-----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, BaYf0lK41xpL6m4jcfNwBSFUsjlKq8TraTgsqUP4diPf5JyE0wti7rqNIcrQUD9z drgnjLm4cLE3N5NeCh9+rg== 0000950134-99-003360.txt : 19990430 0000950134-99-003360.hdr.sgml : 19990430 ACCESSION NUMBER: 0000950134-99-003360 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 19990130 FILED AS OF DATE: 19990429 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-K SEC ACT: SEC FILE NUMBER: 000-26732 FILM NUMBER: 99604852 BUSINESS ADDRESS: STREET 1: 4121 INTERNATIONAL PKWY CITY: CARROLLTON STATE: TX ZIP: 75007 BUSINESS PHONE: 9723075555 MAIL ADDRESS: STREET 1: 4121 INTERNTIONAL PKWY CITY: CARROLLTON STATE: TX ZIP: 75007 10-K 1 FORM 10-K FOR FISCAL YEAR END JANUARY 30, 1999 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 JANUARY 30, 1999 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 CARROLLTON, TEXAS 75007 (Address of principal executive offices) (Zip Code) REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (972) 307-5555 Securities Registered Pursuant to Section 12(b) of the Act: NONE Securities Registered Pursuant to Section 12(g) of the Act: TITLE OF EACH CLASS ------------------- Common Stock, $0.01 par value 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. --- The aggregate market value of Common Stock held by non-affiliates of the registrant on April 23, 1999 was approximately $78,282,598. 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 23, 1999, the registrant had 8,892,736 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 January 30, 1999, filed herewith as Exhibit 13. Part III incorporates information by reference from the definitive Proxy Statement for the 1999 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 mall-based specialty retailer of casual apparel and related accessories for young men and women, principally between the ages of 13 and 19. At fiscal year-end 1998, the Company operated 312 stores in both metropolitan and middle markets in 32 states. The Company opened 63 new stores and closed one store during fiscal 1998. In addition, the Company plans to open approximately 30 new stores in fiscal 1999, five of which have been opened as of April 1999. Management believes that current demographic trends provide the Company with the opportunity to continue its 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 is a leading retailer of brand name casual apparel and related accessories to teenagers. The principal elements of the Company's business strategy are: o Focus on the Male and Female Teenage Customer. 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 broader customer base than many of its specialty store competitors thereby reducing 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 with friends, as well as on their own. o 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 1,600 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, jewelry and other accessory items. The Company regularly monitors store sales by classification, style 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. o 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 L.E.I., JNCO, Dr. Marten, Billabong, and Mudd 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. 2 3 o 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 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. o Attentive Customer Service. The Company is committed to offering professional and attentive 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. o 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 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. o 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. o Distribution Capabilities. The Company has a 110,000 square-foot distribution center that can support the merchandising needs of about 500 stores, providing for our continued store expansion into the next century. The Company believes the distribution center is a critical element in its future growth plans. 3 4 STORE LOCATIONS As of April 23, 1999, the Company operated 317 stores in 32 states. The Company's existing stores are located in metropolitan markets such as Dallas, Chicago, Atlanta, Boston and Kansas City, 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 KANSAS MISSOURI OKLAHOMA TEXAS - CONT. ------- ------ -------- -------- ------------- Huntsville Hays Columbia Enid Port Arthur Mobile Hutchinson Jefferson City Lawton San Angelo Montgomery Manhattan Joplin Norman San Antonio (4) Salina Kansas City (3) Oklahoma City (4) Sherman ARKANSAS Topeka Springfield Shawnee Temple -------- Wichita (2) St. Louis (3) Tulsa (2) Texarkana Fayetteville Tyler Fort Smith KENTUCKY NEBRASKA PENNSYLVANIA Victoria Jonesboro -------- -------- ------------ Waco Little Rock (2) Ashland Grand Island Altoona Wichita Falls Bowling Green Lincoln Erie FLORIDA Elizabethtown Omaha (2) Harrisburg VIRGINIA ------- Florence/Cincinnati Johnstown -------- Fort Myers Owensboro NEW HAMPSHIRE Lancaster Jacksonville Lexington ------------- Philadelphia (2) Charlottesville Orlando (3) Louisville (2) Manchester Scranton Chesapeake Pensacola Paducah Salem State College Christiansburg Tallahassee Danville Tampa (2) LOUISIANA NEW JERSEY SOUTH CAROLINA Dulles/Washington D.C. --------- ---------- -------------- Fredericksburg GEORGIA Alexandria Freehold Charleston (2) Harrisonburg ------- Baton Rouge (2) Livingston Columbia (2) Manassas Athens Bossier City Mays Landing Greenville Newport News Atlanta (7) Houma Paramus Myrtle Beach Norfolk Augusta Lafayette Depford/Philadelphia Spartanburg Roanoke Macon Lake Charles Rockaway Springfield Monroe Wayne SOUTH DAKOTA Virginia Beach ILLINOIS New Orleans (3) ------------ Winchester -------- Shreveport NEW MEXICO Sioux Falls Bloomington ---------- WEST VIRGINIA Carbondale MARYLAND Albuquerque (2) TENNESSEE ------------- Champaign -------- Las Cruces --------- Bridgeport Chicago (13) Baltimore (2) Santa Fe Chattanooga Charleston (2) Fairview Heights/St. Louis Frederick Clarksville Morgantown Moline NEW YORK Jackson Parkersburg Peoria MASSACHUSETTS -------- Johnson City Rockford ------------- Albany (2) Kingsport WISCONSIN Springfield Boston (5) Nanuet Knoxville (2) --------- Rochester (3) Memphis (3) INDIANA MICHIGAN Staten Island Nashville (3) Appleton ------- -------- Syracuse (2) Eau Claire Elkhart Ann Arbor TEXAS Green Bay Evansville Battlecreek NORTH CAROLINA ----- Madison (2) Fort Wayne Detroit (4) -------------- Abilene Milwaukee (4) Indianapolis Flint Charlotte (2) Amarillo Wausau Lafayette Grand Rapids Concord Austin (2) Merrillville Holland Fayetteville Beaumont Muncie Jackson Greensboro College Station South Bend Monroe Hickory Corpus Christi Terre Haute Port Huron High Point Dallas/Fort Worth (9) Portage Raleigh-Durham (3) Denton IOWA Saginaw Winston-Salem El Paso (3) ---- Harlingen Cedar Rapids (2) MINNESOTA OHIO Houston (12) Council Bluffs --------- ---- Killeen Davenport Mankato Cincinnati (2) Laredo Des Moines (3) Minneapolis/St. Paul (3) Cleveland (4) Longview Dubuque St. Cloud Columbus Lubbock Fort Dodge Dayton (2) McAllen Iowa City MISSISSIPPI Heath Midland Sioux City ----------- Lancaster Odessa Biloxi Lima Hattiesburg Mansfield Jackson New Philadelphia Meridian Niles Tupelo St. Clairsville Sandusky Toledo Youngstown Zanesville
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 ------------------------------------ 1994 1995 1996 1997 1998 ---- ---- ---- ---- ---- Number of stores open at beginning of period.... 65 90 126 183 250 Number of new stores opened .................... 26 39 57 67 63 Number of stores closed ........................ 1 3 -- -- 1 --- --- --- --- --- Number of stores open at end of period ......... 90 126 183 250 312 === === === === ===
The Company's expansion strategy is to continue to open stores in enclosed shopping malls in both metropolitan and middle markets. The Company expects to open approximately 20-30 new stores during fiscal 1999, five of which have been opened as of April 1999. 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 total 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. The Company 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 In 1998, the Company's 312 stores averaged $717,976 in annualized net sales or approximately $306 in annualized net sales per square foot. In general, the Company's newer stores typically generate lower sales volumes and operating cash flow than its more mature stores. Capital expenditures, including leasehold improvements and furniture and fixtures, for the 63 new stores opened during fiscal 1998 averaged approximately $180,000 (approximately $105,000 net of all landlord allowances), and initial gross inventory requirements (which were partially financed by trade credit) averaged approximately $100,000 per store. Pre-opening costs ranged from $9,000 to $13,000 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 during which they are opened and current fashion trends. There can be no assurance that future 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 1,600 SKUs, with most merchandise selling at prices ranging between $15 and $40. The Company's merchandise includes high visibility names such as JNCO, Dr. Marten, L.E.I., Billabong and Mudd 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: o Juniors: The Juniors category includes casual sportswear separates designed for fashion-current teenage girls, such as knit tops, woven shirts and vests, denim, dresses and swimwear. Key brands in this category include Paris Blues, L.E.I., Mossimo, XOXO, and Mudd. o Young Men: The Young Mens 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 brands in this category include JNCO, Dr. Marten, Kikwear, BC Ethic, Billabong and Hurley. o Accessories: The Accessories category includes a variety of male, female and unisex accessories including sunglasses, watches, wallets, hair accessories, backpacks, necklaces, hats and other accessories. Key brands in this category include Fossil, Storm, and Black Flys. o Unisex Apparel: The Unisex category consists 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. o Footwear: The Company offers a limited selection of male, female and unisex footwear including sandals and active footwear. Key brands in this category include Dr. Marten, Adidas, and Skechers. The following table sets forth the Company's merchandise by category as an approximate percentage of net sales for fiscal 1998:
PERCENTAGE OF NET SALES ----------------------- Juniors.................................................................... 32% Young Men.................................................................. 29 Accessories ............................................................... 17 Unisex Apparel ............................................................ 12 Footwear .................................................................. 10 --- 100% ===
