-----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, G+WDXBH8Pc7mMljY0DTxrrJKsdHRAycyGYwYdcaGrcCGdSDaJ8tCRdwIzblls9pJ O5Wjx9tcfnXDxkXhfQPcMQ== 0000950134-97-003128.txt : 19970424 0000950134-97-003128.hdr.sgml : 19970424 ACCESSION NUMBER: 0000950134-97-003128 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 9 CONFORMED PERIOD OF REPORT: 19970201 FILED AS OF DATE: 19970423 SROS: NASD 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-K405 SEC ACT: 1934 Act SEC FILE NUMBER: 000-26732 FILM NUMBER: 97585918 BUSINESS ADDRESS: STREET 1: 4801 SPRING VALLEY STE 108B CITY: DALLAS STATE: TX ZIP: 75244 BUSINESS PHONE: 2149915500 MAIL ADDRESS: STREET 1: 4801 SPRING VALLEY ROAD SUITE 108B CITY: DALLAS STATE: TX ZIP: 75244 10-K405 1 FORM 10-K FOR YEAR ENDED FEBRUARY 1, 1997 1 ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTIONS 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 (MARK ONE) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED FEBRUARY 1, 1997 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM TO 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 incorporation or organization) Identification No.) 4121 INTERNATIONAL PARKWAY 75007 CARROLLTON, TEXAS (Zip Code) (Address of principal executive offices)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (972) 307-5555 SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED ------------------- ----------------------------------------- Common Stock, $0.01 par value Nasdaq National Market
Securities Registered Pursuant to Section 12(g) of the Act: NONE Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No ----- Indicate by check mark if disclosure of delinquent filers pursuant to item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] The aggregate market value of Common Stock held by non-affiliates of the registrant on April 11, 1997 was approximately $279,829,872. All outstanding shares of voting stock, except for shares held by executive officers and members of the Board of Directors and their affiliates, are deemed to be held by non-affiliates. On April 11, 1997, the registrant had 8,598,697 shares of Common Stock outstanding. DOCUMENTS INCORPORATED BY REFERENCE Part II incorporates information by reference from the registrant's Annual Report to Shareholders for the fiscal year ended February 1, 1997, filed herewith as Exhibit 13. Part III incorporates information by reference from the definitive Proxy Statement for the 1997 Annual Meeting of Shareholders, to be filed with the Commission no later than 120 days after the end of the registrant's fiscal year covered by this Form 10-K. ================================================================================ 2 PART I ITEM 1. BUSINESS. Gadzooks, Inc. (the "Company" or "Gadzooks") is a rapidly growing specialty retailer of casual apparel and related accessories for young men and women principally between the ages of 13 and 19. The Company currently operates 196 stores in both metropolitan and middle markets in 25 states throughout the Mid- Atlantic, Midwest, Southeast and Southwest regions of the United States. The Company opened 57 new stores during fiscal 1996. In addition, the Company plans to open approximately 60 to 65 new stores in fiscal 1997, 13 of which have been opened as of April 1997. Management believes that current demographic trends provide the Company with the opportunity to continue its rapid store expansion program. According to the U.S. Census Bureau, there are approximately 25 million teenagers in the United States today and the number is expected to grow to approximately 31 million by the year 2010. Management believes that teenagers represent both a growing part of the U.S. population and an increasing source of purchasing power. The Company was incorporated in Texas in 1982, its executive offices are located at 4121 International Parkway, Carrollton, Texas 75007, and its telephone number is (972) 307-5555. BUSINESS STRATEGY The Company's goal is to become a leading retailer of brand name casual apparel and related accessories to teenagers in each of the markets it serves. The principal elements of the Company's business strategy to accomplish this goal are as follows: - Focus on the Male and Female Teenage Customer. The Company was founded on management's belief that teenagers represent a significant segment of the population that has been traditionally underserved by the retailing market. Consequently, the Gadzooks concept focuses on providing fashionable casual apparel and accessories to both male and female teenage customers. By offering merchandise for both sexes, Gadzooks believes that it serves a much broader customer base than many of its specialty store competitors and that it reduces the potential fashion risk of concentrating on one gender exclusively. Furthermore, Gadzooks believes that it attracts additional customers by creating a shopping environment where it is comfortable for both males and females to shop as couples or with friends, as well as on their own. - Multiple Merchandise Categories. A key component of the Company's merchandising strategy is to reduce its dependence on any one fashion, style, brand or item by offering products in a broad range of categories. Each Gadzooks store carries approximately 2,000 stock-keeping units or "SKUs" (excluding different sizes of the same item), including woven and knit tops, jeans, shorts, junior dresses, swimwear, t-shirts, footwear, sunglasses, watches, costume jewelry and other accessory items. The Company regularly monitors store sales by classification, SKU and size to identify emerging fashion trends, and manages the product mix in its stores to respond to the spending patterns of its customers. The Company believes that its success to date has been largely attributable to its ability to meet the changing fashion preferences of its customers. - Emphasis on Brand Name Merchandise. Another key feature of the Company's merchandising strategy is to offer a wide variety of popular brand name merchandise based on its belief that its customers shop primarily for recognized labels and designs. The Company's merchandise includes high visibility names such as Mossimo, JNCO, BC Ethic, 26 Red, Wu-Wear, Tag Rag and Lip Service and other popular fashions and brand name merchandise. The Company concentrates on merchandise that appeals to the mainstream teenager rather than relying on "cutting edge" products. The Company believes that this strategy is consistent with its philosophy of responding to its customers' fashion preferences as opposed to attempting to establish fashion trends. - Metropolitan and Middle Market Locations. A central aspect of the Company's strategy has been the development of a store concept that is successful in both metropolitan and middle markets. The 2 3 Company believes that teenagers throughout the United States frequently have similar fashion preferences as a result of the influence of television programs, MTV and music and fashion magazines. As a result, the Company has been able to operate stores successfully across a broad range of demographic and geographic markets, increasing the number of potential sites available to the Company. - Attentive Customer Service. The Company is committed to offering professional, attentive and personalized customer service. Gadzooks hires young, energetic, service-oriented sales associates who understand teenagers and can relate to their changing needs and preferences. The Company strives to give its teenage customers the same level of respect and attention that is generally given to adult customers at other retail stores. The Company trains sales associates to greet each customer personally, to inform the customer about new fashion trends and to suggest merchandise to suit the customer's wardrobe and lifestyle needs. The Company believes that the high level of service given to its teenage customers differentiates Gadzooks from its competition. - Entertaining Store Environment. The Company believes that its stores are visually appealing and provide a fun and enjoyable shopping experience for its customers. Gadzooks stores are designed to create a high energy, fun environment using neon lighting, television monitors featuring popular music videos, playful mannequins and creative, eye-catching signage. The Company's signature Volkswagen Beetle, decorated with merchandise, is a feature attraction in the stores. The Company believes that its entertaining store design encourages customers to visit the stores more frequently and to shop in the stores for longer periods of time. While Gadzooks stores are designed to appeal primarily to the teenage customer, the Company also strives to create a shopping environment that is comfortable for adults. - Investment in Systems and Personnel. The Company is committed to investing in information systems and using current technology to help execute its merchandising strategy. The Company's systems provide its buyers and merchandise planners with daily sales and inventory information by store, SKU and size, allowing Gadzooks to respond to changing customer preferences and to stock the appropriate quantities and styles of merchandise at each store. The Company is also committed to attracting and retaining highly-qualified, service-oriented management and sales associates and providing them with career advancement opportunities. The corporate culture at Gadzooks promotes the open exchange of new ideas and information between all levels of the Company thereby enabling management to supplement the data from its information systems with the practical experience of its employees. 3 4 STORE LOCATIONS The Company currently operates 196 stores in 25 states. The Company's existing stores are located in metropolitan markets such as Dallas, Atlanta, Kansas City, Chicago and Cincinnati, as well as middle markets such as Amarillo, Texas; Tupelo, Mississippi; and Roanoke, Virginia. The following store list shows the number of stores that Gadzooks operates in each state and the cities in which Gadzooks stores are located. ALABAMA-3 INDIANA-7 MARYLAND-1 OKLAHOMA-6 VIRGINIA-7 Huntsville Evansville Frederick Lawton Charlottesville Mobile Fort Wayne Norman Chesapeake Montgomery Indianapolis MINNESOTA-3 Oklahoma City(3) Harrisonburg Lafayette Minneapolis/St. Paul Tulsa Newport News ARKANSAS-5 Merrillville St. Cloud Roanoke Fayetteville Muncie SOUTH CAROLINA-6 Springfield Fort Smith Terre Haute MISSISSIPPI-3 Charleston(2) (Washington, D.C.) Jonesboro Hattiesburg Columbia(2) Virginia Beach Little Rock(2) IOWA-8 Jackson Greenville Cedar Rapids Tupelo Spartanburg WEST VIRGINIA-3 FLORIDA-4 Council Bluffs Charleston Jacksonville Davenport MISSOURI-9 TENNESSEE-10 Huntington Orlando Des Moines(3) Columbia Chattanooga Parkersburg Pensacola Dubuque Joplin Kingsport Tallahassee Sioux City Kansas City(3) Knoxville(2) WISCONSIN-8 Springfield Memphis(3) Appleton GEORGIA-6 KANSAS-6 St. Louis(3) Nashville(3) Eau Claire Athens Hays Green Bay Atlanta(4) Manhattan NEBRASKA-4 TEXAS-53 Madison(2) Macon Salina Grand Island Abilene Milwaukee(3) Topeka Lincoln Amarillo ILLINOIS-15 Wichita(2) Omaha(2) Austin(2) Bloomington Beaumont Carbondale KENTUCKY-4 NEW MEXICO-3 College Station Chicago(8) Ashland Albuquerque(2) Corpus Christi Fairview Heights Florence/Cincinnati Las Cruces Dallas/Ft. Worth(10) (St. Louis) Lexington Denton Moline Paducah NORTH CAROLINA-5 El Paso(2) Peoria Charlotte Harlingen Rockford LOUISIANA-10 Durham Houston(12) Springfield Alexandria Greensboro Killeen Baton Rouge Hickory Laredo Bossier City High Point Longview Houma Lubbock Lafayette OHIO-7 McAllen Lake Charles Cincinnati(2) Midland Monroe Cleveland(4) Odessa New Orleans(2) Dayton Port Arthur Shreveport San Angelo San Antonio(4) Sherman Temple Texarkana Tyler Victoria Waco Wichita Falls
4 5 EXPANSION STRATEGY The following table provides a history of the Company's store expansion program over the past five fiscal years.
FISCAL YEAR -------------------------------- 1992 1993 1994 1995 1996 ---- ---- ---- ---- ---- Number of stores open at beginning of period.......... 33 43 65 90 126 Number of new stores opened........................... 10 23 26 39 57 Number of stores closed............................... -- 1 1 3 -- -- -- -- --- --- Number of stores open at end of period................ 43 65 90 126 183 == == == === ===
The Company's expansion strategy is to continue to open stores in enclosed shopping malls in both metropolitan markets and middle markets primarily in the Mid-Atlantic, Midwest, Southeast and Southwest, and the Company is considering expansion into other regions. The Company opened 57 new stores during fiscal 1996. The Company expects to open approximately 60 to 65 new stores during fiscal 1997, 13 of which have been opened as of April 1997. The Company believes that the broad appeal of the Gadzooks concept enables it to operate successfully in diverse geographic and demographic markets, thereby increasing the number of potential sites available to the Company. The Company selects locations for new store openings to achieve a balance between (i) test markets where the Company has had no previous operating experience, (ii) new markets where the Company has tested a Gadzooks store and believes that the Company can successfully expand, and (iii) mature markets where the Company desires to add new stores at attractive locations as they become available. In general, the Company will open the highest number of stores in new markets where the Company's concept has recently been introduced and where the Company believes that it can capitalize on the potential of these markets. The Company typically expands from existing markets into contiguous new markets and attempts to cluster its stores within a market area in order to achieve management and operating efficiencies and to enhance its name recognition. In addition, from time to time the Company analyzes stores for potential closing. The Company has from time to time analyzed potential acquisitions of small chains of stores that serve its target customer in order to provide the Company with more rapid access to desirable locations and new markets and may consider such acquisitions again in the future. Except for a limited number of stores acquired from former franchisees, the Company has never made any such acquisitions and does not currently have any agreements for any in the future. STORE-LEVEL ECONOMICS The Company's 183 stores averaged $814,838 in net sales and produced net sales per square foot of approximately $356. Stores which were opened during all of fiscal 1996, a total of 126 stores, generated average store-level operating cash flow (defined as store operating income before depreciation and excluding changes in working capital) of approximately $158,000, or 19.5% of average net sales. In general, the Company's newer stores typically generate lower sales volumes and operating cash flow than its more mature stores. Given the Company's plan to significantly expand its store base in new geographic markets, the Company believes that its store-level averages will decline slightly in the near term. Capital expenditures, including leasehold improvements and furniture and fixtures, for the 57 new stores opened during fiscal 1996 averaged approximately $167,000 (approximately $100,000 net of all landlord allowances), and initial gross inventory requirements (which were partially financed by trade credit) averaged approximately $60,000 per store. Pre-opening costs range from $8,000 to $10,000 for travel, hiring and training, and other miscellaneous costs associated with the set-up of a new store prior to its opening for business. Inventory requirements vary at new stores depending on the season and current fashion trends. There can be no assurance that in the future, the average store-level sales and operating cash flow will not vary from historical results or that the total estimated capital expenditures for new stores will not increase. 5 6 MERCHANDISING The Company's merchandising strategy is to provide a wide range of brand name casual apparel and related accessories that reflect the fashion preferences of young men and women principally between the ages of 13 and 19. Each store typically carries an inventory of approximately 2,000 SKUs, with most merchandise selling at prices ranging between $15 and $50. The Company's merchandise includes high visibility names such as Mossimo, JNCO, BC Ethic, 26 Red, Wu-Wear, Tag Rag and Lip Service and other popular fashions and brand name merchandise. The Company concentrates on merchandise that appeals to the mainstream teenager rather than relying on "cutting edge" products. The Company believes that this strategy is consistent with its philosophy of responding to its customers' fashion preferences as opposed to attempting to establish fashion trends. The Company classifies all of its merchandise into one of five categories as follows: - - Young Men: The Company's Young Men category includes casual sportswear separates reflecting current fashion trends, such as woven and knit tops and bottoms made of denim and other fabrics. The key vendors in this category include Mossimo, JNCO, BC Ethic and Reactor. - - Juniors (Young The Company's Juniors category includes casual sportswear Women): separates designed for the fashion-current young woman, such as knit tops, woven shirts and vests, denim, dresses and swimwear. The key vendors in this category include Generation X, Lip Service, Tag Rag and Jalate. - - Accessories: The Company offers a variety of male, female and unisex accessories including sunglasses, watches, wallets, key chains, handbags, earrings, necklaces, hats and other accessories. The key vendors in this category include Oakley, Fossil, Mossimo and Zedhead. - - Unisex Apparel: The Company offers unisex apparel, consisting primarily of t-shirts with logos containing current topics and humorous designs and phrases. This category includes merchandise from various vendors as well as a small selection of Company-designed products. Periodically, the Company will supplement this category with other apparel appropriate for both sexes. - - Footwear: The Company offers male, female and unisex footwear including sandals and active footwear. The key vendors in this category include Dr. Martens, Airwalk and Vans.
