a comparable store sales decrease of $15.5 million, or 10.3 percent, and a sales decrease of $1.9 million due to closed stores, partially offset by $1.6 million of sales for the new stores not yet included in the comparable store sales base. The Company experienced comparable store sales increases in all its major categories except men's merchandise, which has now been completely liquidated as a result of the Company's transition to an all-female merchandise assortment. The Company's average transaction size decreased by 6.9 percent, and the number of transactions per average store decreased by 2.8 percent. Gross profit Gross profit decreased approximately $18.0 million to $22.9 million during the first six months of fiscal 2003 from $40.9 million during the comparable six months of fiscal 2002. As a percentage of net sales, gross profit decreased 9.9 percentage points to 16.5 percent from 26.4 percent for the comparable six months of last year. Merchandise margins as a percentage of sales were 7.5 percent lower than the prior year. This decrease is primarily attributable to the liquidation of the men's inventory and increased markdown activity in the junior category during the period. Additionally, there was a 2.0 percent increase in occupancy costs as a percentage of sales and a 0.5 percent increase in buying and distribution costs as a percentage of sales. The increase in occupancy, buying and distribution costs as a percentage of sales was due primarily to the negative leverage effect of the comparable store sales decrease. Selling, general and administrative expenses Selling, general and administrative expenses increased approximately $4.4 million to $42.4 million during the first six months of 2003 from $38.0 million during the comparable six months of fiscal 2002. The aggregate increase in SG&A is primarily attributable to costs of $3.0 million associated with the liquidation of the men's merchandise, lease termination costs of $2.7 million and additional advertising and marketing expenses of $906,000 related to the transition. As a percentage of net sales, SG&A increased 6.0 percent to 30.5 percent during the first six months of fiscal 2003 from 24.5 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, costs associated with the liquidation of the men's merchandise, lease termination costs and the increase in advertising and marketing costs related to the transition. Interest The Company recorded $17,000 in net interest expense during the first six months of fiscal 2003 compared to $65,000 in net interest income in the comparable period of last year. The change is due primarily to higher fees associated with the larger credit facility, and to a lesser extent, increased letter of credit activity, lower average cash balances and lower market interest rates. Income tax benefit The Company's income tax status changed to an income tax benefit of $7.5 million during the first six months of fiscal 2003 from an income tax provision of $1.2 million in the comparable period of last year as a result of the operating loss recorded in the first six months of fiscal 2003. The Company anticipates an operating loss for fiscal 2003 and expects to return to profitability in fiscal 2004; however, should the loss for fiscal 2003 exceed projections, the Company may need to recognize a valuation allowance to significantly reduce its existing deferred tax asset balance and possibly reduce or eliminate any future tax benefits associated with the generation of net operating losses. The Company will perform a review of its financial performance at the end of each quarter during 2003 to evaluate the likelihood of realizing its deferred tax assets. 12 LIQUIDITY AND CAPITAL RESOURCES General The Company is currently meeting its cash requirements through cash and cash equivalents on-hand and its line of credit. The Company is also seeking alternative methods for raising additional capital, which may not be available on favorable terms, if at all. Cash Flows At August 2, 2003, cash and cash equivalents were $5.0 million, a decrease of $15.8 million since February 1, 2003. The primary uses of cash were a net loss before depreciation of $7.1 million, capital expenditures of $2.8 million and net working capital changes of $5.9 million. Credit Facility On April 11, 2003, the Company and Wells Fargo Retail Finance LLC ("Wells Fargo") entered into a three-year $30 million revolving credit agreement (the "Facility"), which is secured by an exclusive and first priority, perfected interest in all assets of the Company. The Company's borrowings under the agreement are limited to 85% of the net recovery value of eligible inventory (as defined by the Facility) plus 85% of eligible credit card accounts receivable less certain financial reserves specified by Wells Fargo. 