6 7 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. The Company expects to continue to adjust its emphasis in particular categories in response to changing fashion trends and, therefore, its merchandise mix may vary slightly from time-to-time. In an effort to keep the stores fresh and exciting, the Company's visual merchandising department, in conjunction with the marketing and buying 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 through shipments from its distribution center on a daily basis to encourage our customers to frequently visit our stores. To reduce the risk associated with the introduction of new products, the Company 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, buyers, associate buyers and assistant buyers. 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 attend concerts and other events attended by teenagers. The General Merchandising Manager and the buyers regularly monitor merchandise flow through the stores and strive to maintain the appropriate merchandise mix to meet customer demand. Due to changes in fashion trends and seasonality, the Company purchases merchandise from numerous vendors throughout the year. During fiscal 1998, the Company did business with approximately 750 vendors. No single vendor accounted for more than 10% of merchandise purchases. Certain of the Company's vendors have limited financial resources and production capabilities. Gadzooks believes that strong vendor relationships are important to the growth and success of the Company. ALLOCATION AND DISTRIBUTION OF MERCHANDISE The Company continually strives to improve its merchandising, distribution, planning and allocation methods to manage its inventory more productively. The Company's Vice President of Planning and Allocation and staff work closely with the buyers to meet the requirements of determining the correct inventory levels for all stores and merchandise categories. The Company divides its stores into different categories based upon, among other things, geographic location, demographics, sales volume, competition and store capacity. Merchandise allocation and distribution are based in part on sales and inventory 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 relocated its headquarters to a larger site in the Dallas metropolitan area which includes a distribution facility of approximately 110,000 square feet. Vendors deliver merchandise to this facility, where it is inspected, entered into the Company's computer system, ticketed (to the extent that it was not pre-ticketed by the vendor), allocated to stores and boxed for distribution to the Company's stores. Merchandise is typically shipped to stores daily via United Parcel Service, providing Gadzooks stores with a steady flow of new merchandise. For certain key products, the Company maintains a backstock at its distribution center that is allocated and distributed to the stores through an automated replenishment system. 7 8 STORE OPERATIONS Gadzooks stores are open seven days a week during normal mall hours. The Company's store operations are managed by a Senior Vice President of Store Operations, Director of Store Operations, regional managers and district managers, who 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 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 and other operating statistics. In addition, stock options are granted to district managers and above at the time they assume their position, with additional grants each year thereafter. 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 store expansion program will be dependent on its ability to promote and/or recruit qualified district and store managers. The Company has an established training program for future district managers. Store managers, many of whom are selected from among the Company's assistant managers, currently complete a one-week training program with a designated training store manager 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 constantly enhancing its 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 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 unannounced visits to the stores by shoppers, who are unknown by the store employees, and store operations personnel, 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 signs, video monitors featuring popular music videos, playful mannequins and creative, eye-catching signage. The Company's signature Volkswagen Beetle is a feature attraction in the stores. The Company typically 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. 8 9 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 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 has plans to continue to improve and enhance numerous functions on a continuing basis. In 1998, the Company significantly upgraded its information technology infrastructure network to support many new and ongoing initiatives to take advantage of emerging technology. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Impact of Year 2000 Issue." ADVERTISING AND PROMOTION The Company relies primarily on mall traffic, 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 and 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 "Gadzooks" (in various formats) and "Gaditude". 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. 9 10 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, with national specialty chains such as The Gap and certain divisions of The Limited, with numerous other teen retailers such as American Eagle Outfitters, The Buckle, Hot Topic, Pacific Sunwear and Wet Seal, and with local specialty stores in certain markets, and to a lesser extent, with mass merchandisers and companies providing shopping sites via the internet. Many of the Company's competitors are larger and have substantially greater 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 23, 1999, the Company had 1,167 full-time employees and 2,368 part-time employees. Of the Company's 3,535 employees, 169 were corporate personnel, 77 were distribution center employees and 3,289 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. GROWTH STRATEGY; FUTURE OPERATING RESULTS The Company's net sales 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 its growth strategy by opening new stores for the foreseeable future, and its future operating results will depend, to a certain degree, upon its ability to open and operate new stores successfully and to manage a larger business profitably. The Company anticipates opening approximately 20-30 new stores during fiscal 1999. In the future, the Company plans to enter 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 "Business -- Expansion Strategy." The Company anticipates that it will spend approximately $8.0 million for capital expenditures and approximately $2.0 million for initial inventories to open approximately 30 new stores, remodel eight existing stores and refurbish 50-55 existing stores in fiscal 1999. 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, and funds available under the Company's revolving line of credit will be sufficient to fund its expansion requirements through at least 1999. There can be no assurance that the Company may not be required to seek additional sources of funds for such expansion. 11 12 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 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 4.4%, (3.6%), 3.3% and 3.1% in the first, second, third and fourth quarters of fiscal 1997, respectively, and (0.5%), (0.6%), (6.9%) and (10.9%) in the first, second, third and fourth quarters of fiscal 1998 respectively. The Company has recorded comparable store sales decreases in past months, quarters and years, and there can be no assurance that comparable store sales for any particular month, 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, 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 quarterly 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. 12 13 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 1998 fiscal year, no single vendor accounted for more than 10% 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, 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 "Business -- Purchasing." DEPENDENCE ON KEY PERSONNEL The Company's success will depend largely on the efforts and abilities of senior management. The loss of the services of any member of senior management could have a material adverse effect on the Company's business, financial condition and results of operations. 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, with national specialty chains such as The Gap and certain divisions of The Limited, with numerous regional chains such as The Buckle, Pacific Sunwear, Wet Seal, Hot Topic and American Eagle Outfitters, with smaller chains and local specialty stores, and to a lesser extent, with mass merchandisers and companies providing shopping sites via the internet. 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 fluctuated substantially since the Company's initial public offering in October 1995. The Company's Common Stock is quoted on The Nasdaq Stock 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. 13 14 The Company has adopted a Shareholder Rights Plan which is intended to deter an unfriendly takeover of the Company and to help ensure current shareholders receive fair value upon the sale of their stock to another party seeking control of the Company. See "Notes to Financial Statements - Note 12 Shareholder Rights Plan." 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 June 1999 and January 2009. 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. The Company's office and distribution center is located in Carrollton, Texas, under a lease that 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. See "Notes to Financial Statements Note 13 Contingency". 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 information in response to item 5 is contained in the section entitled "Corporate Information - Share Price Data" located on page 24 of the registrant's 1998 Annual Report to Shareholders, filed as Exhibit 13 to this Report. Such Market for Registrant's Common Equity and Related Stockholder Matters are incorporated herein by reference. 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 7 of the registrant's 1998 Annual Report to Shareholders, filed as Exhibit 13 to this Report. Such Selected Financial Data is incorporated herein by reference. 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 8 to 11 of the registrant's 1998 Annual Report to Shareholders, filed as Exhibit 13 to this Report. Such Management's Discussion and Analysis of Financial Condition and Results of Operations are incorporated herein by reference. 14 15 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. The Company does not engage in trading market risk sensitive instruments and does not purchase as investments, as hedges, or for purposes "other than trading" instruments that are likely to expose the Company to market risk, whether it be from interest rate, foreign currency exchange, commodity price or equity price risk. The Company has issued no debt instruments, entered into no forward or futures contracts, purchased no options and entered into no swaps. The Company's primary market risk exposure is that of interest rate risk. A change in LIBOR or the Prime Rate as set by Wells Fargo Bank (Texas), National Association, would affect the rate at which the Company could borrow funds under its Revolving Line. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. The information in response to item 8 is contained in the registrant's 1998 Annual Report to Shareholders, filed as Exhibit 13 to this Report. Such information 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................................................... 9 Balance Sheets at January 30, 1999 and January 31, 1998.............................. 12 Statements of Income for the Years Ended January 30, 1999, January 31, 1998, and February 1, 1997......................................... 13 Statements of Stockholders' Equity for the Years Ended January 30, 1999, January 31, 1998, and February 1, 1997......................................... 14 Statements of Cash Flows for the Years Ended January 30, 1999, January 31, 1998, and February 1, 1997......................................... 15 Notes to Financial Statements........................................................ 16 - 22 Report of Independent Accountants.................................................... 23 Corporate Information................................................................ 24
*The indicated pages of the Company's 1998 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 PricewaterhouseCoopers LLP dated March 8, 1999, except as to the second paragraph of Note 6, which is as of April 5, 1999, appearing in the accompanying 1998 Annual Report to Shareholders are incorporated by referenced in this Report. With the exception of the aforementioned information and information incorporated in Items 5, 6 and 7, the 1998 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 28, 1998 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 28, 1999 - ------------------------------------------- and Chief Executive Officer Gerald R. Szczepanski (Principal Executive Officer) /s/ Monty R. Standifer Senior Vice President, Chief April 28, 1999 - ------------------------------------------- Financial Officer, Treasurer and Monty R. Standifer Secretary (Principal Financial and Accounting Officer) /s/ G. Michael Machens Director April 28, 1999 - ------------------------------------------- G. Michael Machens /s/ Robert E.M. Nourse Director April 28, 1999 - ------------------------------------------- Robert E.M. Nourse /s/ Ron G. Stegall Director April 28, 1999 - ------------------------------------------- Ron G. Stegall /s/ Lawrence H. Titus, Jr. Director April 28, 1999 - ------------------------------------------- Lawrence H. Titus, Jr.