The following table sets forth the Company's merchandise by category as an approximate percentage of net sales for fiscal 1996:
PERCENTAGE OF NET SALES ----------------------- Juniors (Young Women)....................................... 30% Young Men................................................... 27 Accessories................................................. 20 Unisex Apparel.............................................. 13 Footwear.................................................... 10 --- 100% ===
By offering products in multiple categories, the Company is able to shift its merchandise emphasis among and within its core categories to respond to changing customer preferences. For example, in response to increased demand for junior and young men's apparel in fiscal 1996, the Company increased its emphasis in 6 7 these merchandise categories and decreased its emphasis in the merchandise categories that the Company identified as having decreased demand. The Company expects to continue to adjust its emphasis on particular categories in response to fashion trends and, therefore, its merchandise mix may vary slightly at different times. In an effort to keep the stores fresh and exciting, the Company's merchandising staff provides specific floor sets and merchandising ideas to the stores and regularly instructs district and store managers on the creative display of merchandise. The merchandise presentation in the stores is significantly changed three times each year to highlight specific merchandise for each of the Company's three peak selling seasons and to maintain a current look. In addition, the Company maintains a constant flow of new merchandise to the stores in order to meet changing fashion preferences. To reduce the risk associated with the introduction of new products, the Company frequently tests products in selected stores before determining if it will purchase the product for a broader group of stores. PURCHASING The Company's purchasing staff consists of a General Merchandising Manager, five buyers, four associate buyers and five assistants. The General Merchandising Manager and the buyers analyze current fashion directions by visiting major fashion markets and maintaining close relationships with the Company's vendors in order to identify styles and trends. In addition, the Company's buyers regularly attend concerts and other events attended by teenagers. The General Merchandising Manager and the buyers constantly monitor merchandise flow through the stores and strive to maintain the appropriate merchandise mix to meet customer demand. Several of the buyers were formerly district managers or store managers of the Company and are familiar with the Company's customers and their merchandise preferences. Due to changes in fashion trends and seasonality, the Company purchases merchandise from numerous vendors throughout the year. During fiscal 1996, the Company did business with approximately 990 vendors. Of those vendors, Mossimo, Inc. accounted for approximately 6% of the Company's merchandise purchases, and no other single vendor accounted for more than 5% of merchandise purchases. Certain of the Company's vendors have limited financial resources and production capabilities. The Company believes that its relationships with its vendors are good. ALLOCATION AND DISTRIBUTION OF MERCHANDISE The Company continually strives to improve its merchandising, distribution, planning and allocation methods to manage its inventory more efficiently. The Company's Director of Planning and Allocation and the six personnel in the planning and allocation department work closely with merchandise buyers and store personnel to meet the requirements of individual stores for appropriate merchandise in sufficient quantities. The Company divides its stores into different categories based on, among other things, geographic location, demographics and sales volume. Product allocation and distribution are based in part on an analysis of the stores by category. Information from the Company's point-of-sale computer system is regularly reviewed and analyzed to assist in making merchandise allocation and markdown decisions. In May 1997, the Company will relocate its headquarters to a larger site, in the Dallas metropolitan area, which will include a distribution facility of approximately 110,000 square feet. Merchandise will be delivered by the vendors to this facility, where it will be inspected, entered into the Company's computer system, allocated to stores, ticketed (to the extent that it was not pre-ticketed by the vendor) and boxed for distribution to the Company's stores. Currently, merchandise is typically shipped to stores daily via United Parcel Service, providing Gadzooks stores with a steady flow of new merchandise. For key products, the Company maintains a backstock at its distribution center that is allocated and distributed to the stores through an automatic replenishment program. STORE OPERATIONS Gadzooks stores are open seven days a week during normal mall hours. The Company's store operations are managed by a Vice President of Store Operations, four regional managers and 26 district managers who 7 8 generally have responsibility for 8 to 10 stores within a geographic district. Individual stores are managed by a store manager and two assistant store managers. A typical store has three full time and 6 to 12 part time sales associates, depending on the season. Gadzooks compensates its district and store managers with a base salary, a performance bonus based on store sales, expense control and loss prevention, and, in the case of district managers, stock options. Sales associates are compensated on an hourly basis. The Company believes that its continued success is dependent in part on its ability to attract, retain and motivate quality employees. In particular, the success of the Company's expansion program will be dependent on its ability to promote and/or recruit qualified district and store managers. To date, the vast majority of the Company's district managers were previously Gadzooks store managers. The Company has recently established a training program for future district managers. In addition, store managers, many of whom are selected from among the Company's sales associates, currently complete a two-week training program either at the Company's headquarters or a designated training store before taking responsibility for a store. The hiring and training of new sales associates are the responsibility of store managers, and the Company has established training and operations manuals to assist them in this process. The Company is developing enhanced training programs for its store managers, assistant managers and sales associates. Management considers its employees' knowledge of the Company's customers and merchandise to be significant to its marketing approach and customer satisfaction. While all Gadzooks store employees are responsible for the general appearance of the store, restocking of shelves and merchandise presentation, the Company's major emphasis in training its store employees is to give priority to customer service and assistance. Sales associates regularly act as greeters, meeting customers as they enter the store, handing out promotional materials and offering assistance. The Company trains its sales associates to inform the customer about new fashion trends and to suggest merchandise that suits the customer's wardrobe and lifestyle needs. The Company monitors the customer service level at each store through various programs, including its "I Spy" program of unannounced visits to the stores by shoppers who are unknown by the store employees and by regularly reviewing and responding to comment cards received from its customers. STORE ENVIRONMENT The Company believes that its stores are visually appealing and provide a fun and enjoyable shopping experience for its customers. Gadzooks stores are designed to create a high energy, fun environment using neon lighting, television monitors featuring popular music videos, playful mannequins and creative, eye-catching signage. Store entrances are typically decorated with a brightly colored checkerboard floor, and a Volkswagen Beetle, decorated with merchandise, is a feature attraction in the stores. The Company displays a significant amount of merchandise on the walls of the store, with male merchandise along one side, female merchandise along the other and t-shirts along part of the back wall. In the center of the store, lower fixtures are used to display merchandise in order to maintain an open feeling. Stores typically feature large windows along the mall which provide an open view of the entire store to mall traffic and are merchandised to draw customers into the store. While Gadzooks stores are designed to appeal primarily to the teenage customer, the Company also strives to create a shopping environment that is comfortable for adults. SITE SELECTION Based on its results to date in both metropolitan and middle markets, the Company believes that it can operate successfully in markets with a broad range of geographic and demographic profiles. The Company takes into account certain demographic factors such as population density, concentration of teenagers, income levels, lifestyle characteristics and the performance of other retailers to identify attractive new markets, evaluate specific shopping malls and project individual store sales volumes. All new store locations are approved by the Board of Directors. Within each shopping mall, the Company typically seeks a highly visible location and often locates its stores near major fashion-oriented department stores, food courts and other specialty stores catering to teenage customers. The Company's existing stores average approximately 2,300 square feet. The Company typically seeks a location of approximately 2,000 to 2,500 square feet with significant store frontage. However, the 8 9 Company's flexible store design enables it to take advantage of well-situated sites with more unique layouts. Once a site is approved, the Company, with the assistance of an outside architect, designs the store to meet the specific site characteristics. The Company's construction department seeks competitive bids from outside contractors for the build-out of each store and oversees the construction process. The Company typically requires six to eight weeks to open a new store after the beginning of build-out. MANAGEMENT INFORMATION SYSTEMS Each Gadzooks store is linked to the Company's headquarters through a point-of-sale system that interfaces with an IBM RS6000 computer equipped with an integrated merchandising, distribution and accounting software package. The Company's point-of-sale computer system has several features, including merchandise scanning, "price look-up," the ability to compile preferred customer lists and on-line credit card approval. These features improve transaction accuracy, speed and checkout time, increase overall store efficiency, and enable the Company to track the productivity of individual sales associates. The Company's management information and control systems enable the Company's corporate headquarters to promptly identify sales trends, replenish depleted store inventories, reprice merchandise and monitor merchandise mix and inventory shrinkage at individual stores and throughout the Company's store network. Management believes that these systems provide a number of benefits, including improved store inventory management, better in-stock availability, higher operating efficiency and fewer markdowns. The Company's merchandising, distribution and accounting software system was installed in late 1993, and the point-of-sale software system was installed during the second quarter of fiscal 1995. The Company estimates that its current management information and control systems are adequate to support the Company's planned expansion, but may upgrade and enhance its computer systems for certain distribution functions in the last half of fiscal 1997. ADVERTISING AND PROMOTION The Company relies primarily on the enthusiasm of its sales associates and existing customers, highly visible store locations and eye-catching signage to attract new customers to the stores. The Company has generally found this approach to be more cost effective than more traditional media advertising. The Company plans the opening of new stores to coincide with peak shopping seasons and mall grand openings when customer traffic is greater. The Company also uses promotions to generate repeat visits to its stores, such as a "preferred customer program" that entitles high volume customers to attend private sale events held twice each year. The Company advertises to a limited extent in national magazines, such as Seventeen and YM in cooperation with certain of its vendors. The Company also benefits from advertising by its vendors, especially where Gadzooks is listed as a retailer of their products. TRADEMARKS The Company has registered on the Principal Register of the United States Patent and Trademark Office its mark "Gadzooks" and the distinctive design of its service mark and has currently pending registration for "Gaditude" and "Cool Stuff for Teens." Each federal registration is renewable indefinitely if the mark is in use at the time of the renewal. The Company is not aware of any claims of infringement or other challenges to the Company's right to use its marks in the United States. COMPETITION The teenage retail apparel and accessories industry is highly competitive. The Company competes with other retailers for customers, suitable retail locations and qualified management personnel. Gadzooks currently competes with traditional department stores such as Foley's and Dillard's, with national specialty chains such as The Gap and certain divisions of The Limited, with numerous regional chains such as The Buckle, Wet Seal and Pacific Sunwear, with smaller chains and local specialty stores and, to a lesser extent, with mass merchandisers. Many of the Company's competitors are larger and have substantially greater 9 10 financial, marketing and other resources than the Company. The principal factors of competition in the Company's business are fashion, merchandise selection, customer service, store location and price. EMPLOYEES At April 11, 1997, the Company had 775 full-time employees and 1,605 part-time employees. Of the Company's 2,380 employees, 122 were corporate personnel, 62 were distribution center employees and 2,196 were store employees. The number of part-time employees fluctuates with seasonal needs. None of the Company's employees is covered by a collective bargaining agreement. The Company seeks to create a casual and supportive working environment and considers its employee relations to be excellent. 10 11 RISK FACTORS This Report contains certain forward looking statements about the business, operations and financial condition of the Company. The actual results of the Company could differ materially from those forward looking statements. The following information sets forth certain factors that could cause the actual results of the Company to differ materially from those contained in the forward looking statements. AGGRESSIVE GROWTH STRATEGY; FUTURE OPERATING RESULTS The Company's net sales and net income have grown significantly during the past several years, primarily as a result of the opening of new stores and, to a lesser extent, increases in comparable store sales. The Company intends to continue to pursue an aggressive growth strategy for the foreseeable future, and its future operating results will depend largely upon its ability to open and operate new stores successfully and to manage a larger business profitably. The Company anticipates opening approximately 60 to 65 new stores during fiscal 1997, which will result in a significant increase in the number of stores operated by the Company. The Company also plans to enter several new markets in various regions of the United States. Expansion into new markets may present competitive and merchandising challenges that are different from those currently encountered by the Company in its existing markets. As an additional part of its growth strategy, the Company has occasionally analyzed the acquisition of other retailers that serve the Company's target customer and may consider such acquisitions again in the future. Except for a limited number of stores acquired from former franchisees, the Company has never made any such acquisitions and does not currently have any agreements for any in the future. There can be no assurance that the operations of any acquired entities could be successfully integrated with the Company's existing operations or that the combined business would be profitable. The Company is subject to a variety of business risks generally associated with rapidly growing companies. The Company's ability to open new stores will depend upon many factors, including, among others, the ability to identify and enter new markets, locate suitable store sites, negotiate acceptable lease terms, hire and train store managers and sales associates and obtain adequate capital resources on acceptable terms. There can be no assurance that the Company will be able to integrate successfully new stores into its operations or that new stores will achieve sales and profitability levels comparable to the Company's existing stores. In addition, there can be no assurance that the Company's expansion within its existing markets will not adversely affect the individual financial performance of the Company's existing stores or its overall results of operations. Furthermore, the Company will need to continually evaluate the adequacy of its store management and management information and distribution systems to manage its planned expansion. There can be no assurance that the Company will anticipate all of the changing demands that its expanding operations will impose on such systems and facilities, and the failure to adapt its systems, facilities and procedures could have a material adverse effect on the Company's business. There can be no assurance that the Company will successfully achieve its planned expansion or, if achieved, that the expansion will result in profitable operations. See "Business -- Store Locations" and "-- Expansion Strategy." The Company anticipates that it will spend approximately $7.0 million for capital expenditures and approximately $4.0 million for initial inventories to open approximately 60 to 65 new stores and to remodel 6 to 7 existing stores in fiscal 1997. The actual costs that the Company will incur in connection with opening new stores cannot be predicted with precision because such costs will vary based upon, among other things, geographic location, the size of the store and the extent of the build-out required at the selected site. The Company believes that its existing cash balances, cash generated from operations, net proceeds received by the Company from its public offerings and funds available under the Company's revolving line of credit will be sufficient to fund its expansion requirements through at least 1997. There can be no assurance that the Company may not be required to seek additional sources of funds for such expansion. FLUCTUATIONS IN COMPARABLE STORE SALES RESULTS A variety of factors affect the Company's comparable store sales results including, among others, economic conditions, fashion trends, the retail sales environment, sourcing and distribution of products and the 11 12 Company's ability to execute its business strategy efficiently. The Company's quarterly comparable store sales results have fluctuated significantly in the past. The Company's comparable store sales results were 24.2%, 10.5%, 10.9% and 15.6% in the first, second, third and fourth quarters of fiscal 1995, respectively, and 7.3%, 8.6%, 5.9% and 3.9% in the first, second, third and fourth quarters of fiscal 1996, respectively. The Company has recorded comparable store sales decreases in past quarters, and there can be no assurance that comparable store sales for any particular quarter or fiscal year will not decrease in the future. The Company's comparable store sales results could cause the price of the Common Stock to fluctuate substantially. CHANGES IN FASHION TRENDS The Company's profitability is largely dependent upon its ability to anticipate the fashion tastes of its customers and to provide merchandise that appeals to their preferences in a timely manner. The fashion tastes of the Company's customers may change frequently, and the Company's failure to anticipate, identify or react appropriately to changes in styles, trends or brand preferences could lead to, among other things, excess inventories and higher markdowns, which could have a material adverse effect on the Company's business. In addition, fashion misjudgments could materially and adversely affect the Company's operating results, comparable store sales results and image with its customers. See "Business -- Merchandising." IMPACT OF ECONOMIC CONDITIONS Certain economic conditions affect the level of consumer spending on merchandise offered by the Company, including, among others, business conditions, interest rates, taxation and consumer confidence in future economic conditions. If the demand for apparel and related merchandise by teenagers were to decline, the Company's business, comparable store sales results and results of operations would be materially and adversely affected. Although the Company advertises in national magazines to a limited extent through cooperative agreements with certain of its vendors, its stores rely principally on mall traffic for customers. Therefore, the Company is dependent upon the continued popularity of malls as a shopping destination and the ability of mall anchor tenants and other attractions to generate customer traffic for its stores. A decrease in mall traffic or a decline in economic conditions in the markets in which the Company's stores are located would adversely affect the Company's growth, net sales, comparable store sales results and profitability. See "Business." QUARTERLY RESULTS AND SEASONALITY The Company's quarterly results of operations may fluctuate materially depending on, among other things, the timing of new store openings and related pre-opening expenses, net sales contributed by new stores, increases or decreases in comparable store sales, shifts in timing of certain holidays and changes in the Company's merchandise mix. The Company's business is also subject to seasonal influences, with heavier concentrations of sales during the Christmas holiday, back-to-school and spring break seasons. As is the case with many apparel retailers, the Company's net sales and net income are typically lower in the first quarter. The Company has experienced first quarter losses in the past and may experience such losses in the future. Because of these fluctuations in net sales and net income, the results of operations of any quarter are not necessarily indicative of the results that may be achieved for a full fiscal year or any future quarter. DEPENDENCE ON KEY VENDORS The Company's business depends on its ability to purchase current season, brand name apparel in sufficient quantities at competitive prices. During the Company's 1996 fiscal year, Mossimo, Inc. accounted for approximately 6% of the Company's merchandise purchases. Of the Company's other vendors, no single vendor accounted for more than 5% of the Company's merchandise purchases. The inability or failure of key vendors to supply the Company with adequate quantities of desired merchandise, the loss of one or more key vendors or a material change in the Company's current purchase terms could have a material adverse effect on the Company's business. Many of the Company's smaller vendors have limited resources, production capacities and operating histories, and many have limited the distribution of their merchandise in the past. The Company has no long-term purchase contracts or other contractual assurances of continued supply, 12 13 pricing or access to new products. There can be no assurance that the Company will be able to acquire desired merchandise in sufficient quantities on terms acceptable to the Company in the future. See "Business -- Merchandising" and "-- Purchasing." DEPENDENCE ON KEY PERSONNEL The Company's success will depend largely on the efforts and abilities of senior management, particularly Gerald R. Szczepanski, the Chairman of the Board and Chief Executive Officer and a founder of the Company. The loss of his services or the services of other members of senior management could have a material adverse effect on the Company's business. The Company has a $1,000,000 key-man life insurance policy on Mr. Szczepanski. There can be no assurance that the Company's existing management team will be able to manage the Company or its growth or that the Company will be able to attract and retain additional qualified personnel as needed in the future. COMPETITION The Company operates in a highly competitive environment. The Company currently competes with traditional retail department stores such as Foley's and Dillard's, with national specialty chains such as The Gap and certain divisions of The Limited, with numerous regional chains such as The Buckle, Wet Seal and Pacific Sunwear, with smaller chains and local specialty stores and, to a lesser extent, with mass merchandisers. Many of these competitors are larger and have substantially greater resources than the Company. Direct competition with these and other retailers may increase significantly in the future, which could require the Company, among other things, to lower its prices and/or increase its advertising expenses. Increased competition could have a material adverse effect on the Company's operations and comparable store sales results. See "Business -- Competition." STOCK PRICE VOLATILITY The market price of the Company's Common Stock has risen substantially since the Company's initial public offering in October 1995. The Company's Common Stock is quoted on the Nasdaq National Market, which has experienced and is likely to experience in the future significant price and volume fluctuations which could adversely affect the market price of the Common Stock without regard to the operating performance of the Company. In addition, the Company believes that factors such as quarterly fluctuations in the financial results of the Company, the Company's comparable store sales results, announcements by other apparel retailers, the overall economy and the condition of the financial markets could cause the price of the Common Stock to fluctuate substantially. ANTI-TAKEOVER MATTERS The Company's Restated Articles and its Bylaws contain provisions that may have the effect of delaying, deterring or preventing a takeover of the Company that shareholders may consider to be in their best interests. The Company's Restated Articles and Bylaws provide for a classified Board of Directors serving staggered terms of three years, the prohibition of shareholder action by written consent in certain circumstances and certain "fair price provisions." Additionally, the Board of Directors has the authority to issue up to 1,000,000 shares of preferred stock having such rights, preferences and privileges as designated by the Board of Directors without shareholder approval. ITEM 2. PROPERTIES. All of the existing stores are leased by the Company, with lease terms (excluding renewal option periods exercisable by the Company at escalating rents) expiring between February 1997 and February 2007. The leases for most of the existing stores are for terms of 10 years and provide for contingent rent based upon a percent of sales in excess of specified minimums. In May 1997, the Company will relocate its office and distribution center to a larger site in the Dallas metropolitan area in order to accommodate its expanding operations. The Company's new office and 13 14 distribution center will be located in Carrollton, Texas and will be occupied under a lease covering approximately 150,000 square feet, which is scheduled to expire on May 1, 2007. ITEM 3. LEGAL PROCEEDINGS. In the ordinary course of its business, the Company is periodically a party to lawsuits. The Company believes that any resulting liability from existing legal proceedings, individually or in the aggregate, will not have a material adverse effect on its operations or financial condition. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. No matters were submitted to a vote of the Company's shareholders during the fourth quarter of the fiscal year covered by this report. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. The Common Stock is traded on the Nasdaq National Market under the symbol "GADZ." The Company consummated its initial public offering in October 1995 at a price of $14.00 per share ($9.33, as adjusted to give effect to the stock split described below). The following table sets forth, for the Company's fiscal periods indicated and is adjusted to give retroactive effect to the Company's three-for-two Common Stock split paid on May 30, 1996, the high and low sale prices per share for the Common Stock, as reported on the Nasdaq National Market.
HIGH LOW ---- ----- 1995 - ---------------------------------------- Third Quarter (from October 5, 1995).... $14 $ 9 1/3 Fourth Quarter.......................... 18 5/6 11 1/3 1996 - ---------------------------------------- First Quarter........................... 30 5/8 15 13/16 Second Quarter.......................... 41 23 1/4 Third Quarter........................... 39 3/4 22 Fourth Quarter.......................... 34 1/4 17 1/2
On April 11, 1997, the last sale price of the Common Stock as reported on the Nasdaq National Market was $33.25 per share. As of April 11, 1997, there were approximately 60 holders of record of the Common Stock, although the Company believes the number of beneficial holders is substantially greater. The Company intends to retain its earnings, if any, to finance the growth and development of its business and does not anticipate paying cash dividends on its Common Stock in the foreseeable future. The payment of any future dividends will be at the discretion of the Company's Board of Directors and will depend upon, among other things, the future earnings, operations, capital requirements and financial condition of the Company. In addition, the Company's current revolving line of credit ("Revolving Line") contains various financial covenants, including covenants relating to net worth, which may have the effect of restricting the Company's ability to pay dividends. ITEM 6. SELECTED FINANCIAL DATA. The selected financial and operating data in response to Item 6 is contained in the section entitled "Selected Financial Data," located on page 15 of the registrant's 1996 Annual Report to Shareholders, filed as Exhibit 13 to this Report. Such Exhibit is incorporated herein by reference. 14 15 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. The information in response to item 7 is contained in the section entitled "Management's Discussion and Analysis of Financial Condition and Results of Operations," located on pages 16 to 19 of the registrant's 1996 Annual Report to Shareholders, filed as Exhibit 13 to this Report. Such Exhibit is incorporated herein by reference. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. The registrant's exposures to market risk associated with activities in derivative financial instruments, other financial instruments, and derivative commodity instruments are not material with respect to its operations or financial condition. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. The information in response to item 8 is contained in the registrant's 1996 Annual Report to Shareholders, filed as Exhibit 13 to this Report. Such Exhibit is incorporated herein by reference. A cross-reference for location of the requested information is below.