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 a minimum maintained excess availability requirement of $3.0 million (as defined by the Facility). Amounts borrowed under the revolving line will bear interest ranging from 1.25% to 2.00% above LIBOR, or 0.25% below to 0.50% above Wells Fargo's prime rate based on credit line utilization. As of August 2, 2003, amounts available to borrow under the new credit line, as limited as described above and by outstanding letters of credit of $5.1 million, totaled $20.9 million. Conversion to All-Female Merchandise Assortment The conversion of all Gadzooks stores to an all-female merchandise assortment took place in July 2003. The Company anticipates an operating loss during the transition phase in fiscal 2003 and expects to return to profitability in fiscal 2004. Although it is not possible to predict all of the costs associated with the transition, the Company plans to spend at least $1.5 million to $2.5 million in fiscal 2003 to market the new concept, of which $906,000 has been spent through August 2, 2003. The Company hired a consulting firm to help with the liquidation of its men's inventory. Under the terms of the agreement, the Company reimbursed the firm for certain operating costs and paid the firm a portion of the sales proceeds based on certain specified levels of sales performance as defined in the contract. A total of $3.0 million has been recorded as selling, general and administrative expenses during the six months ended August 2, 2003 pursuant to this agreement. No assurance can be given that the conversion will be successful, or that the Company will return to profitability. Store Closings The Company has already closed 13 stores and contracted to close 12 additional stores in fiscal 2003. The Company is also pursuing the closure of up to 10 more under-performing stores in fiscal 2003. The costs associated with closing these stores, including, but not limited to, lease termination costs and employee severance, is expected to be between $2.7 million and $3.5 million in the aggregate, of which $2.7 million has been spent through August 2, 2003. Costs and expenses associated with store closures will be recognized at the time the liability is incurred. In addition to the Gadzooks' closings, the Company intends to close one Orchid store during the third quarter and replace it with a more suitably sized location in another mall. No assurance can be given, however, that these stores will be closed during fiscal 2003, that additional stores will not be closed during fiscal 2003 or that the costs related to the closing of the stores will not exceed the range provided. Factoring Currently, 55 percent to 65 percent of the Company's vendors generate liquidity by entering into factoring arrangements whereby factors purchase the vendor's invoices. This financing mechanism allows Gadzooks' vendors to receive payment in a shorter period of time. Any material changes in the terms extended by these factors could adversely affect the Company's ability to meet its cash requirements and maintain necessary liquidity going forward. 13 Capital Expenditures The Company anticipates capital expenditures of $4.3 million to $4.8 million for the remainder of fiscal 2003 to pay for fixtures related to the conversion to an all-female concept, purchase and/or upgrade information systems and reconfigure its distribution center. The Company believes it can satisfy its cash requirements for fiscal 2003 using its existing cash balances, cash generated from operations, and funds available under its revolving credit agreement. The Company is currently seeking alternative methods for raising additional capital, which may not be available on favorable terms, if at all. Future cash flows are subject to a number of variables and there can be no assurance that Gadzooks will have access to sufficient capital to meet its capital requirements. Any significant changes, such as changes in the Company's current vendor or factor payment terms or substantial declines in sales, could materially and adversely impact Gadzooks' liquidity going forward. 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, would affect the rate at which the Company could borrow funds under its credit Facility. 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, as amended. When used in this report, words such an "anticipate," "believe," "estimate," "expect," "intend," "plan," "predict," "project," "will" 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, but not limited to, fluctuations in store sales results, changes in economic conditions, changes in vendor or factor payment terms, fluctuations in quarterly results and other factors discussed in this report, as well as in the "Risk Factors" section of the Company's Annual Report on Form 10-K for the fiscal year ended February 1, 2003. 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. CONTROLS AND PROCEDURES Our management, with the participation of our Chairman of the Board and Chief Executive Officer (our principal executive officer) and our Chief Financial Officer (our principal financial officer) have concluded, based on their evaluation as of the end of the period covered by this report, that our disclosure controls and procedures are effective to ensure that information required to be disclosed by us in the reports filed or submitted by us in under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms, and include controls and procedures designed to ensure that information required to be disclosed by us in such reports is accumulated and communicated to our management, including our principal executive officer and financial officer, as appropriate to allow timely decisions regarding required disclosure. There were no changes in our internal controls during the period covered by this report that have materially affected or are reasonably likely to materially affect our internal controls over financial reporting going forward. 14 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 17, 2003. (b) Information regarding the Company's directors is contained in the Company's Definitive Proxy Statement, which was filed with the Commission on May 13, 2003. (c) Election of Directors: Carolyn Greer Gigli, Ron G. Stegall and Gerald R. Szczepanski were elected to serve as directors until the Company's 2006 annual meeting of shareholders according to the following vote:
For Against or Withheld --- ------------------- Carolyn Greer Gigli 8,688,029 105,176 Ron G. Stegall 8,520,168 273,037 Gerald R. Szczepanski 8,675,009 118,196
Amendment to 1995 Stock Option Plan: The 1995 Non-Employee Director Stock Option Plan (the "Director Plan") was amended to (i) increase the number of shares for which options will be granted to newly-elected or appointed non-employee directors from 5,000 shares to 15,000 shares, (ii) provide for a one-time grant of an option to purchase 10,000 shares to each non-employee director on the day of the Annual Meeting and (iii) increase the number of shares available for issuance under the Director Plan from 100,000 to 200,000. For: 8,341,483 Against or Withheld: 396,314 Abstention: 55,408
Amendment to Employee Stock Purchase Plan: The Employee Stock Purchase Plan was amended to increase the maximum aggregate number of shares reserved for issuance from 110,000 to 160,000. For: 8,610,924 Against or Withheld: 139,198 Abstention: 43,083
Ratification of Accountants: The selection of PricewaterhouseCoopers LLP as the Company's independent accountants for the fiscal year ending January 31, 2004 was ratified by the shareholders according to the following vote: For: 8,651,786 Against or Withheld: 137,864 Abstention: 3,555
(d) None Item 5 - None Item 6 - Exhibits and Reports on Form 8-K. (a) See Index of Exhibits. (b) None. 15 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 4, 2003 By: /s/ JAMES A. MOTLEY ------------------------------------------- James A. Motley Vice President / Chief Financial Officer (Chief Accounting Officer and Duly Authorized Officer of the Registrant) 16 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-- Committed, Senior, Secured Revolving Line of Credit Agreement between the Company and Wells Fargo Retail Finance, LLC dated as of April 11, 2003 (filed as Exhibit 10.38 to the Company's Form 10-K filed with the Commission on April 29, 2003 and incorporated herein by reference). 10.2-- Trademark and Trademark Applications Security Agreement between the Company and Wells Fargo Retail Finance, LLC dated as of April 11, 2003 (filed as Exhibit 10.39 to the Company's Form 10-K filed with the Commission on April 29, 2003 and incorporated herein by reference). 31.1*-- Certification pursuant to Section 302 of the Sarbanes-Oxley Act of Chief Executive Officer. 31.2*-- Certification pursuant to Section 302 of the Sarbanes-Oxley Act of Chief Financial Officer. 32.1*-- Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 of Chief Executive Officer. 32.2*-- Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 of Chief Financial Officer.
- ---------- * Filed herewith. 17 EX-31.1 3 d08885exv31w1.txt CERTIFICATION PURSUANT TO SECTION 302 OF CEO EXHIBIT 31.1 CERTIFICATION PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT 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 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 report; 3. Based on my knowledge, the financial statements and other financial information included in this 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 report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end the period covered by this report based on such evaluation; and c) disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting, which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. DATE: September 4, 2003 By: /s/ Gerald R. Szczepanski ------------------------------- Gerald R. Szczepanski Chairman of the Board and Chief Executive Officer EX-31.2 4 d08885exv31w2.txt CERTIFICATION PURSUANT TO SECTION 302 OF CFO EXHIBIT 31.2 CERTIFICATION PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT 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 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 report; 3. Based on my knowledge, the financial statements and other financial information included in this 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 report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end the period covered by this report based such evaluation; and c) disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting, which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. DATE: September 4, 2003 By: /s/ James A. Motley ----------------------------- James A. Motley Vice President, Chief Financial Officer EX-32.1 5 d08885exv32w1.txt CERTIFICATION PURSUANT TO 18 U.S.C SECTION 1350 EXHIBIT 32.1 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 ended August 2, 2003 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, to the best of my knowledge: 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. /s/ Gerald R. Szczepanski Gerald R. Szczepanski Chairman of the Board and Chief Executive Officer September 4, 2003 EX-32.2 6 d08885exv32w2.txt CERTIFICATION PURSUANT TO 18 U.S.C SECTION 1350 EXHIBIT 32.2 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 ended August 2, 2003 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, to the best of my knowledge: 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. /s/ James A. Motley James A. Motley Vice President and Chief Financial Officer September 4, 2003 -----END PRIVACY-ENHANCED MESSAGE-----