17 18 INDEX TO EXHIBITS
EXHIBIT NO. DESCRIPTION ------- ----------- 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). 3.3 -- First Amendment to the Amended and Restated Bylaws of the Company (filed as Exhibit 3.3 of the Company's Quarterly Report on Form 10-Q for the quarter ended August 2, 1997 filed with the Commission on September 16, 1997 and incorporated herein by reference). 4.1 -- Specimen Certificate for shares of Common Stock, $.01 par value, of the Company (filed as Exhibit 4.1 to the Company's Amendment No. 2 to Form S-1 (No. 33-95090) filed with the Commission on September 8, 1995 and incorporated herein by reference). 4.2 -- Rights Agreement dated as of September 3, 1998 between the Company and ChaseMellon Shareholder Services, L.L.C. (filed as Exhibit 1 to the Company's Form 8-A filed with the Commission on September 4, 1998 and incorporated herein by reference). 10.1 -- 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 (filed as Exhibit 10.3 to the Company's 1996 Annual Report on Form 10-K filed with the Commission on April 23, 1997 and incorporated herein by reference). 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).
18 19 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 (filed as Exhibit 10.10 to the Company's 1996 Annual Report on Form 10-K filed with the Commission on April 23, 1997 and incorporated herein by reference). 10.11 -- Form of Severance Agreement with a schedule of executive officer signatories (filed as Exhibit 10.11 to the Company's 1996 Annual Report on Form 10-K filed with the Commission on April 23, 1997 and incorporated herein by reference). 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 (filed as Exhibit 10.13 to the Company's 1996 Annual Report on Form 10-K filed with the Commission on April 23, 1997 and incorporated herein by reference). 10.14 -- Amendment No. 1 to the 1994 Incentive and Nonstatutory Stock Option Plan for Key Employees dated September 12, 1996 (filed as Exhibit 10.14 to the Company's 1996 Annual Report on Form 10-K filed with the Commission on April 23, 1997 and incorporated herein by reference). 10.15 -- Gadzooks, Inc. Employee Stock Purchase Plan (filed as Exhibit 4.5 to the Company's Form S-8 (No. 333-50639) filed with the Commission on April 21, 1998 and incorporated herein by reference). 10.16 -- Gadzooks, Inc. Deferred Compensation Plan (filed as Exhibit 10.16 to the Company's 1997 annual report on form 10-K filed with the Commission on April 27, 1998 and incorporated herein by reference). 10.17 -- Lease Agreement between Gadzooks, Inc. (Lessee) and CB Midway International, LTD. (Lessor) dated August 23, 1996 (filed as Exhibit 10.17 to the Company's 1997 Annual Report on Form 10-K filed with the Commission on April 27, 1998 and incorporated herein by reference).
19 20 10.18 -- Gadzooks, Inc. 401(k) Plan and Profit Sharing Plan Adoption Agreement (filed as Exhibit 10.18 to the Company's Quarterly Report on Form 10-Q filed with the Commission on June 9, 1998, and incorporated herein by reference). 10.19 -- Amendment No. 1 to the Credit Agreement between the Company and Wells Fargo Bank (Texas), National Association, dated June 11, 1998 (filed as Exhibit 10.19 to the Company's Quarterly Report on Form 10-Q filed with the Commission on September 15, 1998, and incorporated herein by reference). 10.20 -- Amendment No. 6 to the Gadzooks, Inc. 1992 Incentive and Non-Statutory Stock Option Plan dated June 18, 1998 (filed as Exhibit 4.8 to the Company's Form S-8 (No. 333-60869) filed with the Commission on August 7, 1998 and incorporated herein by reference). 10.21 -- Amendment No. 1 to the Gadzooks, Inc. 1995 Non-Employee Director Stock Option Plan dated June 18, 1998 (filed as Exhibit 4.10 to the Company Form S-8 (No. 333-60869) filed with the Commission on August 7, 1998 and incorporated herein by reference). 10.22 -- Employment Agreement dated July 18, 1998, between the Company and David Mangini, as continued by letter agreement (filed as Exhibit 10.22 to the Company's Quarterly Report on Form 10-Q filed with the Commission on September 15, 1998, and incorporated herein by reference). 10.23 -- Executive Retirement Agreement dated June 10, 1998 between the Company and Monty R. Standifer (filed as Exhibit 10.23 to the Company's Quarterly Report on Form 10-Q filed with the Commission on December 15, 1998 and incorporated herein by reference). 10.24 -- Severance Protection Agreement dated September 1, 1998 between the Company and Gerald R. Szczepanski (filed as Exhibit 10.24 to the Company's Quarterly Report on Form 10-Q filed with the Commission on December 15, 1998 and incorporated herein by reference). 10.25 -- Severance Protection Agreement dated September 1, 1998 between the Company and David L. Mangini (filed as Exhibit 10.25 to the Company's Quarterly Report on Form 10-Q filed with the Commission on December 15, 1998 and incorporated herein by reference). 10.26 -- Severance Protection Agreement dated September 1, 1998 between the Company and Monty R. Standifer (filed as Exhibit 10.26 to the Company's Quarterly Report on Form 10-Q filed with the Commission on December 15, 1998 and incorporated herein by reference). 13* -- Pages 17-24 of the Company's 1998 Annual Report to Shareholders. 23* -- Consent of PricewaterhouseCoopers 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). 20 EX-13 2 ANNUAL REPORT TO SECURITY HOLDERS 1 EXHIBIT 13 GADZOOKS ANNUAL REPORT [PICTURE] 98 2 CHANGES IN BOARD OF DIRECTORS Alan W. Crites, a member of the Company's Board of Directors since 1992, retired in November 1998. We want to thank him for his many contributions to the Company's growth during that time. In seeking Alan's replacement, we were fortunate that Ron G. Stegall, a career retailer, agreed to serve as a Director. Ron is Chairman of the Board of electronics retailer InterTAN, Inc., and serves on the Board of superstore retailer Hastings Entertainment, Inc. He also founded and served as Chairman and Chief Executive Officer of BizMart, Inc., an office products superstore chain, and was a retail executive with Tandy Corporation for many years. FINANCIAL & OPERATING HIGHLIGHTS
Fiscal Year Ended JANUARY 30, January 31, Percent 1999 1998 Change ----------- ----------- ----------------- Net sales (in thousands) $ 208,203 $ 171,639 21% Net income (in thousands) $ 387 $ 8,288 (95)% Net income per share Basic $ 0.04 $ 0.95 (96)% Diluted $ 0.04 $ 0.91 (96)% Average shares outstanding (in thousands) Basic 8,852 8,683 2% Diluted 9,036 9,100 (1)% Comparable store sales increase (decrease) (5.6)% 1.8% -- Average net sales per store $ 717,976 $ 794,437 (10)% Average net sales per square foot $ 306 $ 341 (10)% Capital expenditures (in thousands) $ 9,947 $ 12,624 (21)% Number of stores at year end 312 250 25%
* See Financial Information section for further discussion and analysis. GADZOOKS OFFERS A VARIETY OF PRODUCTS FROM RECOGNIZED TEEN FASHION LEADERS. 3 GADZOOKS IS COOL A HIGH-ENERGY SPECIALTY RETAILER CATERING TO YOUNG MEN AND WOMEN PRINCIPALLY BETWEEN 13 AND 19 YEARS OF AGE. ESTABLISHED IN 1983, DALLAS-BASED GADZOOKS CURRENTLY OPERATES 317 MALL-BASED STORES IN METROPOLITAN AND MIDDLE MARKETS IN 32 STATES EAST OF THE ROCKY MOUNTAINS. LETTER TO SHAREHOLDERS [PICTURE] Jerry Szczepanski Chairman and CEO GADZOOKS ended fiscal 1997 on a very positive note, so we entered 1998 full of optimism that the Company would turn in another strong performance for the year. Unfortunately, that would not be the case. The truism in retailing has always been that location is everything. But in teen retailing, merchandise selection and timing have proven to be just as important. There is no better example of that than Gadzooks' performance in fiscal 1998. We simply were not on the same merchandise page with our teen customers, so we struggled with merchandising issues all year. Our sales and profits for fiscal 1998 reflected that effort. For the 12 months of fiscal 1998 ended January 30, 1999, net sales were $208,203,000, up 21.3 percent from $171,639,000 for fiscal 1997. Net income was $387,000 or $0.04 per diluted share, compared with $8,288,000 or $0.91 per diluted share for fiscal 1997. Comparable-store sales, a key measure in retailing, declined 5.6 percent in fiscal 1998, versus a modest 1.8 percent gain in fiscal 1997. It was the first year in the Company's history that we did not record positive comp-store sales gains. 1 4 Working through such a challenging year has provided Gadzooks' management and employees with a different perspective that should prove quite valuable to the Company's future success. During this past year, we analyzed virtually every aspect of our business from as many angles as possible, and reached a number of significant conclusions. FIRST, TEENAGERS ARE STILL GREAT CUSTOMERS The teenage market in the United States is stronger than ever, with over 25 million teens today and growing rapidly. They have a lot of money to spend, and don't hesitate to do so. Industry sources estimate that teen expenditures in 1998 totaled approximately $141 billion, up about 16 percent from the prior year. This type of spending makes teens a very dynamic market. WE HAVE AN OUTSTANDING GROUP OF STORES, AND CONTINUE TO DO A GOOD JOB OF OPENING NEW ONES We have expanded our store base about tenfold during the 1990s, with very few closings along the way. During 1998, we opened 63 new stores and closed one, ending the year with 312 mall-based stores in 32 states east of the Rocky Mountains. We'll be slowing store growth in fiscal 1999 because of our increased emphasis on merchandising and better utilization of the existing assets in our current store base. OUR DISTRIBUTION CENTER HAS SIGNIFICANTLY ENHANCED GADZOOKS' EFFICIENCY We have been able to achieve significant labor efficiencies in our merchandise distribution activities since the facility opened in May 1997. With 110,000 square feet of capacity, our distribution center has the capability to effectively support the merchandising needs of up to 500 stores. That additional capacity will provide Gadzooks with several years of future growth before the center will have to be expanded. [PICTURE] GADZOOKS' ASSOCIATES KNOW WHAT OUR CUSTOMERS WANT... BECAUSE THEY ARE OUR CUSTOMERS. 