PAGE NUMBER(S) IN FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA ANNUAL REPORT* ------------------------------------------- ----------------- Unaudited Quarterly Financial Data.......................... 18 Balance Sheets at February 1, 1997 and January 27, 1996..... 20 Statements of Income for the Years Ended February 1, 1997, January 27, 1996 and January 28, 1995..................... 21 Statements of Stockholders' Equity for the Years Ended February 1, 1997, January 27, 1996 and January 28, 1995... 22 Statements of Cash Flows for the Years Ended February 1, 1997, January 27, 1996 and January 28, 1995............... 23 Notes to Financial Statements............................... 24-30 Report of Independent Accountants........................... 31
- --------------- * The indicated pages of the Company's 1996 Annual Report to Shareholders are filed as Exhibit 13 to this Report. Such Exhibit is incorporated herein by reference. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. None. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. Information with respect to this item is incorporated by reference from the registrant's definitive Proxy Statement to be filed with the Commission not later than 120 days after the end of the registrant's fiscal year. ITEM 11. EXECUTIVE COMPENSATION. Information with respect to this item is incorporated by reference from the registrant's definitive Proxy Statement to be filed with the Commission not later than 120 days after the end of the registrant's fiscal year. 15 16 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. Information with respect to this item is incorporated by reference from the registrant's definitive Proxy Statement to be filed with the Commission not later than 120 days after the end of the registrant's fiscal year. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. Information with respect to this item is incorporated by reference from the registrant's definitive Proxy Statement to be filed with the Commission not later than 120 days after the end of the registrant's fiscal year. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) 1. The financial statements as cross-referenced in Item 8 of this Report, together with the report thereon of Price Waterhouse LLP dated March 12, 1997, appearing in the accompanying 1996 Annual Report to Shareholders are incorporated by referenced in this Report. With the exception of the aforementioned information and information incorporated in Items 6 and 7, the 1996 Annual Report to Shareholders is not deemed filed as part of this Report. 2. Financial statement schedules are omitted because they are not applicable or the required information is shown in the financial statements or notes thereto. 3. Exhibits included or incorporated herein: See Exhibit Index. (b) Reports on Form 8-K There were no reports on Form 8-K filed during the last quarter of the fiscal year covered by this report. 16 17 Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on April 22, 1997 on its behalf by the undersigned, thereunto duly authorized. GADZOOKS, INC. By /s/ GERALD R. SZCZEPANSKI ----------------------------------- Gerald R. Szczepanski Chairman of the Board, President and Chief Executive Officer Each person whose signature appears below hereby authorizes Gerald R. Szczepanski and Monty R. Standifer or either of them, as attorneys-in-fact to sign on his behalf, individually, and in each capacity stated below and to file all amendments and/or supplements to the Annual Report on Form 10-K. Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE --------- ----- ---- /s/ GERALD R. SZCZEPANSKI Chairman of the Board, President April 22, 1997 - ----------------------------------------------------- and Chief Executive Officer Gerald R. Szczepanski (Principal Executive Officer) /s/ MONTY R. STANDIFER Senior Vice President, Chief April 22, 1997 - ----------------------------------------------------- Financial Officer, Treasurer Monty R. Standifer and Secretary (Principal Financial and Accounting Officer) /s/ ALAN W. CRITES Director April 22, 1997 - ----------------------------------------------------- Alan W. Crites /s/ G. MICHAEL MACHENS Director April 22, 1997 - ----------------------------------------------------- G. Michael Machens /s/ ROBERT E.M. NOURSE Director April 22, 1997 - ----------------------------------------------------- Robert E.M. Nourse /s/ LAWRENCE H. TITUS, JR. Director April 21, 1997 - ----------------------------------------------------- Lawrence H. Titus, Jr.
18 INDEX TO EXHIBITS
EXHIBIT NO. DESCRIPTION OF DOCUMENTS PAGE ------- ------------------------ ---- 3.1 -- Second 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). 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). 10.1 -- Purchase Agreement dated as of January 31, 1992 among the Company, Gerald R. Szczepanski, Lawrence H. Titus, Jr. and the Investors listed therein (filed as Exhibit 10.1 to the Company's Form S-1 (No. 33-95090) filed with the Commission on July 28, 1995 and incorporated herein by reference). 10.2 -- Purchase Agreement dated as of May 26, 1994 among the Company, Gerald R. Szczepanski, Lawrence H. Titus, Jr. and the Investors listed therein (filed as Exhibit 10.2 to the Company's Form S-1 (No. 33-95090) filed with the Commission on July 28, 1995 and incorporated herein by reference). *10.3 -- Credit Agreement dated as of January 30, 1997 between the Company and Wells Fargo Bank (Texas), National Association. 10.4 -- Form of Indemnification Agreement with a schedule of director signatories (filed as Exhibit 10.5 to the Company's Form S-1 (No. 33-95090) filed with the Commission on July 28, 1995 and incorporated herein by reference). 10.5 -- Employment Agreement dated January 31, 1992 between the Company and Gerald R. Szczepanski, as continued by letter agreement (filed as Exhibit 10.6 to the Company's Form S-1 (No. 33-95090) filed with the Commission on July 28, 1995 and incorporated herein by reference). 10.6 -- 1992 Incentive and Nonstatutory Stock Option Plan dated February 26, 1992, and Amendments No. 1 through 3 thereto (filed as Exhibit 10.8 to the Company's Form S-1 (No. 33-95090) filed with the Commission on July 28, 1995 and incorporated herein by reference). 10.7 -- 1994 Incentive and Nonstatutory Stock Option Plan for Key Employees dated September 30, 1994 (filed as Exhibit 10.9 to the Company's Form S-1 (No. 33-95090) filed with the Commission on July 28, 1995 and incorporated herein by reference). 10.8 -- 1995 Non-Employee Director Stock Option Plan (filed as Exhibit 10.10 to the Company's Form S-1 (No. 333-00196) filed with the Commission on January 9, 1996 and incorporated herein by reference). 10.9 -- Gadzooks, Inc. Employees' Savings Plan (filed as Exhibit 10.11 to the Company's Form S-1 (No. 33-95090) filed with the Commission on July 28, 1995 and incorporated herein by reference). *10.10 -- Severance Agreement dated September 5, 1996 between the Company and Gerald R. Szczepanski.
19
EXHIBIT NO. DESCRIPTION OF DOCUMENTS PAGE ------- ------------------------ ---- *10.11 -- Form of Severance Agreement with a schedule of executive officer signatories. 10.12 -- Amendment No. 4 to the Gadzooks, Inc. 1992 Incentive and Nonstatutory Stock Option Plan (filed as Exhibit 10.14 to the Company's Amendment No. 3 to Form S-1 (No. 33-95090) filed with the Commission on September 27, 1995 and incorporated herein by reference). *10.13 -- Amendment No. 5 to the Gadzooks, Inc. 1992 Incentive and Nonstatutory Stock Option Plan dated September 12, 1996. *10.14 -- Amendment No. 1 to the 1994 Incentive and Nonstatutory Stock Option Plan for Key Employees dated September 12, 1996. *13 -- Pages 15-31 of the Company's 1996 Annual Report to Shareholders. *23.1 -- Consent of Price Waterhouse LLP. 24 -- Power of Attorney (included on signature page of this report). *27 -- Financial Data Schedule
- --------------- * Filed herewith (unless otherwise indicated exhibits are previously filed). EX-10.3 2 CREDIT AGREEMENT 1 CREDIT AGREEMENT Exhibit 10.3 THIS AGREEMENT is entered into as of January 30, 1997, by and between GADZOOKS, INC., a Texas corporation ("Borrower"), and WELLS FARGO BANK (TEXAS), NATIONAL ASSOCIATION ("Bank"). RECITAL Borrower has requested from Bank the credit accommodation described below, and Bank has agreed to provide said credit accommodation to Borrower on the terms and conditions contained herein. NOW, THEREFORE, for valuable consideration, the receipt and sufficiency of which are hereby acknowledged, Bank and Borrower hereby agree as follows: ARTICLE I THE CREDIT SECTION 1.1. LINE OF CREDIT. (a) Line of Credit. Subject to the terms and conditions of this Agreement, Bank hereby agrees to make advances to Borrower from time to time up to and including June 5, 1998, not to exceed at any time the aggregate principal amount of Ten Million Dollars ($10,000,000.00) ("Line of Credit"), the proceeds of which shall be used to finance Borrower's working capital, general corporate purposes and expansion plans. Borrower's obligation to repay advances under the Line of Credit shall be evidenced by a promissory note substantially in the form of Exhibit A attached hereto ("Line of Credit Note"), all terms of which are incorporated herein by this reference. (b) Limitation on Borrowings. Outstanding borrowings under the Line of Credit, to a maximum of the principal amount set forth above, shall not at any time exceed the product of Annual Traditional Cash Flow multiplied by 1.25. As used in this Agreement, the term "Annual Traditional Cash Flow" will mean, as of any date of determination for the twelve months ended on such date, the sum of the Company's net income, plus depreciation and amortization (each determined in accordance with GAAP), minus any cash gains resulting for the sale of assets of the Company outside of the normal course of the Company's business, minus all non-cash gains. (c) Letter of Credit Subfeature. As a subfeature under the Line of Credit, Bank agrees from time to time during the term thereof to issue multiple letters of credit for the account of Borrower (each, a "Letter of Credit" and collectively, "Letters of Credit"); provided however, that the form and substance of each Letter of Credit shall be subject to approval by Bank, in its sole discretion; and provided further, that the aggregate 2 undrawn amount of all outstanding Letters of Credit shall not at any time exceed Ten Million Dollars ($10,000,000.00). Each Letter of Credit shall be issued for a term not to exceed one hundred eighty (180)days, as designated by Borrower; provided however, that no Letter of Credit shall have an expiration date subsequent to May 2, 1998. The undrawn amount of all Letters of Credit shall be reserved under the Line of Credit and shall not be available for borrowings thereunder. Each Letter of Credit shall be subject to the additional terms and conditions of the Letter of Credit Agreement and related documents, if any, required by Bank in connection with the issuance thereof (each, a "Letter of Credit Agreement" and collectively, "Letter of Credit Agreements"). Each draft paid by Bank under a Letter of Credit shall be deemed an advance under the Line of Credit and shall be repaid by Borrower in accordance with the terms and conditions of this Agreement applicable to such advances; provided however, that if advances under the Line of Credit are not available, for any reason, at the time any draft is paid by Bank, then Borrower shall immediately pay to Bank the full amount of such draft, together with interest thereon from the date such amount is paid by Bank to the date such amount is fully repaid by Borrower, at the rate of interest applicable to advances under the Line of Credit. In such event Borrower agrees that Bank, in its sole discretion, may debit any demand deposit account maintained by Borrower with Bank for the amount of any such draft. (d) Borrowing and Repayment. Borrower may from time to time during the term of the Line of Credit borrow, partially or wholly repay its outstanding borrowings, and reborrow, subject to all of the limitations, terms and conditions contained herein or in the Line of Credit Note; provided however, that the total outstanding borrowings under the Line of Credit shall not at any time exceed the maximum principal amount available thereunder, as set forth above. SECTION 1.2. INTEREST/FEES. (a) Interest. The outstanding principal balance of the Line Of Credit shall bear interest at the rate of interest set forth in the Line of Credit Note. (b) Computation and Payment. Interest shall be computed on the basis of a 360-day year, actual days elapsed, unless such calculation would result in a usurious rate, in which case interest shall be computed on the basis of a 365/366-day year, as the case may be, actual days elapsed. Interest shall be payable at the times and place set forth in the Line of Credit Note. (c) Loan Origination Fee. Borrower shall pay to Bank a non-refundable loan origination fee for the Line of Credit equal to Fifteen Thousand Dollars ($15,000.00), which fee shall be due and payable in full on March 15, 1997. -2- 3 (d) Unused Commitment Fee. Borrower shall pay to Bank a fee equal to one-half percent (.50%) per annum (computed on the basis of a 360-day year, actual days elapsed) on the average daily unused amount of the Line of Credit, which fee shall be calculated on a calendar quarter basis by Bank and shall be due and payable by Borrower in arrears on the fifth day of each calendar quarter. (e) Letter of Credit Fees. Borrower shall pay to Bank fees upon the issuance of each Letter of Credit, upon the payment or negotiation by Bank of each draft under any Letter of Credit and upon the occurrence of any other activity with respect to any Letter of Credit (including without limitation, the transfer, amendment or cancellation of any Letter of Credit) determined in accordance with Bank's standard fees and charges then in effect for such activity. SECTION 1.3. COLLECTION OF PAYMENTS. Borrower authorizes Bank to collect all interest and fees due under the Line of Credit by charging Borrower's demand deposit account number ____________ with Bank, or any other demand deposit account maintained by Borrower with Bank, for the full amount thereof. Should there be insufficient funds in any such demand deposit account to pay all such sums when due, the full amount of such deficiency shall be immediately due and payable by Borrower. ARTICLE II REPRESENTATIONS AND WARRANTIES Borrower makes the following representations and warranties to Bank, which representations and warranties shall survive the execution of this Agreement and shall continue in full force and effect until the full and final payment, and satisfaction and discharge, of all obligations of Borrower to Bank subject to this Agreement. SECTION 2.1. LEGAL STATUS. Borrower is a corporation, duly organized and existing and in good standing under the laws of the State of Texas, and is qualified or licensed to do business (and is in good standing as a foreign corporation, if applicable) in all jurisdictions in which the failure to so qualify or to be so licensed could have a material adverse effect on Borrower. SECTION 2.2. AUTHORIZATION AND VALIDITY. This Agreement, the Line of Credit Note, and each other document, contract and instrument required hereby or at any time hereafter delivered to Bank in connection herewith (collectively, the "Loan Documents") have been duly authorized, and upon their execution and delivery in accordance with the provisions hereof will constitute legal, valid and binding agreements and obligations of Borrower or the -3- 4 party which executes the same, enforceable in accordance with their respective terms. SECTION 2.3. NO VIOLATION. The execution, delivery and performance by Borrower of each of the Loan Documents do not violate any provision of any law or regulation, or contravene any provision of the Articles of Incorporation or By-Laws of Borrower, or result in any breach of or default under any material contract, obligation, indenture or other instrument to which Borrower is a party or by which Borrower may be bound. SECTION 2.4. LITIGATION. There are no pending, or to the best of Borrower's knowledge threatened, actions, claims, investigations, suits or proceedings by or before any governmental authority, arbitrator, court or administrative agency which could reasonably be expected to have a material adverse effect on the financial condition or operation of Borrower other than those disclosed by Borrower to Bank in writing prior to the date hereof. SECTION 2.5. CORRECTNESS OF FINANCIAL STATEMENT. The financial statement of Borrower dated September 28, 1996, a true copy of which has been delivered by Borrower to Bank prior to the date hereof, (a) presents fairly the financial condition of Borrower, (b) discloses all liabilities of Borrower that are required to be reflected or reserved against under generally accepted accounting principles, whether liquidated or unliquidated, fixed or contingent, and (c) has been prepared in accordance with generally accepted accounting principles consistently applied. Since the date of such financial statement there has been no material adverse change in the financial condition of Borrower, nor has Borrower mortgaged, pledged, granted a security interest in or otherwise encumbered any of its assets or properties except in favor of Bank or as otherwise permitted by Bank in writing. SECTION 2.6. INCOME TAX RETURNS. Borrower has no knowledge of any pending assessments or adjustments of its income tax payable with respect to any year. SECTION 2.7. NO SUBORDINATION. There is no agreement, indenture, contract or instrument to which Borrower is a party or by which Borrower may be bound that requires the subordination in right of payment of any of Borrower's obligations subject to this Agreement to any other obligation of Borrower. SECTION 2.8. PERMITS, FRANCHISES. Borrower possesses, and will hereafter possess, all material permits, consents, approvals, franchises and licenses required and rights to all trademarks, trade names, patents, and fictitious names, if any, necessary to enable it to conduct the business in which it is now engaged in compliance with applicable law. -4- 5 SECTION 2.9. ERISA. Borrower is in compliance in all material respects with all applicable provisions of the Employee Retirement Income Security Act of 1974, as amended or recodified from time to time ("ERISA"); Borrower has not violated any provision of any defined employee pension benefit plan (as defined in ERISA) maintained or contributed to by Borrower (each, a "Plan"); no Reportable Event as defined in ERISA has occurred and is continuing with respect to any Plan initiated by Borrower; Borrower has met its minimum funding requirements under ERISA with respect to each Plan; and each Plan will be able to fulfill its benefit obligations as they come due in accordance with the Plan documents and under generally accepted accounting principles. SECTION 2.10. OTHER OBLIGATIONS. Borrower is not in default on any obligation for borrowed money, any purchase money obligation or any other material lease, commitment, contract, instrument or obligation. SECTION 2.11. ENVIRONMENTAL MATTERS. Except as disclosed by Borrower to Bank in writing prior to the date hereof, Borrower is in compliance in all material respects with all applicable federal or state environmental, hazardous waste, health and safety statutes, and any rules or regulations adopted pursuant thereto, which govern or affect any of Borrower's operations and/or properties, including without limitation, the Comprehensive Environmental Response, Compensation and Liability Act of 1980, the Superfund Amendments and Reauthorization Act of 1986, the Federal Resource Conservation and Recovery Act of 1976, and the Federal Toxic Substances Control Act, as any of the same may be amended, modified or supplemented from time to time. None of the operations of Borrower is the subject of any federal or state investigation evaluating whether any remedial action involving a material expenditure is needed to respond to a release of any toxic or hazardous waste or substance into the environment. Borrower has no material contingent liability in connection with any release of any toxic or hazardous waste or substance into the environment. ARTICLE III CONDITIONS SECTION 3.1. CONDITIONS OF INITIAL EXTENSION OF CREDIT. The obligation of Bank to make the initial extension of credit contemplated by this Agreement is subject to the fulfillment to Bank's satisfaction of all of the following conditions: (a) Approval of Bank Counsel. All legal matters incidental to the extension of credit by Bank shall be satisfactory to Bank's counsel. -5- 6 (b) Documentation. Bank shall have received, in form and substance satisfactory to Bank, each of the following, duly executed: (i) This Agreement and the Line of Credit Note. (ii) Corporate Borrowing Resolution. (iii) Certificate of Incumbency. (iv) Such other documents as Bank may require under any other Section of this Agreement. (c) Financial Condition. There shall have been no material adverse change, as determined in good faith by Bank, in the financial condition or business of Borrower, nor any material decline, as determined in good faith by Bank, in the market value of any collateral required hereunder or a substantial or material portion of the assets of Borrower. SECTION 3.2. CONDITIONS OF EACH EXTENSION OF CREDIT. The obligation of Bank to make each extension of credit requested by Borrower hereunder shall be subject to the fulfillment to Bank's satisfaction of each of the following conditions: (a) Compliance. The representations and warranties contained herein and in each of the other Loan Documents shall be true on and as of the date of the signing of this Agreement and on the date of each extension of credit by Bank pursuant hereto, with the same effect as though such representations and warranties had been made on and as of each such date, and on each such date, no Event of Default as defined herein, and no condition, event or act which with the giving of notice or the passage of time or both would constitute such an Event of Default, shall have occurred and be continuing or shall exist. (b) Documentation. Bank shall have received all additional documents which may be required in connection with such extension of credit. ARTICLE IV AFFIRMATIVE COVENANTS Borrower covenants that so long as Bank remains committed to extend credit to Borrower pursuant hereto, or any liabilities (whether direct or contingent, liquidated or unliquidated) of Borrower to Bank under any of the Loan Documents remain outstanding, and until payment in full of all obligations of Borrower subject hereto, Borrower