2 5 [PICTURE] THE TEENAGE MARKET IN THE UNITED STATES IS STRONGER THAN EVER, AND GROWING RAPIDLY. GADZOOKS HAS OVER THREE-HUNDRED STORES PROVIDING THE PRODUCTS AND SERVICE THEY WANT. 317 STORES IN 32 STATES...AND GROWING 3 6 OUR MERCHANDISE SELECTION LACKED THE NAME-BRAND FOCUS OF PREVIOUS YEARS And our product assortment lacked cohesiveness. We simply tried to appeal to too many segments of the teen population. Now we're reemphasizing our core name-brand strategy to emulate the lifestyle of our target mainstream teen customers. We are utilizing market research to understand our customers better -- to continually refine our merchandise to fit our customers' wants and needs. We're buying in greater depth from a narrower assortment of merchandise to increase in-stock positions of higher-demand products. We also concluded that our inventory planning process didn't allow for proper "bottoms-up" assortment plans at the stores. For 1999, we've instituted a new "average store" planning process to provide a better balance between the young men's and junior categories, which should enable us to improve sales and inventory turns. WE HAVE STRENGTHENED OUR MERCHANDISING MANAGEMENT TEAM We reviewed every aspect of the Company's merchandising activities in 1998 and took a number of steps to substantially strengthen our inventory planning and merchandise management capabilities. In January 1999, we hired Paula Masters, a 14-year veteran of junior retail merchandising, as Vice President and General Merchandise Manager. She is responsible for all buying functions and other merchandise management aspects of our business. At the same time, Jeffrey Krainess was named Vice President for Planning and Allocation, with responsibility for enhancing our capabilities to support higher future sales from our fast-growing store base. GADZOOKS IS STRONG FINANCIALLY, WITH NO BANK DEBT AND SIGNIFICANT CASH AVAILABLE FOR FUNDING CONTINUED STORE EXPANSION The Company has traditionally satisfied its cash requirements for store expansion and purchasing inventories mainly from cash flow from operations. At the [PICTURE] UPDATED STORE INTERIORS KEEP OUR CUSTOMERS INTERESTED AND ENTERTAINED, ENCOURAGING SALES. 4 7 end of fiscal 1998, we had $16.4 million in cash on the balance sheet, and a bank credit facility which provides the Company with sufficient liquidity to achieve its growth objectives. WE LEARNED SOME IMPORTANT LESSONS IN 1998 THAT ARE REFLECTED IN OUR 1999 DIRECTION Going forward, we want to achieve several key objectives: O RE-ESTABLISH GADZOOKS' "COOL" IMAGE WITH OUR TEEN CUSTOMERS THROUGH A MORE FOCUSED NAME-BRAND STRATEGY; O ENSURE THAT OUR EXISTING STORES ARE PERFORMING AT THE TOP OF THEIR POTENTIAL; O UPGRADE OUR MERCHANDISE PLANNING AND ALLOCATION SYSTEMS; O INSTITUTE A TIGHTER STORE-LEVEL MERCHANDISE CONTROL SYSTEM; O FURTHER STRENGTHEN OUR COMPANY BY DEVELOPING EXISTING TALENT WHILE CONTINUING TO ATTRACT TOP-PERFORMING INDIVIDUALS. We failed this past year. It was not for lack of effort. In fact, the irony is that you seem to work harder when things are not clicking. For their hard work and competitiveness, our employees are to be commended. However, the point is that we failed, and that is not acceptable. We have made the changes we feel are necessary to assure that 1998 does not repeat itself. We want to thank our shareholders for their support, and we will guarantee that every effort will be made to make 1999 the success it should be. Sincerely, /s/ JERRY SZCZEPANSKI Jerry Szczepanski, Chairman of the Board and Chief Executive Officer April 27, 1999 [PICTURE] BRAND-NAME MERCHANDISE INCLUDES A RANGE OF CLOTHING, SHOES AND ACCESSORIES. 5 8 FINANCIAL INFORMATION [PICTURE] NASDAQ SYMBOL GADZ 6 9 GADZOOKS INC. 7 - -------------------------------------------------------------------------------- SELECTED FINANCIAL DATA ($ in thousands, except operating data and per share amounts)
Fiscal Year Ended ---------------------------------------------------------------------------- JANUARY 30, January 31, February 1, January 27, January 28, 1999 1998 1997 1996 1995 ----------- ----------- ----------- ----------- ----------- INCOME STATEMENT DATA: Net sales $ 208,203 $ 171,639 $ 128,388 $ 84,602 $ 56,463 Cost of goods sold 157,729 120,309 87,418 58,015 38,379 --------- --------- --------- --------- --------- Gross profit 50,474 51,330 40,970 26,587 18,084 Selling, general and administrative expenses(1) 50,526 38,773 29,212 19,794 14,702 --------- --------- --------- --------- --------- Operating income (loss) (52) 12,557 11,758 6,793 3,382 Interest income (expense), net 536 706 945 (179) (240) --------- --------- --------- --------- --------- Income before income taxes 484 13,263 12,703 6,614 3,142 Provision for income taxes 97 4,975 4,712 2,538 1,201 --------- --------- --------- --------- --------- Net income $ 387 $ 8,288 $ 7,991 $ 4,076 $ 1,941 ========= ========= ========= ========= ========= Net income per share Basic $ 0.04 $ 0.95 $ 0.94 $ 0.67 $ 0.34 Diluted $ 0.04 $ 0.91 $ 0.87 $ 0.60 $ 0.32 Average shares outstanding Basic 8,852 8,683 8,525 6,095 5,671 Diluted 9,036 9,100 9,143 6,742 5,976 SELECTED OPERATING DATA: Comparable store sales increase (decrease)(2) (5.6)% 1.8% 6.1% 14.7% 8.4% Number of stores at year end 312 250 183 126 90 Average net sales per store $ 717,976 $ 794,437 $ 814,838 $ 776,807 $ 698,108 Average net sales per square foot $ 306 $ 341 $ 356 $ 343 $ 306 Total square footage at end of period 736,214 585,092 421,572 284,953 204,711 Operating income percentage -- 7.3% 9.2% 8.0% 6.0% Capital expenditures (in 000s) $ 9,947 $ 12,624 $ 6,864 $ 5,959 $ 3,445 BALANCE SHEET DATA: Working capital $ 31,629 $ 34,878 $ 34,333 $ 20,368 $ 4,262 Total assets 86,442 84,321 64,747 45,611 19,836 Total debt -- -- -- 178 3,026 Redeemable preferred stock and cumulative dividends -- -- -- -- 10,631 Shareholders' equity (deficit) 60,031 58,480 49,063 30,765 (2,204) ========= ========= ========= ========= =========
(1) A provision for closing outlet stores was combined with January 28, 1995 selling, general and administrative expenses. (2) A store becomes comparable after it has been open for 14 full fiscal months. 10 GADZOOKS 8 INC. - -------------------------------------------------------------------------------- MANAGEMENT'S DISCUSSION AND ANALYSIS of Financial Condition and Results of Operations GENERAL Gadzooks is a mall-based specialty retailer of casual apparel and related accessories for young men and women, principally between the ages of 13 and 19. The Company opened its first store in 1983, and at fiscal year-end 1998, operated 312 stores in 32 states east of the Rocky Mountains. The Company has been on a rapid expansion program, opening 57 new stores in fiscal 1996, 67 new stores in fiscal 1997, and 63 new stores in fiscal 1998. One store was closed during fiscal 1998. 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 1998 1997 1996 ---- ---- ---- Net sales 100.0% 100.0% 100.0% Cost of goods sold, including buying, distribution and occupancy costs 75.8 70.1 68.1 ----- ----- ----- Gross profit 24.2 29.9 31.9 Selling, general and administrative expenses 24.2 22.6 22.7 ----- ----- ----- Operating income -- 7.3 9.2 Interest income, net 0.3 0.4 0.7 ----- ----- ----- Income before income taxes 0.3 7.7 9.9 Provision for income taxes 0.1 2.9 3.7 ----- ----- ----- Net income 0.2% 4.8% 6.2% ===== ===== ===== Number of stores open at end of period 312 250 183
FISCAL 1998 COMPARED TO FISCAL 1997 Net sales increased approximately $36.6 million, or 21.3%, to $208.2 million during fiscal 1998 from $171.6 million in fiscal 1997. Net sales of the 63 new stores opened during fiscal 1998 and for those stores not yet qualifying as comparable stores contributed $45.4 million of the increase in sales. Comparable store sales decreased by $8.8 million, or 5.6%, in fiscal 1998. The decrease in comparable sales was primarily due a decline in the unisex T-shirt category, and to a lesser extent declines in the footwear and accessory categories. A store becomes comparable after it has been open for 14 full fiscal months. Gross profit decreased approximately $0.8 million to $50.5 million in fiscal 1998 from $51.3 million in fiscal 1997. As a percentage of sales, gross profit decreased to 24.2% in fiscal 1998 from 29.9% in fiscal 1997. The decrease in gross profit resulted primarily from increased markdowns and promotional activities to clear out slow-moving inventory during the third and fourth quarters of fiscal 1998. Gross profit for the fourth quarter of fiscal 1998 was negatively impacted by a charge of approximately $0.6 million to reduce the cost of slow-moving inventory down to fair value. Store occupancy costs increased as a percentage of sales primarily due to the lower average sales per store in 1998. Selling, general and administrative expenses increased approximately $11.8 million to $50.5 million during fiscal 1998 from $38.8 million in fiscal 1997 and increased as a percentage of sales to 24.2% in fiscal 1998 from 22.6% in fiscal 1997. The increase as a percentage of sales was due to the inability to leverage corporate overhead costs and store payroll costs over lower than expected sales as well as the addition of several new executives and managers. Operating income decreased approximately $12.6 million to about breakeven during fiscal 1998 from $12.6 million in fiscal 1997. As a percentage of sales, operating income decreased to about zero percent in fiscal 1998 from 7.3% in fiscal 1997. Net interest income decreased approximately $0.2 million to $0.5 million during fiscal 1998 from $0.7 million net interest income in fiscal 1997. The Company's interest income decreased due to the use of a portion of its short-term cash investments in connection with the Company's fiscal 1998 store expansion program. Income tax expense was $97,188 for fiscal 1998, compared to $5.0 million in fiscal 1997. The decrease in the Company's effective income tax rate was primarily attributable to tax-free interest income which accounted for a significantly larger portion of income before income taxes in fiscal 1998. 11 GADZOOKS INC. 9 - -------------------------------------------------------------------------------- FISCAL 1997 COMPARED TO FISCAL 1996 Net sales increased approximately $43.2 million, or 33.6%, to $171.6 million during fiscal 1997 from $128.4 million in fiscal 1996. Net sales of the 67 new stores opened during fiscal 1997 and for those stores not yet qualifying as comparable stores contributed $41.1 million of the increase in sales. Comparable store sales increased 1.8% in fiscal 1997 and contributed $2.1 million to the increase in sales. The increase in comparable sales was primarily due to strong sales in the young men's category. Fiscal 1996 was a 53 week period. The fifty-third week contributed $1.9 million to net sales in fiscal 1996. Gross profit increased approximately $10.3 million to $51.3 million in fiscal 1997 from $41.0 million in fiscal 1996. As a percentage of sales, gross profit decreased to 29.9% in fiscal 1997 from 31.9% in fiscal 1996. The decrease in gross profit resulted primarily from substantial markdowns taken during the second quarter of fiscal 1997 in the junior apparel and accessories categories. Store occupancy costs increased by approximately one half of one percent primarily as a result of lower sales in the second quarter. Selling, general and administrative expenses increased approximately $9.6 million to $38.8 million during fiscal 1997 from $29.2 million in fiscal 1996, but decreased as a percentage of sales to 22.6% in fiscal 1997 from 22.7% in fiscal 1996. The slight decrease as a percentage of sales was primarily due to the leveraging of corporate overhead expenses and lower management bonuses. Operating income increased approximately $0.8 million to $12.6 million during fiscal 1997 from $11.8 million in fiscal 1996. As a percentage of sales, operating income decreased to 7.3% in fiscal 1997 from 9.2% in fiscal 1996. Net interest income decreased approximately $0.2 million to $0.7 million during fiscal 1997 from $0.9 million in fiscal 1996. The Company's interest income decreased due to the use of short-term cash investments to fund the Company's continuing store expansion program. Income tax expense was $5.0 million for fiscal 1997, compared to $4.7 million in fiscal 1996. The effective income tax rate in fiscal 1997 was 37.5%, compared to 37.1% in fiscal 1996. The increase in the Company's effective income tax rate was primarily attributable to the Company's expansion into states with higher state income tax rates. 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, 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 (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 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 1998 Fiscal 1997 -------------------------------------------------------------------------------------- FIRST SECOND THIRD FOURTH FIRST SECOND THIRD FOURTH QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER ------- ------- ------- ------- ------- ------- ------- ------- Statement of income data: Net sales $ 45,026 $ 48,202 $ 50,697 $ 64,278 $ 34,070 $ 36,780 $ 41,268 $ 59,521 Gross profit 12,702 12,286 11,535 13,951 10,127 9,022 12,639 19,542 Operating income (loss) 2,082 857 (1,293) (1,698) 1,893 141 2,869 7,654 Net income (loss) 1,417 606 (738) (898) 1,324 171 1,920 4,873 Net income (loss) per share Basic $ 0.16 $ 0.07 $ (0.08) $ (0.10) $ 0.15 $ 0.02 $ 0.22 $ 0.56 Diluted $ 0.16 $ 0.07 $ (0.08) $ (0.10) $ 0.15 $ 0.02 $ 0.21 $ 0.54 Average shares outstanding Basic 8,795 8,836 8,886 8,890 8,592 8,669 8,730 8,739 Diluted 9,095 9,071 8,886 8,890 9,124 9,110 9,064 9,102 Selected operating data: Stores open at end of period 275 304 311 312 197 221 232 250 ======== ======== ======== ======== ======== ======== ======== ========
12 GADZOOKS 10 INC. - -------------------------------------------------------------------------------- Management's Discussion and Analysis, continued 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. In fiscal 1997, $3.1 million was spent on a new distribution center and corporate headquarters for the Company. The Company has satisfied its cash requirements principally from cash flow from operations and proceeds from the sale of equity securities. CASH FLOWS. During fiscal 1998, 1997 and 1996, cash flows from operating activities were $6.2 million, $7.6 million, and $5.6 million, respectively. Cash flow from operations before working capital changes decreased to $4.6 million in fiscal 1998 from $11.7 million in the prior year. The decrease was due primarily to the reduction in net income. The increase in cash flow from operations before working capital changes from $9.9 million in fiscal 1996 to $11.7 million in fiscal 1997 was primarily caused by increases in net income and depreciation expense of $0.3 million and $1.1 million, respectively. Working capital components generated $1.6 million of cash flow in fiscal 1998. Cash was generated by a reduction in inventory of $1.4 million and increases in accounts payable and other liabilities of $1.4 million and $1.3 million, respectively. Offsetting those increases in cash was a decrease in income taxes payable of $2.5 million. In fiscal 1997, working capital used $4.1 million of cash flow. An inventory increase of $12.6 million offset by an increase in accounts payable of $9.1 million primarily caused the net use of working capital. Working capital used $4.2 million of cash flow in fiscal 1996, primarily the result of a $4.5 million increase in inventory. Cash used in investing activities approximated $0.8 million, $9.4 million and $19.3 million for fiscal 1998, 1997 and 1996, respectively. The Company spent $9.9 million on capital expenditures during fiscal 1998, of which $8.9 million was used to open new or remodel and refurbish existing stores and $1.0 million was used to upgrade information systems. The Company spent $12.6 million on capital expenditures during fiscal 1997, of which $8.5 million was used to open new or remodel existing stores, and $4.1 million was used to build-out and furnish the new corporate headquarters and distribution center as well as to upgrade information systems. The Company opened 63, 67, and 57 new stores in fiscal 1998, 1997 and 1996, respectively. Net cash flow provided by financing activities totaled $1.2 million, $1.1 million and $10.3 million for fiscal 1998, 1997 and 1996, respectively. During fiscal 1998, the Company received $0.6 million from the exercise of employee stock options as well as $0.7 million of related tax benefit. The Company used $0.2 million for net purchases of treasury stock. During fiscal 1997, the Company received $0.4 million from the exercise of employee stock options as well as $0.7 million of related tax benefit. During fiscal 1996, the Company received $9.1 million from a public equity offering and $1.2 million as a tax benefit from the exercise of employee stock options. CREDIT FACILITY. The Company intends to renew and revise its existing credit facility with Wells Fargo Bank and has received a commitment letter from the bank dated April 6, 1999. The revised facility would provide an unsecured revolving line of credit totaling $10 million. The facility would permit the Company to borrow the lesser of 150% of trailing twelve-month cash flow (as defined in the credit agreement) or $10 million. Assuming that the revised credit facility had been executed prior to year-end, the amount available to borrow (prior to reduction for outstanding letters of credit) at January 31, 1999 would have been $7.6 million. Amounts borrowed under the revolving line will continue to bear interest at the lessor of either Prime Rate or 195 basis points above LIBOR. The renewed revolving line would continue to provide for the issuance of letters of credit that are generally used in connection with international merchandise purchases. Outstanding letters of credit issued by the bank reduce amounts otherwise available for borrowing under the line of credit. The renewed credit agreement would continue to subject the Company to various restrictions on the incurrence of additional indebtedness, acquisitions, loans to officers, and stock repurchases. The revised covenants will continue to require the Company to maintain a certain minimum tangible net worth, minimum working capital and other financial covenants. In addition the Company will be required to pay a commitment fee of 0.50% on the unused portion of the revolving line. Any amount borrowed under the new revolving line of credit will become due on June 1, 2000, the date the renewed credit agreement will mature. No assurance can be given that negotiations will be successfully completed with the bank regarding the revised facility. As of January 30, 1999 the Company was in technical default of the net income requirement and fixed coverage charge ratio covenants of its current credit agreement dated June 11, 1998. Wells Fargo has issued waivers on both covenants through April 30, 1999, by which time the Company expects to have the new loan agreement in place with revised covenants. As of January 30, 1999, no borrowings were outstanding under the revolving line, and $0.3 million in letters of credit were outstanding. As of April 2, 1999, no letters of credit or borrowings were outstanding under the current revolving line. CAPITAL EXPENDITURES. The Company anticipates that it will spend approximately $8.0 million on capital expenditures in fiscal 1999 to open 30 new stores, remodel eight existing stores and refurbish 50-55 existing stores. During fiscal 1998, the Company had capital expenditures of $9.9 million, of which $8.9 million was used to open 63 new stores, remodel five existing stores and refurbish approximately 50 stores. The Company's average capital expenditures to construct a new store during fiscal 1998, including leasehold improvements and furniture and fixtures, averaged approximately $180,000 (approximately $105,000 net of landlord construction allowances). The Company anticipates that its cash requirements for initial inventories in stores expected to open in fiscal 1999 will be approximately $2.0 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. 13 GADZOOKS INC. 11 - -------------------------------------------------------------------------------- Pre-opening costs range from $9,000 to $13,000 for travel, hiring, training and other miscellaneous costs associated with the setup of a new store prior to its opening for business. Pre-opening costs are expensed as incurred. 