shall, unless Bank otherwise consents in writing: SECTION 4.1. PUNCTUAL PAYMENTS. Punctually pay all principal, interest, fees or other liabilities due under any of -6- 7 the Loan Documents at the times and place and in the manner specified therein. SECTION 4.2. ACCOUNTING RECORDS. Maintain adequate books and records in accordance with generally accepted accounting principles consistently applied, and permit any representative of Bank, at any reasonable time, to inspect, audit and examine such books and records, to make copies of the same, and to inspect the properties of Borrower. SECTION 4.3. FINANCIAL STATEMENTS. Provide to Bank all of the following, in form and detail satisfactory to Bank: (a) not later than 100 days after and as of the end of each fiscal year, an audited financial statement of Borrower, prepared by a certified public accountant, to include balance sheet, income statement, statement of cash flow, source and application of funds statement, and Form 10-K; (b) not later than 50 days after and as of the end of each fiscal quarter, a Form 10-Q; (c) not later than 30 days after and as of the end of each fiscal month, a financial statement of Borrower, prepared by Borrower; (d) not later than 10 days after Bank's request, an inventory collateral report, and an aged listing of accounts receivable and accounts payable and; (e) not later than 30 days after and as of the end of each month, a Borrowing Base Certificate; (f) contemporaneously with each annual and quarterly financial statement of Borrower required hereby, a certificate of the president or chief financial officer of Borrower that said financial statements present fairly the financial condition of the Borrower and that there exists no Event of Default nor any condition, act or event which with the giving of notice or the passage of time or both would constitute an Event of Default; (g) from time to time such other information as Bank may reasonably request. SECTION 4.4. COMPLIANCE. Preserve and maintain all licenses, permits, governmental approvals, rights, privileges and franchises necessary for the conduct of its business; and comply with the provisions of all documents pursuant to which Borrower is organized and/or which govern Borrower's continued existence and with the requirements of all laws, rules, regulations and -7- 8 orders of any governmental authority applicable to Borrower and/or its business. SECTION 4.6. FACILITIES. Keep all properties useful or necessary to Borrower's business in good repair and condition, and from time to time make necessary repairs, renewals and replacements thereto so that such properties shall be fully and efficiently preserved and maintained. SECTION 4.7. TAXES AND OTHER LIABILITIES. Pay and discharge when due any and all indebtedness, obligations, assessments and taxes, both real or personal, including without limitation Federal and state income taxes and state and local property taxes and assessments, except such (a) as Borrower may in good faith contest or as to which a bona fide dispute may arise, and (b) for which Borrower has made provision, to Bank's satisfaction, for eventual payment thereof in the event Borrower is obligated to make such payment. SECTION 4.8. LITIGATION. Promptly give notice in writing to Bank of any material litigation pending or threatened against Borrower. SECTION 4.9. FINANCIAL CONDITION. Maintain Borrower's financial condition as follows using generally accepted accounting principles consistently applied and used consistently with prior practices (except to the extent modified by the definitions herein): (a) Current Ratio not at any time less than 2.0 to 1.0, with "Current Ratio" defined as total current assets divided by total current liabilities, with the Line of Credit being included as a current liability for this purpose. (b) Working Capital not at any time less than $15,000,000.00, with "Working Capital" defined as total current assets minus total current liabilities, with the Line of Credit being included as a current liability for this purpose. (c) Tangible Net Worth not less than $41,000,000.00 during the period beginning the date hereof and ending February 1, 1997; and for the fiscal year beginning February 2, 1997, and during each subsequent fiscal year of the Borrower, not less than the sum of (i) the minimum Tangible Net Worth that the Borrower was required to maintain by this covenant during the fiscal year of the Borrower immediately preceding the year of determination, plus (ii) seventy percent (70%) of the Borrower's net income after taxes during the fiscal year of the Borrower immediately preceding the year of determination (with net income after taxes being determined in accordance with generally accepted accounting principles but before giving effect to the payment of any -8- 9 dividends); provided, that no reduction will be made to the amount of Tangible Net Worth required to be maintained by the Borrower hereunder as a result of the Borrower's net income after taxes being a negative number. (d) Total Liabilities divided by Tangible Net Worth not at any time greater than .75 to 1.0, with "Total Liabilities" defined as the aggregate of current liabilities and non-current liabilities less subordinated debt approved by the Bank, and with "Tangible Net Worth" as defined above. (e) Net income after taxes not less than $1.00 on a trailing three quarter basis, determined as of each fiscal quarter end. (f) Maintain, on a rolling four quarter basis (i.e. as of the end of each fiscal quarter for the four quarter period ended as of the end of each quarter for which any determination is being made), a Fixed Charge Coverage of not less than 1.35 to 1.0. For purposes of this financial covenant, "Fixed Charge Coverage" means, as of any date of determination, (i) the sum of Annual Traditional Cash flow, plus interest expense, plus rental expense, divided by (ii) the sum of the Company's current portion of long-term debt, plus interest expense, plus rental expense, plus any cash dividends paid by the Company. (g) Maintain a ratio of (i) an amount equal to the sum of (A) the face amount of all outstanding Documentary and Stand-by Letters of Credit, plus (B) the indebtedness under the Revolving Note to; (ii) total inventory of Company of not less than sixty-five percent (65%) throughout the term hereof. SECTION 4.10. NOTICE TO BANK. Promptly (but in no event more than five (5) days after the occurrence of each such event or matter) give written notice to Bank in reasonable detail of: (a) the occurrence of any Event of Default, or any condition, event or act which with the giving of notice or the passage of time or both would constitute an Event of Default; (b) any change in the name or the organizational structure of Borrower, or any material action, claim, investigation, suit or proceeding pending or asserted by or before any governmental authority, arbitrator, court or administrative agency; (c) the occurrence and nature of any Reportable Event or Prohibited Transaction, each as defined in ERISA, or any funding deficiency with respect to any Plan; or (d) any termination or cancellation of any insurance policy which Borrower is required to maintain, or any uninsured or partially uninsured loss through liability or property damage, or through fire, theft or any other cause affecting Borrower's property. -9- 10 ARTICLE V NEGATIVE COVENANTS Borrower further covenants that so long as Bank remains committed to extend credit to Borrower pursuant hereto, or any liabilities (whether direct or contingent, liquidated or unliquidated) of Borrower to Bank under any of the Loan Documents remain outstanding, and until payment in full of all obligations of Borrower subject hereto, Borrower will not without Bank's prior written consent: SECTION 5.1. USE OF FUNDS. Use any of the proceeds of any credit extended hereunder except for the purposes stated in Article I hereof. SECTION 5.2. [Intentionally Omitted]. SECTION 5.3. OTHER INDEBTEDNESS. Create, incur, assume or permit to exist any indebtedness or liabilities resulting from borrowings, loans or advances, whether secured or unsecured, matured or unmatured, liquidated or unliquidated, joint or several, except (a) the liabilities of Borrower to Bank, and(b) any other liabilities of Borrower existing as of, and disclosed to Bank prior to, the date hereof, and (c) other liabilities not to exceed an aggregate principal amount of $1,000,000.00. SECTION 5.4. MERGER, CONSOLIDATION, TRANSFER OF ASSETS. Merge into or consolidate with any other entity; make any substantial change in the nature of Borrower's business as conducted as of the date hereof; nor sell, lease, transfer or otherwise dispose of all or a substantial or material portion of Borrower's assets except in the ordinary course of its business. SECTION 5.5. GUARANTIES. Guarantee or become liable in any way as surety, endorser (other than as endorser of negotiable instruments for deposit or collection in the ordinary course of business), accommodation endorser or otherwise for, nor pledge or hypothecate any assets of Borrower as security for, any liabilities or obligations of any other person or entity, except any of the foregoing in favor of Bank. SECTION 5.6. LOANS, ADVANCES, INVESTMENTS. Make any loans or advances to or investments in any person or entity, except (a) any of the foregoing existing as of, and disclosed to Bank prior to, the date hereof, and (b) loans to officers not to exceed $150,000 in each individual instance, with the aggregate of all loans to officers not to exceed $250,000 at any time. SECTION 5.7. PLEDGE OF ASSETS. Mortgage, pledge, grant or permit to exist a security interest in, or lien upon, all or any portion of Borrower's assets now owned or hereafter acquired, except (a) any of the foregoing in favor of Bank or which is existing as of, and disclosed to Bank in writing prior to, the -10- 11 date hereof; (b) liens, mortgages, encumbrances or security interests to secure payment of the borrowings authorized hereunder and those permitted under Section 5.6 herein; (c) pledges or deposits to secure obligations under workmen's compensation laws or of similar legislation; (d) deposits to secure public or statutory obligations; (e) statutory mechanics', carriers', workmen's, repairmen's liens or other like items in the ordinary course of business in respect to obligations which are not overdue or are being contested in good faith; (f) liens, mortgages, encumbrances, or security interests granted by the Borrower on equipment, furniture and/or fixtures in connection with additional purchases of such equipment, furniture and/or fixtures not in excess of $250,000 per fiscal year of the Borrower; and (g) statutory or contractual landlords liens in respect of obligations which are not overdue or being contested in good faith. SECTION 5.8. PURCHASES. Borrower will agree not to incur any debt resulting from the purchase of any Treasury Stock. SECTION 5.9. NEGATIVE PLEDGE. Enter into any agreement whereby Borrower or any subsidiary agrees not to mortgage, pledge, grant or permit to exist a security interest in, or lien upon, all or any portion of Borrower's or any subsidiaries' assets now owned or hereafter acquired, except any of the foregoing in favor of Bank or which is existing as of and disclosed to Bank in writing prior to the date hereof. Section 5.10. ACQUISITIONS. Make any new acquisition with a total consideration to be paid in excess of Ten Million Dollars ($10,000,000.00) without prior Bank consent. ARTICLE VI EVENTS OF DEFAULT SECTION 6.1. The occurrence of any of the following shall constitute an "Event of Default" under this Agreement: (a) Borrower shall fail to pay when due any principal, interest, fees or other amounts payable under any of the Loan Documents. (b) Any financial statement or certificate furnished to Bank in connection with, or any representation or warranty made by Borrower or any other party under this Agreement or any other Loan Document shall prove to be incorrect, false or misleading in any material respect when furnished or made. (c) Any default in the performance of or compliance with any obligation, agreement or other provision contained herein or in any other Loan Document (other than those referred to in -11- 12 subsections (a) and (b) above), and with respect to any such default which by its nature can be cured, such default shall continue for a period of twenty (20) days from its occurrence. (d) Any default in the payment or performance of any obligation, or any defined event of default, under the terms of any contract or instrument (other than any of the Loan Documents) pursuant to which Borrower has incurred any debt or other liability to any person or entity, including Bank. (e) The filing of a notice of judgment lien in excess of $100,000 against Borrower; or the recording of any abstract of judgment in excess of $100,000 against Borrower in any county in which Borrower has an interest in real property; or the service of a notice of levy and/or of a writ of attachment or execution, or other like process, against assets of Borrower in excess of $100,000; or the entry of a judgment in excess of $100,000 against Borrower. (f) Borrower shall become insolvent, or shall suffer or consent to or apply for the appointment of a receiver, trustee, custodian or liquidator of itself or any of its property, or shall generally fail to pay its debts as they become due, or shall make a general assignment for the benefit of creditors; Borrower shall file a voluntary petition in bankruptcy, or seeking reorganization, in order to effect a plan or other arrangement with creditors or any other relief under the Bankruptcy Reform Act, Title 11 of the United States Code, as amended or recodified from time to time ("Bankruptcy Code"), or under any state or federal law granting relief to debtors, whether now or hereafter in effect; or any involuntary petition or proceeding pursuant to the Bankruptcy Code or any other applicable state or federal law relating to bankruptcy, reorganization or other relief for debtors is filed or commenced against Borrower, or Borrower shall file an answer admitting the jurisdiction of the court and the material allegations of any involuntary petition; or Borrower shall be adjudicated a bankrupt, or an order for relief shall be entered against Borrower by any court of competent jurisdiction under the Bankruptcy Code or any other applicable state or federal law relating to bankruptcy, reorganization or other relief for debtors. (g) The dissolution or liquidation of Borrower; or Borrower, or its directors, shall take action seeking to effect the dissolution or liquidation of Borrower. SECTION 6.2. REMEDIES. Upon the occurrence of any Event of Default: (a) all principal and accrued and unpaid interest outstanding under each of the Loan Documents, any term thereof to the contrary notwithstanding, shall at Bank's option and without notice become immediately due and payable without presentment, -12- 13 demand, or any notices of any kind, including without limitation notice of nonperformance, notice of protest, protest, notice of dishonor, notice of intention to accelerate or notice of acceleration, all of which are hereby expressly waived by each Borrower; (b) the obligation, if any, of Bank to extend any further credit under any of the Loan Documents shall immediately cease and terminate; and (c) Bank shall have all rights, powers and remedies available under each of the Loan Documents, or accorded by law, including without limitation the right to resort to any or all security for any credit accommodation from Bank subject hereto and to exercise any or all of the rights of a beneficiary or secured party pursuant to applicable law. All rights, powers and remedies of Bank may be exercised at any time by Bank and from time to time after the occurrence of an Event of Default, are cumulative and not exclusive, and shall be in addition to any other rights, powers or remedies provided by law or equity. ARTICLE VII MISCELLANEOUS SECTION 7.1. NO WAIVER. No delay, failure or discontinuance of Bank in exercising any right, power or remedy under any of the Loan Documents shall affect or operate as a waiver of such right, power or remedy; nor shall any single or partial exercise of any such right, power or remedy preclude, waive or otherwise affect any other or further exercise thereof or the exercise of any other right, power or remedy. Any waiver, permit, consent or approval of any kind by Bank of any breach of or default under any of the Loan Documents must be in writing and shall be effective only to the extent set forth in such writing. SECTION 7.2. NOTICES. All notices, requests and demands which any party is required or may desire to give to any other party under any provision of this Agreement must be in writing delivered to each party at the following address: BORROWER: GADZOOKS, INC. 4801 Spring Valley Road, Suite 108B Dallas, Texas 75244 BANK: WELLS FARGO BANK (TEXAS), NATIONAL ASSOCIATION 1445 Ross Avenue, Suite 300 Dallas, Texas 75202 or to such other address as any party may designate by written notice to all other parties. Each such notice, request and demand shall be deemed given or made as follows: (a) if sent by hand delivery, upon delivery; (b) if sent by mail, upon the -13- 14 earlier of the date of receipt or three (3) days after deposit in the U.S. mail, first class and postage prepaid; and (c) if sent by telecopy, upon receipt. SECTION 7.3. COSTS, EXPENSES AND ATTORNEYS' FEES. Borrower shall pay to Bank immediately upon demand the full amount of all payments, advances, charges, costs and expenses, including reasonable attorneys' fees (to include outside counsel fees and all allocated costs of Bank's in-house counsel to the extent permissible), expended or incurred by Bank in connection with (a) Bank's continued administration of this Agreement and the other Loan Documents, and the preparation of any amendments and waivers hereto and thereto, (b) the enforcement of Bank's rights and/or the collection of any amounts which become due to Bank under any of the Loan Documents, and (c) the prosecution or defense of any action in any way related to any of the Loan Documents, including without limitation, any action for declaratory relief, whether incurred at the trial or appellate level, in an arbitration proceeding or otherwise, and including any of the foregoing incurred in connection with any bankruptcy proceeding (including without limitation, any adversary proceeding, contested matter or motion brought by Bank or any other person) relating to any Borrower or any other person or entity. SECTION 7.4. SUCCESSORS, ASSIGNMENT. This Agreement shall be binding upon and inure to the benefit of the heirs, executors, administrators, legal representatives, successors and assigns of the parties; provided however, that Borrower may not assign or transfer its interest hereunder without Bank's prior written consent. Bank reserves the right to sell, assign, transfer, negotiate or grant participations in all or any part of, or any interest in, Bank's rights and benefits under each of the Loan Documents. In connection therewith, Bank may disclose all documents and information which Bank now has or may hereafter acquire relating to any credit extended by Bank to Borrower, Borrower or its business, or any collateral required hereunder. SECTION 7.5. ENTIRE AGREEMENT; AMENDMENT. This Agreement and the other Loan Documents constitute the entire agreement between Borrower and Bank with respect to any extension of credit by Bank subject hereto and supersede all prior negotiations, communications, discussions and correspondence concerning the subject matter hereof. This Agreement may be amended or modified only by a written instrument executed by each party hereto. SECTION 7.6. NO THIRD PARTY BENEFICIARIES. This Agreement is made and entered into for the sole protection and benefit of the parties hereto and their respective permitted successors and assigns, and no other person or entity shall be a third party beneficiary of, or have any direct or indirect cause of action or -14- 15 claim in connection with, this Agreement or any other of the Loan Documents to which it is not a party. SECTION 7.7. TIME. Time is of the essence of each and every provision of this Agreement and each other of the Loan Documents. SECTION 7.8. SEVERABILITY OF PROVISIONS. If any provision of this Agreement shall be prohibited by or invalid under applicable law, such provision shall be ineffective only to the extent of such prohibition or invalidity without invalidating the remainder of such provision or any remaining provisions of this Agreement. SECTION 7.9. COUNTERPARTS. This Agreement may be executed in any number of counterparts, each of which when executed and delivered shall be deemed to be an original, and all of which when taken together shall constitute one and the same Agreement. SECTION 7.10. GOVERNING LAW. This Agreement shall be governed by and construed in accordance with the laws of the State of Texas. SECTION 7.11. SAVINGS CLAUSE. It is the intention of the parties to comply strictly with applicable usury laws. Accordingly, notwithstanding any provision to the contrary in the Loan Documents, in no event shall any Loan Documents require the payment or permit the payment, taking, reserving, receiving, collection or charging of any sums constituting interest under applicable laws that exceed the maximum amount permitted by such laws, as the same may be amended or modified from time to time (the "Maximum Rate"). If any such excess interest is called for, contracted for, charged, taken, reserved or received in connection with any Loan Documents, or in any communication by Lender or any other person to Borrower or any other person, or in the event that all or part of the principal or interest hereof or thereof shall be prepaid or accelerated, so that under any of such circumstances or under any other circumstance whatsoever the amount of interest contracted for, charged, taken, reserved or received on the amount of principal actually outstanding from time to time under the Loan Documents shall exceed the Maximum Rate, then in such event it is agreed that: (i) the provisions of this paragraph shall govern and control; (ii) neither Borrower nor any other person or entity now or hereafter liable for the payment of any Loan Documents shall be obligated to pay the amount of such interest to the extent it is in excess of the Maximum Rate; (iii) any such excess interest which is or has been received by Lender, notwithstanding this paragraph, shall be credited against the then unpaid principal balance hereof or thereof, or if any of the Loan Documents has been or would be paid in full by such credit, refunded to Borrower; and (iv) the provisions of each of the Loan Documents, and any other -15- 16 communication to Borrower, shall immediately be deemed reformed and such excess interest reduced, without the necessity of executing any other document, to the Maximum Rate. The right to accelerate the maturity of the Loan Documents does not include the right to accelerate, collect or charge unearned interest, but only such interest that has otherwise accrued as of the date of acceleration. Without limiting the foregoing, all calculations of the rate of interest contracted for, charged, taken, reserved or received in connection with any of the Loan Documents which are made for the purpose of determining whether such rate exceeds the Maximum Rate shall be made to the extent permitted by applicable laws by amortizing, prorating, allocating and spreading during the period of the full term of such Loan Documents, including all prior and subsequent renewals and extensions hereof or thereof, all interest at any time contracted for, charged, taken, reserved or received by Lender. The terms of this paragraph shall be deemed to be incorporated into each of the other Loan Documents. To the extent that Article 5069-1.04 of the Texas Revised Civil Statutes is relevant to Lender for the purpose of determining the Maximum Rate, Bank hereby elects to determine the applicable rate ceiling under such Article by the indicated (weekly) rate ceiling from time to time in effect, subject to Lender's right subsequently to change such method in accordance with applicable law, as the same may be amended or modified from time to time. SECTION 7.12. RIGHT OF SETOFF; DEPOSIT ACCOUNTS. Upon the occurrence of an Event of Default, (a) Borrower hereby authorizes Bank, at any time and from time to time, without notice, which is hereby expressly waived by each Borrower, and whether or not Bank shall have declared any credit extended hereunder to be due and payable in accordance with the terms hereof, to set off against, and to appropriate and apply to the payment of, Borrower's obligations and liabilities under the Loan Documents (whether matured or unmatured, fixed or contingent, liquidated or unliquidated), any and all amounts owing by Bank to Borrower (whether payable in U.S. dollars or any other currency, whether matured or unmatured, and in the case of deposits, whether general or special (except trust and escrow accounts), time or demand and however evidenced), and (b) pending any such action, to the extent necessary, to hold such amounts as collateral to secure such obligations and liabilities and to return as unpaid for insufficient funds any and all checks and other items drawn against any deposits so held as Bank, in its sole discretion, may elect. Borrower hereby grants to Bank a security interest in all deposits and accounts maintained with Bank and its affiliates to secure the payment of all obligations and liabilities of Borrower to Bank under the Loan Documents. -16- 17 SECTION 7.13. BUSINESS PURPOSE. Borrower represents and warrants that any credit extended hereunder is for a business, commercial, investment, agricultural or other similar purpose and not primarily for a personal, family or household use. SECTION 7.14. ARBITRATION. (a) Arbitration. Upon the demand of any party, any Dispute shall be resolved by binding arbitration (except as set forth in (e) below) in accordance with the terms of this Agreement. A "Dispute" shall mean any action, dispute, claim or controversy of any kind, whether in contract or tort, statutory or common law, legal or equitable, now existing or hereafter arising under or in connection with, or in any way pertaining to, any of the Loan Documents, or any past, present or future extensions of credit and other activities, transactions or obligations of any kind related directly or indirectly to any of the Loan Documents, including without limitation, any of the foregoing arising in connection with the exercise of any self-help, ancillary or other remedies pursuant to any of the Loan Documents. Any party may by summary proceedings bring an action in court to compel arbitration of a Dispute. Any party who fails or refuses to submit to arbitration following a lawful demand by any other party shall bear all costs and expenses incurred by such other party in compelling arbitration of any Dispute. (b) Governing Rules. Arbitration proceedings shall be administered by the American Arbitration Association ("AAA") or such other administrator as the parties shall mutually agree upon in accordance with the AAA Commercial Arbitration Rules. All Disputes submitted to arbitration shall be resolved in accordance with the Federal Arbitration Act (Title 9 of the United States Code), notwithstanding any conflicting choice of law provision in any of the Loan Documents. The arbitration shall be conducted at a location in Texas selected by the AAA or other administrator. If there is any inconsistency between the terms hereof and any such rules, the terms and procedures set forth herein shall control. All statutes of limitation applicable to any Dispute shall apply to any arbitration proceeding. All discovery activities shall be expressly limited to matters directly relevant to the Dispute being arbitrated. Judgment upon any award rendered in an arbitration may be entered in any court having jurisdiction; provided however, that nothing contained herein shall be deemed to be a waiver by any party that is a bank of the protections afforded to it under 12 U.S.C. Section 91 or any similar applicable state law. (c) No Waiver; Provisional Remedies, Self-Help and Foreclosure. No provision hereof shall limit the right of any party to exercise self-help remedies such as setoff, foreclosure against or sale of any real or personal property collateral or security, or to obtain provisional or ancillary remedies, -17- 18 including without limitation injunctive relief, sequestration, attachment, garnishment or the appointment of a receiver, from a court of competent jurisdiction before, after or during the pendency of any arbitration or other proceeding. The exercise of any such remedy shall not waive the right of any party to compel arbitration hereunder. (d) Arbitrator Qualifications and Powers; Awards. Arbitrators must be active members of the Texas State Bar with expertise in the substantive laws applicable to the subject matter of the Dispute. Arbitrators are empowered to resolve Disputes by summary rulings in response to motions filed prior to the final arbitration hearing. Arbitrators (i) shall resolve all Disputes in accordance with the substantive law of the state of Texas, (ii) may grant any remedy or relief that a court of the state of Texas could order or grant within the scope hereof and such ancillary relief as is necessary to make effective any award, and (iii) shall have the power to award recovery of all costs and fees, to impose sanctions and to take such other actions as they deem necessary to the same extent a judge could pursuant to the Federal Rules of Civil Procedure, the Texas Rules of Civil Procedure or other applicable law. Any Dispute in which the amount in controversy is $5,000,000 or less shall be decided by a single arbitrator who shall not render an award of greater than $5,000,000 (including damages, costs, fees and expenses). By submission to a single arbitrator, each party expressly waives any right or claim to recover more than $5,000,000. Any Dispute in which the amount in controversy exceeds $5,000,000 shall be decided by majority vote of a panel of three arbitrators; provided however, that all three arbitrators must actively participate in all hearings and deliberations. (e) Judicial Review. Notwithstanding anything herein to the contrary, in any arbitration in which the amount in controversy exceeds $25,000,000, the arbitrators shall be required to make specific, written findings of fact and conclusions of law. In such arbitrations (i) the arbitrators shall not have the power to make any award which is not supported by substantial evidence or which is based on legal error, (ii) an award shall not be binding upon the parties unless the findings of fact are supported by substantial evidence and the conclusions of law are not erroneous under the substantive law of the state of Texas, and (iii) the parties shall have in addition to the grounds referred to in the Federal Arbitration Act for vacating, modifying or correcting an award the right to judicial review of (A) whether the findings of fact rendered by the arbitrators are supported by substantial evidence, and (B) whether the conclusions of law are erroneous under the substantive law of the state of Texas. Judgment confirming an award in such a proceeding may be entered only if a court determines the award is supported by substantial evidence and not based on legal error under the substantive law of the state of Texas. -18- 19 (f) Miscellaneous. To the maximum extent practicable, the AAA, the arbitrators and the parties shall take all action required to conclude any arbitration proceeding within 180 days of the filing of the Dispute with the AAA. No arbitrator or other party to an arbitration proceeding may disclose the existence, content or results thereof, except for disclosures of information by a party required in the ordinary course of its business, by applicable law or regulation, or to the extent necessary to exercise any judicial review rights set forth herein. If more than one agreement for arbitration by or between the parties potentially applies to a Dispute, the arbitration provision most directly related to the Loan Documents or the subject matter of the Dispute shall control. This arbitration provision shall survive termination, amendment or expiration of any of the Loan Documents or any relationship between the parties. NOTICE: THIS DOCUMENT AND ALL OTHER DOCUMENTS RELATING TO THE INDEBTEDNESS CONSTITUTE A WRITTEN LOAN AGREEMENT WHICH REPRESENTS THE FINAL AGREEMENT BETWEEN THE PARTIES AND MAY NOT BE CONTRADICTED BY EVIDENCE OF PRIOR, CONTEMPORANEOUS OR SUBSEQUENT ORAL AGREEMENTS OF THE PARTIES. THERE ARE NO UNWRITTEN ORAL AGREEMENTS BETWEEN THE PARTIES RELATING TO THE INDEBTEDNESS. IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be executed as of the day and year first written above. WELLS FARGO BANK (TEXAS), GADZOOKS, INC. NATIONAL ASSOCIATION FORMERLY FIRST INTERSTATE BANK OF TEXAS, N.A. By: /s/ Monty R. Standifer By: /s/ Jeffrey S. A. Cook --------------------------------- --------------------------------- Monty Standifer Jeffrey S. A. Cook Chief Financial Officer Relationship Manager and Vice President -19- 20 EXHIBIT A WELLS FARGO BANK REVOLVING LINE OF CREDIT NOTE - -------------------------------------------------------------------------------- $10,000,000.00 Dallas, Texas January 30, 1997 FOR VALUE RECEIVED, the undersigned GADZOOKS, INC. ("Borrower") promises to pay to the order of WELLS FARGO BANK (TEXAS), NATIONAL ASSOCIATION ("Bank") at its office at North Texas RCBO, 1445 Ross, Suite 300, Dallas, TX 75202, or at such other place as the holder hereof may designate, in lawful money of the United States of America and in immediately available funds, the principal sum of $10,000,000.00, or so much thereof as may be advanced and be outstanding, with interest thereon, to be computed on each advance from the date of its disbursement as set forth herein. DEFINITIONS: As used herein, the following terms shall have the meanings set forth after each, and any other term defined in this Note shall have the meaning set forth at the place defined: (a) "Business Day" means any day except a Saturday, Sunday or any other day on which commercial banks in Texas are authorized or required by law to close. (b) "Fixed Rate Term" means a period commencing on a Business Day and continuing for 1, 2 or 3 months, as designated by Borrower, during which all or a portion of the outstanding principal balance of this Note bears interest determined in relation to LIBOR; provided however, that no Fixed Rate Term may be selected for a principal amount less than $100,000.00; and provided further, that no Fixed Rate Term shall extend beyond the scheduled maturity date hereof. If any Fixed Rate Term would end on a day which is not a Business Day, then such Fixed Rate Term shall be extended to the next succeeding Business Day. (c) "LIBOR" means the rate per annum (rounded upward, if necessary, to the nearest whole 1/8 of 1%) determined by dividing Base LIBOR by a percentage equal to 100% less any LIBOR Reserve Percentage. (i) "Base LIBOR" means the rate per annum for United States dollar deposit quoted by Bank as the Inter-Bank Market Offered Rate, with the understanding that such rate is quoted by Bank for the purpose of calculating effective rates of interest for loans making reference thereto, on the first day of a Fixed Rate Term for delivery of funds on said date for a period of time approximately equal to the number of days in such Fixed Rate Term and in an amount approximately equal to the principal amount to which such Fixed Rate Term applies. Borrower understands and agrees that Bank may base its quotation of the Inter-Bank Market Offered Rate upon such offers or other market indicators of the 21 Inter-Bank Market as Bank in its discretion deems appropriate including, but not limited to, the rate offered for U.S. dollar deposits on the London Inter-Bank Market. (ii) "LIBOR Reserve Percentage" means the reserve percentage prescribed by the Board of Governors of the Federal Reserve System (or any successor) for "Eurocurrency Liabilities" (as defined in Regulation D of the Federal Reserve Board, as amended), adjusted by Bank for expected changes in such reserve percentage during the applicable Fixed Rate Term. (d) "Prime Rate" means at any time the rate of interest most recently announced within Bank at its principal office as its Prime Rate, with the understanding that the Prime Rate is one of Bank's base rates and serves as the basis upon which effective rates of interest are calculated for those loans making reference thereto, and is evidenced by the recording thereof after its announcement in such internal publication or publications as Bank may designate. INTEREST: (a) Interest. The outstanding principal balance of this Note shall bear interest (computed on the basis of a 360-day year, actual days elapsed, unless such calculation would result in a usurious rate, in which case interest shall be computed on the basis of a 365/366-day year, as the case may be, actual days elapsed) at the lesser of (i) either (A) at a fluctuating rate per annum equal to the Prime Rate in effect from time to time, or (B) at a fixed rate per annum determined by Bank to be 1.95000% above LIBOR in effect on the first day of the applicable Fixed Rate Term, or (ii) the Maximum Rate. When interest is determined in relation to the Prime Rate, each change in the rate of interest hereunder shall become effective on the date each Prime Rate change is announced within Bank. With respect to each LIBOR selection option selected hereunder, Bank is hereby authorized to note the data, principal amount, interest rate and Fixed Rate Term applicable thereto and any payments made thereon on Bank's books and records (either manually or by electronic entry) and/or on any schedule attached to this Note, which notations shall be prima facie evidence of the accuracy of the information noted. (b) Selection of Interest Rate Options. At any time any portion of this Note bears interest determined in relation to LIBOR, it may be continued by Borrower at the end of the Fixed Rate Term applicable thereto so that all or a portion thereof bears interest determined in relation to the Prime Rate or to LIBOR for a new Fixed Rate Term designated by Borrower. At any time any portion of this Note bears interest determined in relation to the Prime Rate, Borrower may convert all or a portion -2- 22 thereof so that it bears interest determined in relation to LIBOR for a Fixed Rate Term designated by Borrower. At such time as Borrower requests an advance hereunder or wishes to select a LIBOR option for all or a portion of the outstanding principal balance hereof, and at the end of each Fixed Rate Term, Borrower shall give Bank notice specifying: (i) the interest rate option selected by Borrower; (ii) the principal amount subject thereto; and (iii) for each LIBOR selection, the length of the applicable Fixed Rate Term. Any such notice may be given by telephone so long as, with respect to each LIBOR selection, (A) Bank receives written confirmation from Borrower not later than 3 Business Days after such telephone notice is given, and (B) such notice is given to Bank prior to 10:00 a.m., California time, on the first day of the Fixed Rate Term. For each LIBOR option requested hereunder, Bank will quote the applicable fixed rate to Borrower at approximately 10:00 a.m., California time, on the first day of the Fixed Rate Term. If Borrower does not immediately accept the rate quoted by Bank, any subsequent acceptance by Borrower shall be subject to a redetermination by Bank of the applicable fixed rate; provided however, that if Borrower fails to accept any such rate by 11:00 a.m., California time, on the Business Day such quotation is given, then the quoted rate shall expire and Bank shall have no obligation to permit a LIBOR option to be selected on such day. If no specific designation of interest is made at the time any advance is requested hereunder or at the end of any Fixed Rate Term, Borrower shall be deemed to have made a Prime Rate interest selection for such advance or the principal amount to which such Fixed Rate Term applied. (c) Additional LIBOR Provisions. (i) If Bank at any time shall determine that for any reason adequate and reasonable means do not exist for ascertaining LIBOR, then Bank shall promptly give notice thereof to Borrower. If such notice is given and until such notice has been withdrawn by Bank, then (A) no new LIBOR option may be selected by Borrower, and (B) any portion of the outstanding principal balance hereof which bears interest determined in relation to LIBOR, subsequent to the end of the Fixed Rate Term applicable thereto, shall bear interest determined in relation to the Prime Rate. (ii) If any law, treaty, rule, regulation or determination of a court or governmental authority or any change therein or in the interpretation or application thereof (each, a "Change in Law") shall make it unlawful for Bank (A) to make LIBOR options available hereunder, or (B) to maintain interest rates based on LIBOR, then in the former event, any obligation of Bank to make available such unlawful LIBOR options shall immediately be cancelled, and in the latter event, any such unlawful LIBOR-based interest rates then outstanding shall be converted, at Bank's option, so that interest on the portion of the outstanding principal balance subject thereto is determined -3- 23 in relation to the Prime Rate; provided however, that if any such Change in Law shall permit any LIBOR-based interest rates to remain in effect until the expiration of the Fixed Rate Term applicable thereto, then such permitted LIBOR-based interest rates shall continue in effect until the expiration of such Fixed Rate Term. Upon the occurrence of any of the foregoing events, Borrower shall pay to Bank immediately upon demand such amounts as may be necessary to compensate Bank for any fines, fees, charges, penalties or other costs incurred or payable by Bank as a result thereof and which are attributable to any LIBOR options made available to Borrower hereunder, and any reasonable allocation made by Bank among its operations shall be conclusive and binding upon Borrower. (iii) If any Change in Law or compliance by Bank with any request or directive (whether or not having the force of law) from any central bank or other governmental authority shall: (A) subject Bank to any tax, duty or other charge with respect to any LIBOR options, or change the basis of taxation of payments to Bank of principal, interest, fees or any other amount payable hereunder (except for changes in the rate of tax on the overall net income of Bank); or (B) impose, modify or hold applicable any reserve, special deposit, compulsory loan or similar requirement against assets held by, deposits or other liabilities in or for the account of, advances or loans by, or any other acquisition of funds by any office of Bank; or (C) impose on Bank any other condition; and the result of any of the foregoing is to increase the cost to Bank of making, renewing or maintaining any LIBOR options hereunder and/or to reduce any amount receivable by Bank in connection therewith, then in any such case, Borrower shall pay to Bank immediately upon demand such amounts as may be necessary to compensate Bank for any additional costs incurred by Bank and/or reductions in amounts received by Bank which are attributable to such LIBOR options. In determining which costs incurred by Bank and/or reductions in amounts received by Bank are attributable to any LIBOR options made available to Borrower hereunder, any reasonable allocation made by Bank among its operations shall be conclusive and binding upon Borrower. -4- 24 (d) Payment of Interest. Interest accrued on this Note shall be payable on the 2nd day of each March, June, September and December, commencing March 2, 1997. BORROWING AND REPAYMENT: (a) Borrowing and Repayment. Borrower may from time to time during the term of this Note borrow, partially or wholly repay its outstanding borrowings, and reborrow, subject to all of the limitations, terms and conditions of this Note and of the Credit Agreement between Borrower and Bank defined below; provided however, that the total outstanding borrowings under this Note shall not at any time exceed the principal amount stated above. The unpaid principal balance of this obligation at any time shall be the total amounts advanced hereunder by the holder hereof less the amount of principal payments made hereon by or for any Borrower, which balance may be endorsed hereon from time to time by the holder. The outstanding principal balance of this Note shall be due and payable in full on June 5, 1998. (b) Advances. Advances hereunder, to the total amount of the principal sum available hereunder, may be made by the holder at the oral or written request of (i) GERALD SZCZEPANSKI or MONTY STANDIFER or JANA WILSON or RONALD SZCZEPANSKI, any one acting alone, who are authorized to request advances and direct the disposition of any advances until written notice of the revocation of such authority is received by the holder at the office designed above. The holder shall have no obligation to determine whether any person requesting an advance is or has been authorized by any Borrower. (c) Application