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 believes that its existing cash balances, cash generated from operations, and funds available under its credit facility will be sufficient to satisfy its cash requirements through fiscal 1999. IMPACT OF THE YEAR 2000 ISSUE The Year 2000 issue is the result of some computer programs having been written using two digits rather than four to define the applicable year. Any computer programs that have date sensitive software and use the two digit method of determining time periods may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in a system failure or miscalculations causing disruptions. The Company has received formal communications from the third-party suppliers of its merchandising, financial and store point-of-sale operating systems which confirm that these core systems are Year 2000 compliant. The Company has assessed and compiled a project list of certain software developed by the Company which require modification or replacement in order to become Year 2000 compliant. Management presently believes that such modifications or replacements will be both tested and completed no later than September 1999. However, if such modifications or replacements are not made, or are not completed timely, the Year 2000 issue could have an immaterial impact on the operations of the Company. In addition, the Company is initiating formal communications with its shipping companies and formulating a contingency plan to ensure that the delivery of merchandise to its distribution center and stores will not be affected by the Year 2000 issue. No vendor represents more than 10% of the Company's sales; however the Company will be contacting key vendors prior to the holiday season for clarification on their Year 2000 plans in order to ensure merchandise receipts will not be disrupted. There can be no guarantee that the systems of other companies on which the Company's systems or operations rely will be timely converted or that a failure to convert by another company will not have a material adverse effect on the Company. The Company will utilize both internal and external resources to modify, or replace, and test its information systems for Year 2000 compliance. The costs associated with ensuring Year 2000 compliance will be expensed in accordance with the guidelines established by the AICPA's Emerging Issues Task Force Release #96-14 "Accounting for the Costs Associated with Modifying Computer Software for the Year 2000." The Company expects to spend approximately $300,000, to be funded from operating cash flows, in order to achieve Year 2000 compliance. The costs to ensure the Company's systems are Year 2000 compliant and the date on which such modifications or replacements will be completed are based on management's best estimates, which were derived utilizing numerous assumptions of future events including the continued availability of certain resources, third party modification plans and other factors. There can be no guarantee that these estimates will be achieved and the actual results could differ materially from those plans. 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. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company does not engage in trading market risk sensitive instruments and does not purchase as investments, as hedges, or for purposes "other than trading" instruments that are likely to expose the Company to market risk, whether it be from interest rate, foreign currency exchange, commodity price or equity price risk. The Company has issued no debt instruments, entered into no forward or futures contracts, purchased no options and entered into no swaps. The Company's primary market risk exposure is that of interest rate risk. A change in LIBOR or the Prime Rate as set by Wells Fargo Bank would affect the rate at which the Company could borrow funds under its credit facility. STATEMENT REGARDING FORWARD-LOOKING DISCLOSURE Certain sections of this Annual Report on Form 10-K, including the preceding "Management's Discussion and Analysis of Financial Condition and Results of Operations," contain various forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Exchange Act, which represent the Company's expectations or beliefs concerning future events. These forward-looking statements involve risks and uncertainties, and the Company cautions that these statements are further qualified by important factors that could cause actual results to differ materially from those in the forward-looking statements, including, without limitation, those set forth in the "Risk Factors" section of the Company's Annual Report on Form 10-K for the fiscal year ended January 30, 1999. 14 GADZOOKS 12 INC. - -------------------------------------------------------------------------------- BALANCE SHEETS
JANUARY 30, January 31, 1999 1998 ------------ ------------ ASSETS Current assets: Cash and cash equivalents $ 16,353,393 $ 9,755,083 Short-term investments -- 9,157,209 Accounts receivable 3,001,651 2,815,444 Inventory 34,403,807 35,763,833 Other current assets 1,987,077 1,426,539 ------------ ------------ 55,745,928 58,918,108 ------------ ------------ Leaseholds, fixtures and equipment, net 30,696,262 25,403,044 ------------ ------------ $ 86,442,190 $ 84,321,152 ============ ============ LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable $ 18,148,736 $ 16,721,808 Accrued payroll and benefits 2,498,758 2,111,284 Other current liabilities 3,469,776 2,712,060 Income taxes payable -- 2,494,855 ------------ ------------ 24,117,270 24,040,007 Accrued rent 2,294,275 1,800,730 Commitments and contingencies (Notes 7 and 13) 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, 8,892,736 and 8,754,577 shares issued and outstanding, respectively 88,927 87,546 Additional paid-in capital 42,197,629 40,868,605 Retained earnings 17,855,453 17,524,264 Treasury stock, at cost, 15,226 and no shares, respectively (111,364) -- ------------ ------------ 60,030,645 58,480,415 ------------ ------------ $ 86,442,190 $ 84,321,152 ============ ============
The accompanying notes are an integral part of these financial statements. 15 GADZOOKS INC. 13 - -------------------------------------------------------------------------------- STATEMENTS OF INCOME
Fiscal Year Ended --------------------------------------------------- January 30, January 31, February 1, 1999 1998 1997 ------------- ------------- ------------- Net sales $ 208,202,866 $ 171,639,147 $ 128,388,380 Costs and expenses: Cost of goods sold, including buying, distribution and occupancy costs 157,728,597 120,308,942 87,417,930 Selling, general and administrative expenses 50,526,730 38,773,576 29,212,565 ------------- ------------- ------------- 208,255,327 159,082,518 116,630,495 ------------- ------------- ------------- Operating income (loss) (52,461) 12,556,629 11,757,885 Interest expense (58,265) (52,313) (26,367) Interest income 594,738 758,580 971,382 ------------- ------------- ------------- Income before income taxes 484,012 13,262,896 12,702,900 Provision for income taxes 97,188 4,974,998 4,711,500 ------------- ------------- ------------- Net income $ 386,824 $ 8,287,898 $ 7,991,400 ============= ============= ============= Net income per share Basic $ 0.04 $ 0.95 $ 0.94 ============= ============= ============= Diluted $ 0.04 $ 0.91 $ 0.87 ============= ============= ============= Average shares outstanding Basic 8,851,609 8,682,582 8,525,322 ============= ============= ============= Diluted 9,035,841 9,100,027 9,142,921 ============= ============= =============
The accompanying notes are an integral part of these financial statements. 16 GADZOOKS 14 INC. - -------------------------------------------------------------------------------- STATEMENTS OF SHAREHOLDERS' EQUITY
Common Stock Additional Retained Treasury Stock Shares Capital Paid-In Capital Earnings Shares Capital Total ------ ------- --------------- -------- ------ ------- ----- 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 Stock issued under option plans 170,137 1,702 407,647 -- -- -- 409,349 Tax benefit from exercise of stock options -- -- 719,937 -- -- -- 719,937 Net income -- -- -- 8,287,898 -- -- 8,287,898 ---------- -------- ------------ ------------ ------ ---------- ------------ BALANCE, JANUARY 31, 1998 8,754,577 87,546 40,868,605 17,524,264 -- -- 58,480,415 Stock issued under option plans 138,159 1,381 604,713 -- -- -- 606,094 Purchase of treasury stock -- -- -- -- 29,500 (312,031) (312,031) Sale of treasury stock -- -- -- (55,635) (14,274) 200,667 145,032 Tax benefit from exercise of stock options -- -- 724,311 -- -- -- 724,311 Net income -- -- -- 386,824 -- -- 386,824 ---------- -------- ------------ ------------ ------ ---------- ------------ BALANCE, JANUARY 30, 1999 8,892,736 $ 88,927 $ 42,197,629 $ 17,855,453 15,226 $ (111,364) $ 60,030,645 ========== ======== ============ ============ ====== ========== ============
The accompanying notes are an integral part of these financial statements. 17 GADZOOKS INC. 15 - -------------------------------------------------------------------------------- STATEMENTS OF CASH FLOWS
Fiscal Year Ended --------------------------------------------- JANUARY 30, January 31, February 1, 1999 1998 1997 ------------ ------------ ------------ Cash flows from operating activities: Net income $ 386,824 $ 8,287,898 $ 7,991,400 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation 4,653,433 3,376,442 2,227,401 Deferred income taxes (433,967) 3,587 (347,500) Changes in operating assets and liabilities: Accounts receivable (186,207) (1,531,534) (793,141) Inventory 1,360,026 (12,552,797) (4,503,951) Other assets (126,571) (101,092) 179,639 Accounts payable 1,426,928 9,067,685 (840,884) Accrued payroll and benefits 387,474 (1,023,868) 1,267,495 Income taxes payable (2,494,855) 1,380,193 (206,107) Other liabilities 1,251,260 732,631 662,595 ------------ ------------ ------------ Net cash provided by operating activities 6,224,345 7,639,145 5,636,947 ------------ ------------ ------------ Cash flows from investing activities: Capital expenditures, net (9,946,650) (12,623,714) (6,864,184) Purchases of short-term investments (7,596,979) (18,177,257) (14,129,847) Proceeds from redemption of short-term investments 16,754,188 21,439,895 1,710,000 ------------ ------------ ------------ Net cash used in investing activities (789,441) (9,361,076) (19,284,031) ------------ ------------ ------------ Cash flows from financing activities: Principal payments on long-term obligations -- -- (44,716) Issuance of common stock, net 606,094 409,349 9,098,884 Purchase of treasury stock (312,031) -- -- Sale of treasury stock under employee stock purchase plan 145,032 -- -- Tax benefit from exercise of stock options 724,311 719,937 1,208,000 ------------ ------------ ------------ Net cash provided by financing activities 1,163,406 1,129,286 10,262,168 ------------ ------------ ------------ Net increase (decrease) in cash and cash equivalents 6,598,310 (592,645) (3,384,916) Cash and cash equivalents at beginning of period 9,755,083 10,347,728 13,732,644 ------------ ------------ ------------ Cash and cash equivalents at end of period $ 16,353,393 $ 9,755,083 $ 10,347,728 ============ ============ ============ Cash paid during the year for: Interest $ 63,240 $ 50,240 $ 20,106 Income taxes 4,407,154 2,849,664 4,057,107 ============ ============ ============
The accompanying notes are an integral part of these financial statements. 18 GADZOOKS 16 INC. - -------------------------------------------------------------------------------- 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 January 30, 1999, the Company had 312 company-owned stores in metropolitan and middle markets in 32 states east of the Rocky Mountains. 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 1998, 1997, and 1996 represent the 52 or 53 week periods ended January 30, 1999, January 31, 1998 and February 1, 1997, 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 January 31, 1998, all securities were classified as held-to-maturity based on the Company's positive intent and ability to hold the securities to maturity. These securities were carried at amortized cost, which approximated fair 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. 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. An impairment loss will be recognized if the sum of the expected future cash flows (undiscounted and before interest) from the use of the assets is less than the net book value of the assets. The amount of the impairment loss will generally be measured as the difference between the net book value of the assets and the estimated fair value of the related assets. 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 were expensed as incurred in fiscal 1998. In fiscal 1997 and 1996, such costs were expensed in the month the store opened. This change had an immaterial impact on the Company's financial statements. INCOME TAXES Deferred income taxes are provided on the 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, and (ii) dilutive potential common shares resulting from stock options. The three-for-two stock split has been given retroactive effect in the financial statements. 19 GADZOOKS INC. 17 - -------------------------------------------------------------------------------- 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 January 30, 1999 and January 31, 1998 and the reported amounts of revenues and expenses during each of the three years in the period ended January 30, 1999. 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 OFFERING 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 portion of the net proceeds, after deducting expenses associated with the offering, totaled $9,016,586. 4 SHORT-TERM INVESTMENTS The amortized cost and estimated fair value of investments are as follows:
January 31, 1998 ----------------------------------------------------- Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value ----------- ----------- ----------- ----------- Commercial paper $ 4,439,188 $ 463 $ 42 $ 4,439,609 Tax exempt securities backed by municipal bonds 12,868,021 396 3,160 12,865,257 ----------- ----------- ----------- ----------- Less cash equivalents 8,150,000 -- -- 8,150,000 ----------- ----------- ----------- ----------- Total investment securities $ 9,157,209 $ 859 $ 3,202 $ 9,154,866 =========== =========== =========== ===========
At January 30, 1999 there were no short-term investment securities. Investments classified as held-to-maturity at January 31, 1998 had various maturity dates that did not exceed one year. 5 LEASEHOLDS, FIXTURES AND EQUIPMENT Leaseholds, fixtures and equipment are summarized as follows:
JANUARY 30, January 31, 1999 1998 ------------ ------------ Leasehold improvements $ 27,715,153 $ 22,233,244 Fixtures and equipment 16,876,857 12,490,384 ------------ ------------ 44,592,010 34,723,628 Less accumulated depreciation (13,895,748) (9,320,584) ------------ ------------ $ 30,696,262 $ 25,403,044 ============ ============
20 GADZOOKS 18 INC. - -------------------------------------------------------------------------------- Notes to Financial Statements, continued 6 LONG-TERM OBLIGATIONS On June 11, 1998, the Company renewed its credit agreement with Wells Fargo Bank, increasing its unsecured revolving line of credit from $10 million to $20 million. The total amount available to borrow pursuant to the credit agreement is limited to 125% of cash flow (as defined in the credit agreement) for the trailing 12-month period. Amounts borrowed under the revolving line bear interest at the lesser of either Prime Rate or 195 basis points above LIBOR. The Company pays commitment fees of 0.35% on the unused portion of the revolving line of credit. The credit agreement also provides for the issuance of letters of credit that are generally used in connection with international merchandise purchases. Outstanding letters of credit issued by the bank reduce amounts otherwise available for borrowing under the revolving line of credit. The credit facility subjects the Company to various restrictions on the incurrence of additional indebtedness, acquisitions, loans to officers and stock repurchases. The covenants also require the Company to maintain certain tangible net worth, working capital, net income and fixed charge coverage minimums as well as certain other ratios. No borrowings were outstanding under the revolving line, and letters of credit totaling $343,986 were outstanding at year-end. The Company was in technical default of the minimum net income and fixed charge coverage covenants as of January 30, 1999. Wells Fargo Bank has issued waivers of both covenant violations through April 30, 1999. The Company intends to renew and revise its existing credit facility with Wells Fargo Bank and has received a commitment letter from the bank dated March 29, 1999. The revised facility would provide an unsecured revolving line of credit totaling $10 million. The facility would permit the Company to borrow the lesser of 150% of trailing twelve-month cash flow (as defined in the credit agreement) or $10 million. Amounts borrowed under the revolving line will continue to bear interest at the lessor of either Prime Rate or 195 basis points above LIBOR. The renewed revolving line would continue to provide for the issuance of letters of credit. The renewed credit agreement would continue to subject the Company to various restrictions on the incurrence of additional indebtedness, acquisitions, loans to officers and stock repurchases. The revised covenants will continue to require the Company to maintain a certain minimum tangible net worth, minimum working capital and other financial covenants. In addition the Company will be required to pay a commitment fee of 0.50% on the unused portion of the revolving line. Any amount borrowed under the new revolving line of credit will become due on June 1, 2000, the date the renewed credit agreement will mature. 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 based on a percentage of store sales and specify rental increases over the term of the lease. Total rent expense under these operating leases was $18,717,424, $13,822,868 and $9,602,618, for fiscal years 1998, 1997, and 1996, respectively. Included in these total rent figures are $511,000, $566,000 and $775,856 of contingent rent for fiscal years 1998, 1997 and 1996, respectively. Accrued rent of $2,294,275 as of January 30, 1999 and $1,800,730 as of January 31, 1998 has been provided to account for rent expenses on a straight-line basis. Future minimum lease payments under non-cancelable operating leases as of January 30, 1999 are as follows:
Fiscal year ----------- 1999 $ 19,215,013 2000 19,192,736 2001 19,183,566 2002 18,973,664 2003 18,319,483 Thereafter 54,173,794 ------------- Total minimum lease payments $ 149,058,256 =============
21 GADZOOKS INC. 19 - -------------------------------------------------------------------------------- 8 INCOME TAXES The provision for federal and state income taxes consists of the following:
Fiscal ---------------------------------------- 1998 1997 1996 ----------- ----------- ----------- Current tax expense $ 531,155 $ 4,971,411 $ 5,037,623 Deferred tax expense (benefit) (433,967) 3,587 (326,123) ----------- ----------- ----------- $ 97,188 $ 4,974,998 $ 4,711,500 =========== =========== ===========
The following table reconciles the provision for income taxes to the amount computed by applying the U.S. statutory federal tax rate of 34% to pre-tax income:
Fiscal ----------------------------------------- 1998 1997 1996 ----------- ----------- ----------- Tax provision at the federal corporate rate $ 164,564 $ 4,509,385 $ 4,318,986 State income taxes, net of related federal benefit 31,209 564,420 418,449 Tax exempt interest (69,613) (182,731) (175,547) Other, net (28,972) 83,924 149,612 ----------- ----------- ----------- Provision for income taxes $ 97,188 $ 4,974,998 $ 4,711,500 =========== =========== ===========
Deferred tax assets (liabilities) are comprised of the following:
JANUARY 30, January 31, 1999 1998 ----------- ----------- Deferred tax assets: Accruals not currently deductible $ 1,305,955 $ 825,436 Depreciation 100,164 219,383 Deferred compensation 98,809 -- ----------- ----------- 1,504,928 1,044,819 Deferred tax liabilities (282,789) (256,647) ----------- ----------- $ 1,222,139 $ 788,172 =========== ===========