of Payments. Each payment made on this Note shall be credited first, to any interest then due and second, to the outstanding principal balance hereof. All payments credited to principal shall be applied first, to the outstanding principal balance of this Note which bears interest determined in relation to the Prime Rate, if any, and second, to the outstanding principal balance of this Note which bears interest determined in relation to LIBOR, with such payments applied to the oldest Fixed Rate Term first. PREPAYMENT: (a) Prime Rate. Borrower may prepay principal on any portion of this Note which bears interest determined in relation to the Prime Rate at any time, in any amount and without penalty. (b) LIBOR. Borrower may prepay principal on any portion of this Note which bears interest determined in relation to LIBOR at any time and in the minimum amount of $10,000.00; provided however, that if the outstanding principal balance of such portion of this Note is less than said amount, the minimum prepayment amount shall be the entire outstanding principal -5- 25 balance thereof. In consideration of Bank providing this prepayment option to Borrower, or if any such portion of this Note shall become due and payable at any time prior to the last day of the Fixed Rate Term applicable thereto, Borrower shall pay to Bank immediately upon demand a fee which is the sum of the discounted monthly differences for each month from the month of prepayment through the month in which such Fixed Rate Term matures, calculated as follows for each such month: (i) Determine the amount of interest which would have accrued each month on the amount prepaid at the interest rate applicable to such amount had it remained outstanding until the last day of the Fixed Rate Term applicable thereto. (ii) Subtract from the amount determined in (i) above the amount of interest which would have accrued for the same month on the amount prepaid for the remaining term of such Fixed Rate Term at LIBOR in effect on the date of prepayment for new loans made for such term and in a principal amount equal to the amount prepaid. (iii) If the result obtained in (ii) for any month is greater than zero, discount that difference by LIBOR used in (ii) above. Each Borrower acknowledges that prepayment of such amount may result in Bank incurring additional costs, expenses and/or liabilities, and that it is difficult to ascertain the full extent of such costs, expenses and/or liabilities. Each Borrower, therefore, agrees to pay the above-described prepayment fee and agrees that said amount represents a reasonable estimate of the prepayment costs, expenses and/or liabilities of Bank. EVENTS OF DEFAULT: This Note is made pursuant to and is subject to the terms and conditions of that certain Credit Agreement between Borrower and Bank dated as of January 30, 1997, as amended from time to time (the "Credit Agreement"). Any default in the payment or performance of any obligation under this Note, or any defined event of default under the Credit Agreement, shall constitute an "Event of Default" under this Note. MISCELLANEOUS: (a) Remedies. Upon the occurrence of any Event of Default as defined in the Credit Agreement, the holder of this Note, at the holder's option, may declare all sums of principal and accrued and unpaid interest outstanding hereunder to be immediately due and payable without presentment, demand, or any notices of any kind, including without limitation notice of nonperformance, notice of protest, protest, notice of dishonor, notice of intention to accelerate or notice of acceleration, all -6- 26 of which are expressly waived by each Borrower, and the obligation, if any, of the holder to extend any further credit hereunder shall immediately cease and terminate. Each Borrower shall pay to the holder immediately upon demand the full amount of all payments, advances, charges, costs and expenses, including reasonable attorneys' fees (to include outside counsel fees and all allocated costs of the holder's in-house counsel to the extent permissible), expended or incurred by the holder in connection with the enforcement of the holder's rights and/or the collection of any amounts which become due to the holder under this Note, and the prosecution or defense of any action in any way related to this Note, including without limitation, any action for declaratory relief, whether incurred at the trial or appellate level, in an arbitration proceeding or otherwise, and including any of the foregoing incurred in connection with any bankruptcy proceeding (including without limitation, any adversary proceeding, contested matter or motion brought by Bank or any other person) relating to any Borrower or any other person or entity. (b) Obligations Joint and Several. Should more than one person or entity sign this Note as a Borrower, the obligations of each such Borrower shall be joint and several. (c) Governing Law. this Note shall be governed by and construed in accordance with the laws of the state of Texas. (d) Savings Clause. It is the intention of the parties to comply strictly with applicable usury laws. Accordingly, notwithstanding any provision to the contrary in this Note, or in any contract, instrument or document evidencing or securing the payment hereof or otherwise relating hereto (each, a "Related Document"), in no event shall this Note or any Related Document require the payment or permit the payment, taking, reserving, receiving, collection or charging of any sums constituting interest under applicable laws that exceed the maximum amount permitted by such laws, as the same may be amended or modified from time to time (the "Maximum Rate"). If any such excess interest is called for, contracted for, charged, taken, reserved or received in connection with this Note or any Related Document, or in any communication by Bank or any other person to Borrower or any other person, or in the event that all or part of the principal or interest hereof or thereof shall be prepaid or accelerated, so that under any of such circumstances or under any other circumstance whatsoever the amount of interest contracted for, charged, taken, reserved or received on the amount of principal actually outstanding from time to time under this Note shall exceed the Maximum Rate, then in such event it is agreed that: (i) the provisions of this paragraph shall govern and control; (ii) neither Borrower nor any other person or entity now or hereafter liable for the payment of this Note or any Related Document shall be obligated to pay the amount of such interest to the extent it is in excess of the Maximum Rate; (iii) any such -7- 27 excess interest which is or has been received by Bank, notwithstanding this paragraph, shall be credited against the then unpaid principal balance hereof or thereof, or if this Note or any Related Document has been or would be paid in full by such credit, refunded to Borrower; and (iv) the provisions of this Note and each Related Document, and any other communication to Borrower, shall immediately be deemed reformed and such excess interest reduced, without the necessity of executing any other document, to the Maximum Rate. The right to accelerate the maturity of this Note and any Related Document does not include the right to accelerate, collect or charge unearned interest, but only such interest that has otherwise accrued as of the date of acceleration. Without limiting the foregoing, all calculations of the rate of interest contracted for, charged, taken, reserved or received in connection with this Note and any Related Document which are made for the purpose of determining whether such rate exceeds the Maximum Rate shall be made to the extent permitted by applicable laws by amortizing, prorating, allocating and spreading during the period of the full term of this Note or such Related Document, including all prior and subsequent renewals and extensions hereof or thereof, all interest in any time contracted for, taken, reserved or received. The terms of this paragraph shall be deemed to be incorporated into each Related Document. To the extent that Article 5069-1.04 of the Texas Revised Civil Statutes is relevant to Bank for the purpose of determining the Maximum Rate, Bank hereby elects to determine the applicable rate ceiling under such Article by the indicated (weekly) rate ceiling from time to time in effect, subject to Bank's right subsequently to change such method in accordance with applicable law, as the same may be amended or modified from time to time. (e) Right of Setoff; Deposit Accounts. Upon and after the occurrence of an Event of Default, (i) Borrower hereby authorizes Bank, at any time and from time to time, without notice, which is hereby expressly waived by Borrower, and whether or not Bank shall have declared this Note to be due and payable in accordance with the terms hereof, to set off against, and to appropriate and apply to the payment of, Borrower's obligations and liabilities under this Note (whether matured or unmatured, fixed or contingent, liquidated or unliquidated), any and all amounts owing by Bank to Borrower (whether payable in U.S. dollars or any other currency, whether matured or unmatured, and in the case of deposits, whether general or special (except trust and escrow accounts), time or demand and however evidenced), and (ii) pending any such action, to the extent necessary, to hold such amounts as collateral to secure such obligations and liabilities and to return as unpaid for insufficient funds any and all checks and other items drawn against any deposits so held as Bank, in its sole discretion, may elect. Borrower hereby grants to Bank a security interest in all deposits and accounts maintained with Bank and with any other financial institution to secure the -8- 28 payment of all obligations and liabilities of Borrower to Bank under this Note. (f) Business Purpose. Borrower represents and warrants that all loans evidenced by this Note are for a business, commercial, investment, agricultural or other similar purposes and not primarily for a personal, family or household use. (g) Certain Tri-Party Accounts. Borrower and Bank agree that Tex. Civ. Stat. Ann. Art. 5089, ch. 15 (which regulates certain revolving credit loan accounts and revolving tri-party accounts) shall not apply to any revolving loan accounts created under this Note or maintained in connection herewith. NOTICE: THIS NOTE AND ALL OTHER DOCUMENTS RELATING TO THE INDEBTEDNESS EVIDENCED HEREBY CONSTITUTE A WRITTEN LOAN AGREEMENT WHICH REPRESENTS THE FINAL AGREEMENT BETWEEN THE PARTIES AND MAY NOT BE CONTRADICTED BY EVIDENCE OF PRIOR, CONTEMPORANEOUS OR SUBSEQUENT ORAL AGREEMENTS OF THE PARTIES. THERE ARE NO UNWRITTEN ORAL AGREEMENTS BETWEEN THE PARTIES RELATING TO THIS NOTE AND THE INDEBTEDNESS EVIDENCED HEREBY. IN WITNESS WHEREOF, the undersigned has executed this Note as of the date first written above. GADZOOKS, INC. By: --------------------------- MONTY STANDIFER CHIEF FINANCIAL OFFICER -9- EX-10.10 3 SEVERANCE AGREEMENT 1 Exhibit 10.10 SEVERANCE AGREEMENT Agreement made on September 5, 1996, between Gadzooks, Inc., a Texas corporation (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 the termination of the Executive's employment with 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. Termination by the Company without Cause. The Company may at any time terminate Executive's employment without Cause (as defined below) by giving Executive notice of the effective date of termination (which effective date may be the date of such notice). In the event of such termination without Cause, the Company shall have the continuing obligation to make payments of base salary at the rate in effect at the effective date of such termination for a period of twelve (12) months following the effective date of such termination. The Executive will also receive the cash bonus he would have received had the Company achieved the budgeted financial performance for the fiscal year in which such termination occurs, irrespective of whether the Company actually meets such budgeted financial performance goals for such fiscal year. Such cash bonus payment shall be made when payments are otherwise made to executive officers under the Company's cash bonus plan, but in no event later than 120 days after the end of the fiscal year in which such termination occurred. In addition, the Company will continue to pay premiums for Executive's health insurance coverage under the Company's health insurance plan for a period of twelve (12) months following the effective date of such termination. 2. Termination by the Company for Cause. 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") by giving Executive written notice of the effective date of termination (which effective date may be the date of such notice): (A) any act of fraud or dishonesty with respect to any aspect of the Company's or any affiliate's business; (B) 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 2 administrative proceeding seeking an injunction from further violations or a suspension of any right or privilege; (C) 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; or (D) conviction of a felony or of a crime involving moral turpitude. If the Company terminates Executive's employment for any of the reasons set forth above in this Section 2, the Company shall have no further obligations hereunder from and after the effective date of termination and shall have all other rights and remedies available under this or any other agreement and at law or in equity. 3. Voluntary Termination by Executive. In the event that Executive's employment with the Company is terminated by Executive, the Company shall have no further obligations hereunder from and after the date of such termination. 4. Complete Agreement. This Agreement embodies the complete agreement and understanding between the parties and supersedes and preempts any prior understandings, agreements or representations by or between the parties, written or oral, which may have related to the subject matter hereof in any way. Any severance arrangements or agreements between the Company and Executive that existed at any time prior to the execution and delivery of this Agreement are hereby terminated by Executive; provided, however, that Executive shall remain liable for any breach of such arrangements or agreements occurring during the term of such arrangement or agreement. From and after the date of this Agreement, Executive shall not be entitled to any compensation from the Company on account of any such arrangement or agreement. IN WITNESS WHEREOF, the parties have caused this Agreement to be duly executed and delivered on the day and year first above written. GADZOOKS, INC. By: /s/ Monty R. Standifer ---------------------------------- Name: Monty R. Standifer Title: Senior Vice President and CFO /s/ Gerald R. Szczepanski --------------------------------------- Gerald R. Szczepanski 2 EX-10.11 4 FORM OF SEVERANCE AGREEMENT 1 Exhibit 10.11 SEVERANCE AGREEMENT Agreement made on ________________________, 1996, between Gadzooks, Inc., a Texas corporation (the "Company"), and _____________________ ("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 the termination of the Executive's employment with 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. Termination by the Company without Cause. The Company may at any time terminate Executive's employment without Cause (as defined below) by giving Executive notice of the effective date of termination (which effective date may be the date of such notice). In the event of such termination without Cause, the Company shall have the continuing obligation to make payments of base salary at the rate in effect at the effective date of such termination for a period of six (6) months following the effective date of such termination. In addition, the Company will continue to pay premiums for Executive's health insurance coverage under the Company's health insurance plan for a period of six (6) months following the effective date of such termination. 2. Termination by the Company for Cause. 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") by giving Executive written notice of the effective date of termination (which effective date may be the date of such notice): (A) any act of fraud or dishonesty with respect to any aspect of the Company's or any affiliate's business; (B) 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; (C) 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 2 appropriate action to prevent, any material injury to the financial condition or business reputation of the Company or any affiliate; or (D) conviction of a felony or of a crime involving moral turpitude. If the Company terminates Executive's employment for any of the reasons set forth above in this Section 2, the Company shall have no further obligations hereunder from and after the effective date of termination and shall have all other rights and remedies available under this or any other agreement and at law or in equity. 3. Voluntary Termination by Executive. In the event that Executive's employment with the Company is terminated by Executive, the Company shall have no further obligations hereunder from and after the date of such termination. 4. Complete Agreement. This Agreement embodies the complete agreement and understanding between the parties and supersedes and preempts any prior understandings, agreements or representations by or between the parties, written or oral, which may have related to the subject matter hereof in any way. Any severance arrangements or agreements between the Company and Executive that existed at any time prior to the execution and delivery of this Agreement are hereby terminated by Executive; provided, however, that Executive shall remain liable for any breach of such arrangements or agreements occurring during the term of such arrangement or agreement. From and after the date of this Agreement, Executive shall not be entitled to any compensation from the Company on account of any such arrangement or agreement. IN WITNESS WHEREOF, the parties have caused this Agreement to be duly executed and delivered on the day and year first above written. GADZOOKS, INC. By: ---------------------------------- Name: -------------------------------- Title: ------------------------------- ------------------------------------- [Executive] 2 3 SCHEDULE OF SIGNATORIES Monty R. Standifer Loretta S. Beck William S. Kotch III Georgia A. Taylor EX-10.13 5 AMENDMENT NO. 5 TO 1992 STOCK OPTION PLAN 1 Exhibit 10.13 AMENDMENT NO. 5 TO THE GADZOOKS, INC. 1992 INCENTIVE AND NONSTATUTORY STOCK OPTION PLAN WHEREAS, pursuant to Section 9(a) of the 1992 Incentive and Nonstatutory Stock Option Plan, as amended (the "Plan"), any option granted under the Plan is exercisable at such times and under such conditions as determined by the Board of Directors (the "Board") of Gadzooks, Inc. (the "Company"); WHEREAS, pursuant to Section 13(a) of the Plan, the Board may amend the Plan from time to time; and WHEREAS, the Board has approved the following amendment to the Plan. NOW THEREFORE, the Plan is hereby amended as follows: (1) The first paragraph of Section 9(a) of the Plan is hereby amended to read in its entirety as follows: (a) Procedure for Exercise; Rights as a Stockholder. Any Option granted hereunder shall be exercisable at such times and under such conditions as determined by the Board, including performance criteria with respect to the Company and/or the Optionee, and as shall be permissible under the terms of the Plan. Notwithstanding the foregoing, in the event of (i) a proposed sale of substantially all of the Common Stock of the Company, (ii) a proposed sale of substantially all of the assets of the Company, (iii) a proposed merger in which the Company is not to be the surviving corporation (other than with a subsidiary of the Company) or (iv) any other proposed extraordinary corporate transaction which, in the judgment of the Board, might deprive the Optionee of the full value of the Options granted hereunder, the Company shall forward written notification of such transaction to the Optionee, and the Optionee shall have thirty (30) days in which to exercise all or any portion of the Optionee's Options granted hereunder, including any portion of the Optionee's Options which have not yet vested as of such date (to the extent such Options have not been previously exercised), pursuant to the procedure set forth below. Upon the conclusion of such thirty-day period, unless otherwise determined by the Board, all rights of the Optionee hereunder shall terminate. Any exercise of Options by the Optionee shall be effective immediately prior to the occurrence of the transaction giving rise to the right to exercise the Options and, to the extent such transaction does not occur, the exercise shall be deemed rescinded and the Optionee shall again only be entitled to exercise its Options according to the vesting schedules set forth in the Optionee's Option Agreements issued pursuant to Section 16 hereof. 2 IN WITNESS WHEREOF, the Company has caused its duly authorized officer to execute this Amendment No. 5 as of the 12th day of September, 1996. GADZOOKS, INC. By: /s/ Monty R. Standifer -------------------------------- Name: Monty R. Standifer Title: Senior Vice President and CFO EX-10.14 6 AMENDMENT NO. 1 TO 1994 STOCK OPTION PLAN 1 Exhibit 10.14 AMENDMENT NO. 1 TO THE GADZOOKS, INC. 1994 INCENTIVE AND NONSTATUTORY STOCK OPTION PLAN FOR KEY EMPLOYEES WHEREAS, pursuant to Section 9(a) of the 1994 Incentive and Nonstatutory Stock Option Plan for Key Employees (the "Plan"), any option granted under the Plan is exercisable at such times and under such conditions as determined by the Board of Directors (the "Board") of Gadzooks, Inc. (the "Company"); WHEREAS, pursuant to Section 13(a) of the Plan, the Board may amend the Plan from time to time; and WHEREAS, the Board has approved the following amendment to the Plan. NOW THEREFORE, the Plan is hereby amended as follows: (1) The first paragraph of Section 9(a) of the Plan is hereby amended to read in its entirety as follows: (a) Procedure for Exercise; Rights as a Stockholder. Any Option granted hereunder shall be exercisable at such times and under such conditions as determined by the Board, including performance criteria with respect to the Company and/or the Optionee, and as shall be permissible under the terms of the Plan. Notwithstanding the foregoing, in the event of (i) a proposed sale of substantially all of the Common Stock of the Company, (ii) a proposed sale of substantially all of the assets of the Company, (iii) a proposed merger in which the Company is not to be the surviving corporation (other than with a subsidiary of the Company) or (iv) any other proposed extraordinary corporate transaction which, in the judgment of the Board, might deprive the Optionee of the full value of the Options granted hereunder, the Company shall forward written notification of such transaction to the Optionee, and the Optionee shall have thirty (30) days in which to exercise all or any portion of the Optionee's Options granted hereunder, including any portion of the Optionee's Options which have not yet vested as of such date (to the extent such Options have not been previously exercised), pursuant to the procedure set forth below. Upon the conclusion of such thirty-day period, unless otherwise determined by the Board, all rights of the Optionee hereunder shall terminate. Any exercise of Options by the Optionee shall be effective immediately prior to the occurrence of the transaction giving rise to the right to exercise the Options and, to the extent such transaction does not occur, the exercise shall be deemed rescinded and the Optionee shall again only be entitled to exercise its Options according to the vesting schedules set forth in the Optionee's Option Agreements issued pursuant to Section 16 hereof. 2 IN WITNESS WHEREOF, the Company has caused its duly authorized officer to execute this Amendment No. 1 as of the 12th day of September, 1996. GADZOOKS, INC. By: /s/ Monty R. Standifer ----------------------------------- Name: Monty R. Standifer Title: Senior Vice President and CFO EX-13 7 ANNUAL REPORT TO SECURITY HOLDERS 1 SELECTED FINANCIAL DATA
($ in thousands, except operating data and per share amounts) Fiscal Year Ended - --------------------------------------------------------------------------------------------------------------------- FEBRUARY 1, January 27, January 28, January 29, January 30, 1997 1996 1995 1994 1993 ----------- ----------- ----------- ----------- ----------- INCOME STATEMENT DATA: Net sales $ 128,388 $ 84,602 $ 56,463 $ 38,239 $ 25,368 Cost of goods sold 87,418 58,015 38,379 25,699 17,427 --------- --------- --------- --------- --------- Gross profit 40,970 26,587 18,084 12,540 7,941 Selling, general and administrative expenses 29,212 19,794 14,452 10,315 6,765 Provision for closing outlet stores -- -- 250 -- -- --------- --------- --------- --------- --------- Operating income 11,758 6,793 3,382 2,225 1,176 Interest income (expense), net 945 (179) (240) (81) (17) --------- --------- --------- --------- --------- Income before income taxes 12,703 6,614 3,142 2,144 1,159 Provision for income taxes 4,712 2,538 1,201 817 447 --------- --------- --------- --------- --------- Net income $ 7,991 $ 4,076 $ 1,941 $ 1,327 $ 712 ========= ========= ========= ========= ========= Net income per share $ 0.87 $ 0.60 $ 0.32 $ 0.24 $ 0.13 Weighted average shares outstanding 9,143 6,742 5,976 5,506 5,416 SELECTED OPERATING DATA: Comparable store sales increase(1) 6.1% 14.7% 8.4% 3.5% 19.6% Number of stores at year end 183 126 90 65 43 Average net sales per store $ 814,838 $ 776,807 $ 698,108 $ 680,651 $ 692,736 Average net sales per square foot $ 356 $ 343 $ 306 $ 306 $ 346 Total square footage at end of period 421,572 284,953 204,711 148,338 97,920 Operating income percentage 9.2% 8.0% 6.0% 5.8% 4.6% Capital expenditures (in 000s) $ 6,864 $ 5,959 $ 3,445 $ 2,426 $ 1,562 BALANCE SHEET DATA: Working capital $ 34,333 $ 20,368 $ 4,262 $ 2,014 $ 1,937 Total assets $ 64,747 $ 45,611 $ 19,836 $ 13,471 $ 9,038 Total debt -- $ 178 $ 3,026 $ 972 $ 211 Redeemable preferred stock and cumulative dividends -- -- $ 10,631 $ 6,856 $ 6,342 Shareholders' equity (deficit) $ 49,063 $ 30,765 $ (2,204) $ (1,436) $ (2,249)
(1) A store becomes comparable after it has been open for 14 full fiscal months. 15 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GENERAL Gadzooks is a rapidly growing, mall-based specialty retailer of casual apparel and related accessories for young men and women principally between the ages of 13 and 19. The Company opened its first store in 1983, and at year-end 1996, operated 183 stores in 24 states throughout the Mid-Atlantic, Midwest, Southeast and Southwest, regions of the United States. Since fiscal 1992, the Company has been on a rapid expansion program, opening 23 new stores in fiscal 1993, 26 new stores in fiscal 1994, 39 new stores in fiscal 1995, and 57 new stores in 1996. RESULTS OF OPERATIONS The following table sets forth for the periods indicated certain selected income statement data expressed as a percentage of net sales and certain store data:
Fiscal Year - ------------------------------------------------------------------------------ 1996 1995 1994 ----- ----- ----- Net sales 100.0% 100.0% 100.0% Cost of goods sold, including buying, distribution 68.1 68.6 68.0 and occupancy costs ----- ----- ----- Gross profit 31.9 31.4 32.0 Selling, general and administrative expenses 22.7 23.4 25.6 Provision for closing outlet stores -- -- 0.4 ----- ----- ----- Operating income 9.2 8.0 6.0 Interest income (expense), net .7 (0.2) (0.4) ----- ----- ----- Income before income taxes 9.9 7.8 5.6 Provision for income taxes 3.7 3.0 2.1 ----- ----- ----- Net income 6.2% 4.8% 3.5% ===== ===== ===== Number of stores open at end of period 183 126 90
FISCAL 1996 COMPARED TO FISCAL 1995 Net sales increased approximately $43.8 million, or 51.8%, to $128.4 million during fiscal 1996 from $84.6 million in fiscal 1995. Net sales of the 57 new stores opened during fiscal 1996 and for those stores not yet qualifying as comparable stores contributed $39.0 million of the increase in sales. Comparable store sales increased 6.1% in fiscal 1996 and contributed $4.7 million of the increase in sales. The increase in comparable store sales was primarily due to continuous improvements in merchandise assortments supported by strong sales in the junior and young men categories. A store becomes comparable after it has been open for 14 full fiscal months. Fiscal 1996 was a 53 week period. The fifty-third week contributed $1.9 million to the increase in net sales. Gross profit increased approximately $14.4 million to $41.0 million in fiscal 1996 from $26.6 million in fiscal 1995. As a percentage of sales, gross profit increased to 31.9% in fiscal 1996 from 31.4% in fiscal 1995 due to slightly higher merchandise margins and a decrease in buying and distribution costs as a percentage of sales resulting from the Company's larger store base. Selling, general and administrative expenses increased approximately $9.4 million to $29.2 million during fiscal 1996 from $19.8 million in fiscal 1995, but decreased as a percentage of sales to 22.7% in fiscal 1996 from 23.4% in fiscal 1995. The decrease as a percentage of sales was due to the leveraging of certain store and corporate overhead expenses as a percentage of sales, primarily as a result of the comparable store sales increases achieved during the year and the Company's larger store base. 16 3 Operating income increased approximately $5.0 million to $11.8 million during fiscal 1996 from $6.8 million in fiscal 1995. As a percentage of sales, operating income increased to 9.2% in fiscal 1996 from 8.0% in fiscal 1995. Net interest income increased approximately $1.1 million to $0.9 million net interest income during fiscal 1996 from $0.2 million net interest expense in fiscal 1995. The Company's interest income increased due to temporary investments of cash available from the two public stock offerings completed in October 1995 and January 1996. Income tax expense was $4.7 million for fiscal 1996, compared to $2.5 million in fiscal 1995. The effective income tax rate in fiscal 1996 was 37.1%, compared to 38.4% in fiscal 1995. The lower effective income tax rate for fiscal 1996 compared to fiscal 1995 was primarily attributable to higher amounts of non-taxable interest income in fiscal 1996. FISCAL 1995 COMPARED TO FISCAL 1994 Net sales increased approximately $28.1 million, or 49.8%, to $84.6 million during fiscal 1995 from $56.5 million in fiscal 1994. Net sales for the 39 new stores opened during fiscal 1995 and for those stores not yet qualifying as comparable stores contributed $20.6 million of the increase in sales. Comparable store sales increased 14.7% in fiscal 1995 and contributed $7.5 million of the increase in sales. The increase in comparable store sales was primarily due to continued improvements in merchandise assortments and better in-stock positions in the stores as a result of improvements in the Company's inventory planning and allocation systems implemented during the fourth quarter of fiscal 1994. Gross profit increased approximately $8.5 million to $26.6 million in fiscal 1995 from $18.1 million in fiscal 1994. As a percentage of sales, gross profit decreased to 31.4% in fiscal 1995 from 32.0% in fiscal 1994 due to increased buying and distribution costs primarily resulting from the addition of a general merchandising manager and related merchandising staff in late 1994. Selling, general and administrative expenses increased approximately $5.3 million to $19.8 million during fiscal 1995 from $14.5 million in fiscal 1994, but decreased as a percentage of sales to 23.4% in fiscal 1995 from 25.6% in fiscal 1994. The increase in aggregate selling, general and administrative expenses was primarily due to the larger number of stores in operation. The decrease as a percentage of sales was primarily due to a reduction in store operating expenses as a percentage of sales due to comparable store sales increases, and to a lesser extent, a reduction in corporate overhead expense as a percentage of sales due to operating leverage achieved through the Company's larger store base. Operating income increased approximately $3.4 million to $6.8 million during fiscal 1995 from $3.4 million in fiscal 1994. As a percentage of sales, operating income increased to 8.0% in fiscal 1995 from 6.0% in fiscal 1994. Net interest expense decreased approximately $61,000 during fiscal 1995 from fiscal 1994, primarily due to a reduction in average bank borrowings during the fourth quarter of fiscal 1995 as a result of the utilization of funds received from the Company's initial public offering in October 1995. QUARTERLY RESULTS AND SEASONALITY The Company's quarterly results of operations may fluctuate materially depending on, among other things, the timing of new store openings and related pre-opening expenses, net sales contributed by new stores, increases or decreases in comparable store sales, and changes in the Company's merchandise mix. The Company's business is also subject to seasonal influences, with slightly higher sales during the Christmas holiday, back-to-school, and spring break seasons. The Christmas holiday season remains the Company's single most important selling season. The Company believes, however, that the significance of the back-to-school season 17 4 (which affects operating results in the second and third quarters) and spring break season (which affects operating results in the first quarter) reduces somewhat the Company's dependence on the Christmas holiday selling season. As is the case with many apparel retailers, the Company's net sales and net income are typically lower in the first quarter. The Company has experienced first quarter losses in the past and may experience such losses in the future. The following table sets forth certain statement of operations and operating data for each of the Company's last eight fiscal quarters. The quarterly data set forth below were derived from unaudited financial statements of the Company, which in the opinion of management of the Company, contain all adjustments (consisting only of normal recurring adjustments) necessary for fair presentation thereof. Results for any quarter are not necessarily indicative of results that may be achieved for a full fiscal year.
(In thousands, except operating and per share data) Fiscal 1996 Fiscal 1995 - ------------------------------------------------------------------------------------------------------------- FIRST SECOND THIRD FOURTH First Second Third Fourth QUARTER QUARTER QUARTER QUARTER Quarter Quarter Quarter Quarter Statement of Operations Data: Net sales $23,486 $28,504 $31,171 $45,227 $15,999 $18,408 $20,346 $29,849 Gross profit 6,947 8,870 9,834 15,320 4,563 5,619 6,272 10,132 Operating income 961 2,447 2,789 5,561 455 1,280 1,578 3,480 Net income 738 1,647 1,918 3,689 231 696 930 2,218 Net income per share $ 0.08 $ 0.18 $ 0.21 $ 0.41 $ 0.04 $ 0.11 $ 0.14 $ 0.26 Weighted average shares outstanding 9,030 9,116 9,119 9,083 6,075 6,064 6,860 8,408 Selected Operating Data: Stores open at end of period 146 160 174 183 101 111 115 126
LIQUIDITY AND CAPITAL RESOURCES GENERAL. During the last three fiscal years, the Company's primary uses of cash have been to finance new store openings and purchase merchandise inventories. The Company has satisfied its cash requirements principally from proceeds of the sale of equity securities, borrowings under bank credit facilities and cash flow from operations. CASH FLOWS. During fiscal 1996, 1995, and 1994, cash flows from operating activities were $5.6 million, $4.0 million, and $0.3 million, respectively. The Company's net income has increased in each of the last three fiscal years. However, cash flows from operating activities decreased in fiscal 1994 primarily as a result of an increase in inventory, principally in connection with new store openings. While the increase in inventory was partially financed through vendor trade credit, accounts payable did not increase in proportion to the increase in inventory during fiscal 1994 due to changes in the factoring of accounts receivable by many of the Company's vendors, which effectively shortened the Company's payment terms. Since the Company's initial public offering, vendor credit terms have become more favorable to the Company. Cash used in investing activities was approximately $19.3 million, $6.0 million, and $3.4 million for fiscal 1996, 1995, and 1994, respectively. The Company spent $6.9 million in capital expenditures during fiscal 1996, the majority of which was used to open new stores. The Company opened 57, 39, and 26 stores in fiscal 1996, 1995, and 1994, respectively. In addition, $12.4 million of capital resources, in excess of current working capital needs, was used to purchase highly liquid investments during fiscal 1996. Net cash flow provided by financing activities was $10.3 million, $15.4 million, and $3.1 million for fiscal 1996, 1995, and 1994, respectively. During fiscal 1996, the Company received $9.1 million from a secondary public offering and 18 5 $1.2 million as a tax benefit from the exercise of employee stock options. During fiscal 1995, the Company received $20.1 million from its initial public offering and $1.6 million from borrowings on a bank term loan. The Company used $4.4 million for payment on the bank term loan and capital lease obligations, and $2.1 million for payment of cash dividends to holders of Preferred Stock. During fiscal 1994, the Company received $3.0 million from proceeds of a bank term loan and $3.1 million from the issuance of Class A and Class B Preferred Stock. The Company used $2.0 million of proceeds of the Class A Preferred Stock issuance to repurchase Common Stock pursuant to the terms of the Class A Purchase Agreement. In addition, the Company used $0.5 million for repayments on its bank revolving line of credit and $0.4 million for payments on long-term obligations. CREDIT FACILITY. The Company currently has a loan agreement ("Credit Facility") with Wells Fargo Bank which provides for an unsecured revolving line of credit totaling $10.0 million, which bears interest at the lesser of either Prime Rate or 1.95% above LIBOR. The current bank Credit Facility matures on June 5, 1998. The Credit Facility also provides for the issuance of letters of credit under the revolving line that are generally used in certain circumstances in connection with merchandise purchases. At February 1, 1997, no amounts were outstanding under the Credit Facility. The Credit Facility also subjects the Company to various restrictions on the incurrence of additional indebtedness, acquisitions, loans to officers and stock repurchases. The covenants require the Company to maintain a certain minimum current ratio, minimum tangible net worth, minimum working capital, and coverage ratios each month. CAPITAL EXPENDITURES. The Company anticipates that it will spend approximately $7.0 million in capital expenditures to open 55 to 60 new stores and to remodel six or seven existing stores in fiscal 1997. During fiscal 1996, the Company spent $6.2 million in capital expenditures to open 57 new stores and remodel four existing stores and $0.7 million for other capital purchases. The Company's average capital expenditures to construct a new store during fiscal 1996, including leasehold improvements and furniture and fixtures, averaged approximately $167,000 (approximately $100,000 net of landlord construction allowances). The Company anticipates that its cash requirements for opening inventories in stores expected to open in fiscal 1997 will be approximately $4.0 million. The cost of initial inventory for a new store is approximately $100,000; however, the immediate cash requirement for inventory is partially financed through the Company's payable terms with its vendors. Pre-opening costs range from $8,000 to $10,000 for travel, hiring and training, and other miscellaneous costs associated with the setup of a new store prior to its opening for business. Pre-opening costs are expensed in the period when the store opens. The actual costs that the Company will incur in opening new stores cannot be predicted with precision because such costs will vary based upon, among other things, geographic location, the size of the store, and the extent of the build-out required at the selected site. The Company estimates that it will spend approximately $2.0 million to install additional merchandise handling equipment at its new distribution center and to finish-out the new corporate headquarters in the first half of fiscal 1997. The Company may also upgrade and enhance its computer systems for certain distribution functions in the last half of fiscal 1997, which would result in additional capital expenditures of approximately $1.0 million. The Company believes that its existing cash balances, cash generated from operations, and funds available under the Credit Facility will be sufficient to satisfy its cash requirements through fiscal 1997. INFLATION The Company does not believe that inflation has had a material effect on net sales or results of operations. The Company has generally been able to pass on increased costs through increases in selling prices. 19 6 BALANCE SHEETS
- --------------------------------------------------------------------------------------------------------- FEBRUARY 1, January 27, 1997 1996 ----------- ----------- ASSETS Current assets: Cash and cash equivalents $10,347,728 $13,732,644 Short-term investments 12,419,847 -- Accounts receivable 1,283,910 490,769 Inventory 23,211,036 18,707,085 Other current assets 1,329,034 1,161,173 ----------- ----------- 48,591,555 34,091,671 ----------- ----------- Leaseholds, fixtures and equipment, net 16,155,772 11,518,989 ----------- ----------- $64,747,327 $45,610,660 =========== =========== LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable $ 7,654,123 $ 8,495,007 Accrued payroll and benefits 3,135,152 1,867,657 Other current liabilities 2,355,099 1,906,907 Income taxes payable 1,114,662 1,320,769 Current portion of long-term obligations -- 133,256 ----------- ----------- 14,259,036 13,723,596 ----------- ----------- Long-term obligations, less current portion -- 44,716 Accrued rent 1,425,060 1,077,401 Commitments and contingencies (Note 7) Shareholders' equity: Preferred stock, $1.00 par value, 1,000,000 shares authorized, none issued -- -- Common stock, $.01 par value, 25,000,000 shares authorized, 8,584,440 and 5,219,930 shares issued and outstanding, respectively 85,844 52,199 Additional paid-in capital 39,741,021 29,467,782 Retained Earnings 9,236,366 1,244,966 ----------- ----------- 49,063,231 30,764,947 ----------- ----------- $64,747,327 $45,610,660 =========== ===========
The accompanying notes are an integral part of these financial statements. 20 7 STATEMENTS OF INCOME
Fiscal Year Ended - ----------------------------------------------------------------------------------------------------------- FEBRUARY 1, January 27, January 28, 1997 1996 1995 ------------- ------------- ------------- Net sales $ 128,388,380 $ 84,601,819 $ 56,462,742 Costs and expenses: Cost of goods sold, including buying, distribution and occupancy costs 87,417,930 58,015,483 38,378,994 Selling, general and administrative expenses 29,212,565 19,793,831 14,452,161 Provision for closing outlet stores -- -- 250,000 ------------- ------------- ------------- 116,630,495 77,809,314 53,081,155 ------------- ------------- ------------- Operating income 11,757,885 6,792,505 3,381,587 Interest expense (26,367) (347,480) (247,475) Interest income 971,382 168,641 7,894 ------------- ------------- ------------- Income before income taxes 12,702,900 6,613,666 3,142,006 Provision for income taxes 4,711,500 2,538,000 1,201,492 ------------- ------------- ------------- Net income $ 7,991,400 $ 4,075,666 $ 1,940,514 ============= ============= ============= Net income per common and common equivalent share $ 0.87 $ 0.60 $ 0.32 ------------- ------------- ------------- Weighted average common and common equivalent shares outstanding 9,142,921 6,742,416 5,975,836 ============= ============= =============
The accompanying notes are an integral part of these financial statements. 21 8 STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT)
- ------------------------------------------------------------------------------------------------------------------- Common Stock Additional Retained Shares Capital Paid In Earnings Total ------------------------------------------------------------------------ BALANCE, JANUARY 29, 1994 1,428,571 $14,286 $ 30,714 $(1,481,274) $ (1,436,274) Repurchase of common stock (423,280) (4,233) (9,100) (1,986,667) (2,000,000) Accrued preferred stock dividends (666,000) (666,000) Other (42,002) (42,002) Net income 1,940,514 1,940,514 --------- ------- ------------ ----------- ------------ BALANCE, JANUARY 28, 1995 1,005,291 10,053 21,614 (2,235,429) (2,203,762) Issuance of common stock, net of underwriting commissions and expenses 1,687,050 16,871 20,167,697 -- 20,184,568 Conversion of preferred stock 2,527,589 25,275 9,074,726 -- 9,100,001 Accrued preferred stock dividends (500,554) (500,554) Tax benefit from exercise of stock options 203,745 -- 203,745 Other (94,717) (94,717) Net income 4,075,666 4,075,666 --------- ------- ------------ ----------- ------------ BALANCE, JANUARY 27, 1996 5,219,930 52,199 29,467,782 1,244,966 30,764,947 Issuance of common stock, net of underwriting commissions and expenses 400,000 4,000 9,012,586 -- 9,016,586 Stock issued under option plans 131,284 1,313 80,985 -- 82,298 Three-for-two common stock split effected in the form of a 50% stock dividend 2,833,226 28,332 (28,332) -- -- Tax benefit from exercise of stock options 1,208,000 -- 1,208,000 Net Income 7,991,400 7,991,400 --------- ------- ------------ ----------- ------------ BALANCE, FEBRUARY 1, 1997 8,584,440 $85,844 $ 39,741,021 $ 9,236,366 $ 49,063,231 ========= ======= ============ =========== ============
The accompanying notes are an integral part of these financial statements. 22 9 STATEMENTS OF CASH FLOWS
Fiscal Year Ended - ---------------------------------------------------------------------------------------------------------- FEBRUARY 1, January 27, January 28, 1997 1996 1995 ------------ ------------ ------------ Cash flows from operating activities: Net income $ 7,991,400 $ 4,075,666 $ 1,940,514 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation 2,227,401 1,461,265 990,223 Deferred income taxes (347,500) (117,287) (284,995) Provision for closing outlet stores -- -- 250,000 Changes in operating assets and liabilities: Accounts receivable (793,141) (162,751) (55,190) Inventory (4,503,951) (6,974,472) (3,901,016) Other assets 179,639 (611,328) 122,327 Accounts payable (840,884) 3,625,800 147,946 Accrued payroll and benefits 1,267,495 769,352 528,280 Income taxes payable (206,107) 657,311 182,249 Other liabilities 662,595 1,232,423 409,812 ------------ ------------ ------------ Net cash provided by operating activities 5,636,947 3,955,979 330,150 ------------ ------------ ------------ Cash flows from investing activities: Capital expenditures, net (6,864,184) (5,958,770) (3,444,916) Purchases of short-term investments (14,129,847) -- -- Proceeds from redemption of short-term investments 1,710,000 -- -- ------------ ------------ ------------ Net cash used in investing activities (19,284,031) (5,958,770) (3,444,916) ------------ ------------ ------------ Cash flows from financing activities: Repayments of line of credit -- -- (500,000) Principal payments on long-term obligations (44,716) (4,419,729) (446,076) Proceeds from term note -- 1,572,000 3,000,000 Issuance of preferred stock, net -- -- 3,066,787 Issuance of common stock, net 9,098,884 20,184,567 -- Repurchase of common stock -- -- (2,000,000) Payment of preferred stock dividends -- (2,126,554) -- Tax Benefit From Exercise Of Stock Options 1,208,000 203,745 -- ------------ ------------ ------------ Net cash provided by financing activities 10,262,168 15,414,029 3,120,711 ------------ ------------ ------------ Net increase (decrease) in cash and cash equivalents (3,384,916) 13,411,238 5,945 Cash and cash equivalents at beginning of period 13,732,644 321,406 315,461 ------------ ------------ ------------ Cash and cash equivalents at end of period $ 10,347,728 $ 13,732,644 $ 321,406 ============ ============ ============ Cash paid during the year for: Interest $ 20,106 $ 332,099 $ 229,195 Income taxes 4,057,107 1,794,233 1,304,238 Noncash activities: Accrual of preferred stock dividends -- $ 500,554 $ 666,000
The accompanying notes are an integral part of these financial statements. 23 10 NOTES TO FINANCIAL STATEMENTS (1) ORGANIZATION AND NATURE OF THE COMPANY Gadzooks, Inc. (the "Company") is a mall-based, specialty retailer of casual apparel and related accessories for young men and women principally between the ages of 13 and 19. At February 1, 1997, the Company had 183 company-owned stores in operation throughout the Mid-Atlantic, Midwest, Southeast, and Southwest regions of the United States. The Company's fiscal year ends on the Saturday nearest January 31. All references in these financial statements to fiscal years are to the calendar year in which the fiscal year begins. Fiscal years 1996, 1995, and 1994 represent the 52 or 53 week periods ended February 1, 1997, January 27, 1996, and January 28, 1995, respectively. Fiscal 1996 was a 53 week period. (2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES CASH AND CASH EQUIVALENTS Cash and cash equivalents include cash on hand and marketable securities with original maturities of three months or less. SHORT-TERM INVESTMENTS Short-term investments consist of highly liquid investments with original maturities between three and twelve months. Management determines the proper classifications of investments at the time of purchase and reevaluates such designations as of each balance sheet date. At February 1, 1997, all securities are classified as held-to-maturity under the provisions of SFAS No. 115 "Accounting for Certain Investments in Debt and Equity Securities" based on the Company's positive intent and ability to hold the securities to maturity. In accordance with SFAS No. 115, these securities are carried at amortized cost, which approximates fair market value. INVENTORY Inventories are valued at the lower of average cost or market. LEASEHOLDS, FIXTURES AND EQUIPMENT Leaseholds, fixtures and equipment are stated at cost or, in the case of capitalized leases, at the present value of future minimum lease payments. Depreciation of fixtures and equipment is based upon the estimated useful lives of the assets, generally from five to ten years, computed on the straight-line method. Amortization of leasehold improvements is computed on the straight-line method over estimated useful lives or lease terms, if shorter. The Company reviews its long-lived assets for impairment whenever events or changes in circumstances indicate the respective carrying amounts may not be recoverable. REVENUE RECOGNITION Retail merchandise sales are recognized at the point of sale less sales returns. ADVERTISING Advertising costs are expensed when incurred. STORE PRE-OPENING COSTS Costs incurred with the setup of a new store prior to its opening for business are expensed in the period when the store opens. 24 11 INCOME TAXES Deferred income taxes are provided on a liability method. Under this method, deferred tax assets and liabilities are recognized based on differences between the financial statement and the tax bases of assets and liabilities using presently enacted tax rates. EARNINGS PER SHARE AND STOCK SPLITS Earnings per share are computed by dividing net income by the weighted average number of shares outstanding during each period after giving effect to (i) a three-for-two stock split declared by the Board of Directors in May 1996, (ii) a 3.15-to-1 reverse stock split declared by the Board of Directors in July 1995, (iii) the conversion of all redeemable preferred stock into shares of common stock and (iv) common stock equivalents resulting from stock options. Stock options granted with exercise prices below the initial public offering price (see Note 3) during the 12-month period preceding the initial filing date of the initial public offering and through October 5, 1995 have been included in the calculation of common stock equivalents using the treasury stock method as if they were outstanding for all periods prior to the initial public offering. The three-for-two stock split and the 3.15-to-1 reverse stock split have been given retroactive effect in the financial statements. Fully diluted earnings per share do not materially differ from primary earnings per share. USE OF ESTIMATES The preparation of the financial statements in conformity with generally accepted accounting principles requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at February 1, 1997 and January 27, 1996 and the reported amounts of revenues and expenses during each of the three years in the period ended February 1, 1997. Actual results could differ from these estimates. FAIR VALUE OF FINANCIAL INSTRUMENTS All financial instruments classified as current are recorded at cost, which approximates fair value due to the short maturity of these instruments. (3) COMMON STOCK OFFERINGS On October 5, 1995, the Company completed an initial public offering of 1,587,000 shares of common stock that provided net proceeds of $20,662,740. The offering required the automatic conversion of all outstanding shares of the Company's mandatorily redeemable preferred stock into 2,527,589 shares of common stock. Cumulative accrued preferred stock dividends of $2,005,041 and $121,512 for Class A and Class B Preferred Stock, respectively, were paid in cash out of the proceeds of the offering. At the completion of the offering, the Company filed restated articles of incorporation authorizing 1,000,000 shares of undesignated preferred stock and canceling all other classes of preferred stock. On January 31, 1996, the Company completed a secondary offering of 600,000 shares of its common stock (after giving effect to the three-for-two stock split described in Note 2). The Company's net proceeds, after deducting expenses associated with the offering, totaled $9,016,586. 25 12 (4) SHORT-TERM INVESTMENTS The amortized cost and estimated fair market value of investments are as follows:
- --------------------------------------------------------------------------------------- Gross Gross Fair Amortized Unrealized Unrealized Market Cost Gains Losses Value ----------- ----------- ----------- ----------- Commercial paper $ 5,129,733 $ 3,167 $ -- $ 5,132,900 Tax exempt securities backed by 12,846,114 6,735 2,030 12,850,819 municipal bonds Repurchase agreements 1,270,000 -- -- 1,270,000 Other debt securities 900,000 -- 567 899,433 Less cash equivalents 7,726,000 -- -- 7,726,000 ----------- ----------- ----------- ----------- Total investment securities $12,419,847 $ 9,902 $ 2,597 $12,427,152 =========== =========== =========== ===========
Investments classified as held-to-maturity at February 1, 1997 have various maturity dates that do not exceed one year. (5) LEASEHOLDS, FIXTURES AND EQUIPMENT Leaseholds, fixtures and equipment are summarized as follows:
- ------------------------------------------------------------------------ FEBRUARY 1, January 27, 1997 1996 ------------ ------------ Leasehold improvements $ 15,164,836 $ 10,444,481 Fixtures and equipment 7,014,643 4,870,845 ------------ ------------ 22,179,479 15,315,326 Less accumulated depreciation (6,023,707) (3,796,337) ------------ ------------ $ 16,155,772 $ 11,518,989 ============ ============
(6) LONG-TERM OBLIGATIONS
- ------------------------------------------------------------------------------- FEBRUARY 1, January 27, 1997 1996 ---------- ---------- Capital lease obligations $ -- $ 177,972 Less current portion -- (133,256) ---------- ---------- $ -- $ 44,716 ========== ==========
On January 30, 1997, the Company entered into a new credit agreement with Wells Fargo Bank that provides for an unsecured revolving line of credit in the amount of $10 million. The revolving line, under which no amount is outstanding as of February 1, 1997, bears interest at the lesser of either Prime Rate or 1.95% above LIBOR. Any amount 26 13 borrowed under the revolving line of credit becomes due June 5, 1998. The line also provides for the issuance of letters of credit. As of February 1, 1997, none of the available revolving line of credit has been used for the issuance of letters of credit. The bank credit facility subjects the Company to various restrictions on the incurrence of additional indebtedness, acquisitions, loans to officers, and stock repurchases. The covenants also require the Company to maintain a certain minimum current ratio, minimum tangible net worth, minimum working capital and coverage ratios each month. The Company pays commitment fees of 0.50% on the unused portion of the revolving line of credit. (7) LEASES The Company leases store, office, and warehouse space under non-cancelable leases with terms that generally range from five to ten years. Most of the store leases provide for additional rentals on a percentage of store sales and specify rental increases over the term of the lease. Total rent expense under these operating leases was $9,602,618, $6,326,046, and $4,309,819 for fiscal years 1996, 1995, and 1994, respectively. Accrued rent of $1,425,060 as of February 1, 1997 and $1,077,401 as of January 27, 1996 has been provided to account for rent expenses on a straight-line basis. Future minimum lease payments under non-cancelable operating leases as of February 1, 1997 are as follows:
Fiscal year - ------------------------------------------------------------------- 1997 $ 11,612,360 1998 11,876,514 1999 11,677,071 2000 11,487,201 2001 11,375,574 Thereafter 44,039,449 -------------- Total minimum lease payments $ 102,068,169 ==============
The Company paid in full its obligations under capital leases during fiscal 1996. Capital leased assets consisted primarily of computer equipment totaling $214,942, net of accumulated amortization of $233,638 at January 27, 1996. (8) INCOME TAXES The provision for federal and state income taxes consisted of the following:
Fiscal - -------------------------------------------------------------------------------- 1996 1995 1994 ----------- ----------- ----------- Current tax expense $ 5,037,623 $ 2,654,146 $ 1,331,332 Deferred tax benefit (326,123) (116,146) (129,840) ----------- ----------- ----------- $ 4,711,500 $ 2,538,000 $ 1,201,492 =========== =========== ===========
27 14 The provision for income taxes differs from the amount of income taxes, computed by applying the U.S. statutory federal tax rate (34%) to pre-tax income, as a result of the following differences:
Fiscal - ------------------------------------------------------------------------------------------------ 1996 1995 1994 ----------- ----------- ----------- Tax provision at the statutory corporate rate $ 4,318,986 $ 2,248,646 $ 1,068,282 State income taxes, net of related federal tax effect 418,449 211,564 117,786 Other, net (25,935) 77,790 15,424 ----------- ----------- ----------- Provision for income taxes $ 4,711,500 $ 2,538,000 $ 1,201,492 =========== =========== ===========
Deferred tax assets (liabilities) comprised the following:
- ------------------------------------------------------------------- FEBRUARY 1, January 27, 1997 1996 ----------- ----------- Deferred tax assets: Accruals not currently deductible $ 631,240 $ 439,565 Depreciation 427,442 142,517 Other -- 20,495 ----------- ----------- 1,058,682 602,577 Deferred tax liabilities: Capital leases (174,946) (105,537) Other (91,977) (52,778) ----------- ----------- (266,923) (158,315) ----------- ----------- $ 791,759 $ 444,262 =========== ===========
At February 1, 1997 and January 27, 1996, $502,211 and $459,250, respectively, of net current deferred tax assets were classified as other current assets. The early disposition of certain qualified stock options in fiscal 1996 and 1995 resulted in an income tax benefit to the Company of $1,208,000 and $203,745, respectively, that was credited to additional paid-in capital. The income tax benefit is the tax effect of the difference between the market price on the date of exercise and the option price. (9) EMPLOYEE BENEFIT PLANS Effective January 1, 1995, the Company established the Gadzooks, Inc. Employees' Savings Plan (the "401(k) Plan"). The 401(k) Plan is open to substantially all employees who have been employed for one year and who work at least 1,000 hours per year. Under the 401(k) Plan, a participant may contribute up to 15% of earnings with the Company matching 50% of the employee's first 4% contribution. Employee and Company contributions are paid to a corporate trustee and invested in various funds at the discretion of the participant. Company contributions made to participants' accounts become 100% vested on the fifth anniversary of the employee's participation in the Plan. For the years ended February 1, 1997 and January 27, 1996, the Company contributed $88,150 and $67,171, respectively, in matching contributions to the 401(k) Plan. 28 15 (10) STOCK OPTION PLANS The Company has three incentive and nonstatutory stock option plans. The "Employee Plan" for employees and consultants was adopted in February 1992; the "Key Employee Plan" for key employees was adopted in September 1994; and the "Nonemployee Director Plan" for the Company's outside directors was adopted in August 1995. Under these plans, options are granted to purchase common stock at a price no less than fair market value at the grant date. For options granted prior to the initial public offering, the board of directors considered various factors in determining fair market value including, among other things, the rights and preferences of holders of other securities issued by the Company, the financial position and results of operations of the Company, and the liquidity of the Company's common stock. Subsequent to the initial public offering, all shares have been granted at the closing price of the Company's common stock traded on the NASDAQ National Market on the date of grant. Options have vesting periods of generally three to five years from date of grant, and may be exercised at any time once they become vested, but not more than 10 years from date of grant. During fiscal 1995, plans were amended to adjust the maximum aggregate number of shares that may be optioned and sold under the plans to 900,000 shares for the Employee Plan and 272,651 for the Key Employee Plan. The maximum aggregate number of shares that may be optioned and sold under the Nonemployee Director Plan is 30,000 shares. The following table includes option information for the Employee Plan, Key Employee Plan, and Nonemployee Director Plan:
1996 1995 1994 - ------------------------------------------------------------------------------------------------------------------------- WEIGHTED Weighted Weighted AVERAGE Average Average EXERCISE Exercise Exercise SHARES PRICE Shares Price Shares Price ------- ----------- ------- ----------- ------- ----------- Outstanding at beginning of year 675,946 $ 2.13 867,474 $ 1.79 340,678 $ 0.23 Granted 139,115 $ 19.70 141,787 $ 4.48 562,509 $ 2.64 Exercised (154,418) $ 0.53 (150,117) $ 1.11 -- -- Canceled (5,354) $ 10.22 (183,198) $ 3.13 (35,713) $ 0.31 ------- ----------- ------- ----------- ------- ----------- Outstanding at end of year 655,289 $ 6.23 675,946 $ 2.13 867,474 $ 1.79 ------- ----------- ------- ----------- ------- ----------- Available for grant at end of year 242,830 378,858 63,136 ------- ------- ------- -----------
The following table summarizes information about stock options outstanding at February 1, 1997:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE - ----------------------------------------------------------- ------------------------- Weighted Average Weighted Weighted Range of Number Remaining Average Number Average Exercise Outstanding Contractual Exercise Exercisable Exercise Prices at 2/1/97 Life Price at 2/1/97 Price - ----------------------------------------------------------- ------------------------- $ 0.21 - $ 0.53 159,746 7 years $ 0.39 84,289 $ 0.30 $ 1.05 - $ 1.05 48,097 8 years $ 1.05 22,869 $ 1.05 $ 3.15 - $3.15 227,209 7 years $ 3.15 136,326 $ 3.15 $ 5.78 - $17.83 128,737 9 years $ 10.54 11,655 $ 6.99 $ 18.50 - $29.00 88,500 9 years $ 20.31 0 $ 0.00 $ 33.25 - $33.25 3,000 9 years $ 33.25 0 $ 0.00 - ----------------------------------------------------------- ------------------------- $ 0.21 - $33.25 655,289 255,139
29 16 During 1996, the Company has adopted the disclosure-only provision of SFAS No. 123, "Accounting for Stock-Based Compensation," which generally establishes financial accounting and reporting standards for stock-based employee compensation plans. As permitted, the Company measures and records compensation expense in accordance with current practices as prescribed by Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" and provides disclosure about pro forma compensation expense. Such adoption did not result in a charge to earnings in the Company's financial statements. If the Company had elected to recognize compensation expense based on the fair value of options granted at the grant date as prescribed by SFAS No. 123, net income and earnings per share would have been reduced to the pro forma amounts indicated in the following table:
- ----------------------------------------------------------------- 1996 1995 ----------- ----------- Net income - as reported $ 7,991,400 $ 4,075,666 Net income - pro forma $ 7,654,272 $ 4,037,156 Earnings per share - as reported $ .87 $ .60 Earnings per share - pro forma $ .84 $ .60
The fair value of each option grant is estimated on the date of grant using the Black-Scholes Multiple Option pricing model with the following weighted-average assumptions used for grants:
- ------------------------------------------------------ 1996 1995 ---------- ---------- Expected volatility 70% 70% Risk-free interest rate 6.4% 6.3% Expected lives 3.6 years 3.5 years Dividend yield 0% 0%
The weighted average fair value of options granted is $9.52 and $2.16 per share for fiscal 1996 and 1995, respectively. (11) PROVISION FOR CLOSING OUTLET STORES In January 1995, the Company decided to close its two outlet stores and recorded a provision of $250,000 to cover the write-down of inventory and fixed assets of $205,000 and estimated lease termination costs of $45,000. The closing of the outlets was completed during fiscal 1995. No significant adjustments were made to the provision. 30 17 GADZOOKS, INC. REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Shareholders of Gadzooks, Inc. In our opinion, the accompanying balance sheets and the related statements of income, shareholders' equity (deficit) and of cash flows present fairly, in all material respects, the financial position of Gadzooks, Inc. at February 1, 1997 and January 27, 1996, and results of its operations and its cash flows for each of the three years in the period ended February 1, 1997 in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. /s/ PRICE WATERHOUSE LLP Dallas, Texas March 12, 1997 31 EX-23.1 8 CONSENT OF PRICE WATERHOUSE LLP 1 EXHIBIT 23.1 CONSENT OF INDEPENDENT ACCOUNTANTS We hereby consent to the incorporation by reference in the Registration Statements on Form S-8 (Nos. 33-98038 and 333-12097) of Gadzooks, Inc. of our report dated March 12, 1997 appearing on page 31 of the 1996 Annual Report to Shareholders, which is incorporated in this Report on Form 10-K. /s/ PRICE WATERHOUSE LLP PRICE WATERHOUSE LLP Dallas, Texas April 22, 1997 EX-27 9 FINANCIAL DATA SCHEDULE
5 YEAR FEB-01-1997 JAN-28-1996 FEB-01-1997 10,347,728 12,419,847 1,283,910 0 23,211,036 1,329,034 22,179,479 6,023,707 64,747,327 15,684,096 0 0 0 85,844 48,977,387 64,747,327 128,388,380 0 87,417,930 0 29,212,565 0 (945,015) 12,702,900 4,711,500 0 0 0 0 7,991,400 .87 0
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