At January 30, 1999, the Company had an income tax receivable of $2.1 million classified in accounts receivable. The early disposition of certain qualified stock options and the exercise of certain nonqualified stock options in fiscal 1998, 1997 and 1996 resulted in income tax benefits to the Company of $724,311, $719,937 and $1,208,000 respectively, which 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 at least 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 5% contribution. Employee and Company contributions are paid to a corporate trustee and invested in various mutual funds or the Company's common stock at the discretion of the participant. Company contributions made to participants' accounts become 100% vested on the fifth anniversary of the employee's initial participation in the Plan. For the years ended January 30, 1999, January 31, 1998 and February 1, 1997, the Company contributed $117,917, $108,814 and $88,150, respectively, in matching contributions to the 401(k) Plan. 22 GADZOOKS 20 INC. - -------------------------------------------------------------------------------- Notes to Financial Statements, continued On June 18, 1998, the shareholders approved the Gadzooks, Inc. Employee Stock Purchase Plan ("ESPP"). The ESPP allows eligible employees the right to purchase common stock on a monthly basis at 85 percent of the closing market price of the shares on the last day of the respective calendar month. The aggregate number of shares that may be offered under the ESPP is 60,000. During fiscal 1998, 14,274 shares of the Company's common stock were sold to employees pursuant to the plan. The Company may purchase shares of common stock from time-to-time on the open market to provide shares for sale pursuant to the ESPP. During fiscal 1998 the Company established a nonqualified deferred compensation program which permits officers to defer a portion of their compensation, on a pre-tax basis, until their retirement. Participant deferrals are deposited into variable life insurance contracts held in a Rabbi Trust. The insurance premiums in excess of the insurance cost are deemed invested in mutual funds as directed by the participants. The Company may, at its discretion, make matching contributions on behalf of the plan participants. No such matching contributions were made in fiscal 1998. 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 Stock Market on the date of grant. Options have vesting periods of generally two 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 1998, the plans were amended to adjust the maximum aggregate number of shares that may be optioned and sold under the plans to 1,500,000 shares for the Employee Plan and 100,000 shares for the Nonemployee Director Plan. The maximum aggregate number of shares that may be optioned and sold under the Key Employee Plan is 272,651 shares. On December 15, 1998, options to purchase 517,585 shares of the Company's common stock at prices ranging from $17.63 to $29.25 were cancelled and replaced with options to purchase 393,438 shares of common stock at prices of either $9.00 per share or $11.60 per share. The closing price of the Company's common stock on December 15, 1998 was $6.75 per share. The newly issued options vest over the same period as the cancelled options they replaced. For officers of the Company the replacement options provide the right to purchase from 50% to 67% of the number of shares subject to purchase under the cancelled options depending on the exercise price of the options cancelled. For all other employees, the replacement options provide the right to purchase the same number of shares as provided by the cancelled options. The following table includes option information for the Employee Plan, Key Employee Plan, and Nonemployee Director Plan:
Fiscal -------------------------------------------------------------------------- 1998 1997 1996 -------------------------------------------------------------------------- Weighted Weighted Weighted Average Average Average Exercise Exercise Exercise Shares Price Shares Price Shares Price ------ -------- ------ -------- ------ -------- Outstanding at beginning of year 698,360 $ 13.00 655,289 $ 6.23 675,946 $ 2.13 Granted 973,595 14.65 275,182 23.46 139,115 19.70 Exercised (138,159) 4.38 (170,137) 2.41 (154,418) 0.53 Cancelled (663,726) 21.54 (61,974) 17.95 (5,354) 10.22 --------- -------- --------- ------- --------- -------- Outstanding at end of year 870,070 $ 9.71 698,360 $ 13.00 655,289 $ 6.23 --------- -------- --------- ------- --------- -------- Available for grant at end of year 389,603 29,472 242,830 --------- --------- ---------
23 GADZOOKS INC. 21 - -------------------------------------------------------------------------------- The following table summarizes information about stock options outstanding at January 30, 1999:
Options Outstanding Options Exercisable --------------------------------------------------------------------- Weighted Average Weighted Weighted Number Remaining Average Number Average Range of Outstanding Contractual Exercise Exercisable Exercise Exercise Prices at 1/30/99 Life Price at 1/30/99 Price - --------------- ----------- ----------- -------- ----------- -------- $ 0.21 - $ 7.06 189,254 6 years $ 3.61 93,842 $ 2.71 7.25 - 10.15 215,839 9 years 9.37 13,285 9.00 10.38 - 11.56 138,000 9 years 11.49 800 10.50 11.60 - 11.60 298,838 9 years 11.60 18,165 11.60 17.50 - 28.13 28,139 9 Years 24.48 18,523 24.62 - ---------------- ------- ------- $ 0.21 - $28.13 870,070 144,615
During 1996, the Company 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 APB 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:
Fiscal ---------------------------------------------- 1998 1997 1996 ----------- ---------- ----------- Net income - as reported $ 386,824 $8,287,898 $ 7,991,4OO Net income (loss) - pro forma (1,560,440) 7,347,426 7,654,272 Diluted earnings per share - as reported 0.04 0.91 0.87 Diluted earnings (loss) per share - pro forma (0.18) 0.81 0.84
The fair value of each option grant is estimated as of the date of grant using the Black-Scholes Multiple Option pricing model with the following weighted-average assumptions used for grants:
Fiscal ---------------------------------- 1998 1997 1996 --------- --------- --------- Expected volatility 87% 79% 70% Risk-free interest rate 5.1% 5.6% 6.4% Expected lives 3.7 years 4.2 years 3.6 years Dividend yield 0% 0% 0%
The weighted average fair value of options granted is $7.43, $14.14 and $9.52 per share for fiscal 1998, 1997 and 1996 respectively. 24 GADZOOKS 22 INC. - -------------------------------------------------------------------------------- Notes to Financial Statements, continued 11 EARNINGS PER SHARE The following table outlines the Company's calculation of weighted average shares outstanding:
Fiscal --------------------------------- 1998 1997 1996 --------- --------- --------- Weighted average common shares outstanding (basic) 8,851,609 8,682,582 8,525,322 Effect of dilutive options 184,232 417,445 617,599 --------- --------- --------- Weighted average common and dilutive potential shares outstanding (diluted) 9,035,841 9,100,027 9,142,921 ========= ========= =========
The treasury stock method is used to determine dilutive potential common shares outstanding related to stock options. Options which, based on their exercise price, would be antidilutive are not considered in the treasury stock method calculation. Options excluded from the earnings per share calculation due to their antidilutive nature totaled 22,132, 40,332 and 22,500 in fiscal 1998, 1997 and 1996, respectively. 12 SHAREHOLDER RIGHTS PLAN On September 3, 1998, the Company declared a dividend of one Preferred Share Purchase Right ("Right") on each outstanding share of Gadzooks, Inc. common stock. The dividend distribution was made on September 15, 1998 to shareholders of record on that date. The Rights become exercisable if a person or group acquires 20 percent or more of the Company's common stock or announces its intent to do so. Each Right will entitle shareholders to buy one one-thousandth of a new series of junior participating preferred stock at an exercise price of $110. When the Rights become exercisable, the holder of each Right (other than the acquiring person or members of such group) is entitled (1) to purchase, at the Right's then current exercise price, a number of the acquiring company's common shares having a market value of twice such price, (2) to purchase, at the Right's then current exercise price, a number of the Company's common shares having a market value of twice such price, or (3) at the option of the Company, to exchange the Rights (other than Rights owned by such person or group), in whole or in part, at an exchange ratio of one share of common stock (or one-thousandth of a share of the new series of junior participating preferred stock) per Right. The Rights may be redeemed for one cent each by the Company at any time prior to acquisition by a person (or group) of beneficial ownership of 20 percent or more of the Company's common stock. The Rights will expire on September 15, 2008. 13 CONTINGENCY A lawsuit was filed on August 19, 1998 in the United States District Court for the Northern District of Texas on behalf of purchasers of the publicly traded securities of the Company within the inclusive period of July 9, 1998 through July 22, 1998 alleging misleading and incomplete public disclosures regarding the Company's sales results. The Company believes the lawsuit is without merit and intends to defend it vigorously. The liability, if any, associated with this matter is not determinable at this time. While the adverse resolution of this case could negatively impact earnings in the year of disposition, it is the opinion of management that the ultimate resolution of the matter will not have a materially adverse effect on the Company's financial position or results of operations. 25 GADZOOKS INC. 23 - -------------------------------------------------------------------------------- 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, of shareholders' equity and of cash flows present fairly, in all material respects, the financial position of Gadzooks, Inc. at January 30, 1999 and January 31, 1998, and results of its operations and its cash flows for each of the three years in the period ended January 30, 1999 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/ PRICEWATERHOUSECOOPERS LLP Dallas, Texas March 8, 1999, except as to the second paragraph of Note 6, which is as of April 5, 1999 26 GADZOOKS 24 INC. - -------------------------------------------------------------------------------- CORPORATE INFORMATION
DIRECTORS OFFICERS Gerald R. Szczepanski Gerald R. Szczepanski Chairman of the Board President and Co-Founder of Gadzooks Chief Executive Officer Director since 1983 Monty R. Standifer G. Michael Machens(A,C) Senior Vice President General Partner Chief Financial Officer Phillips-Smith Specialty Treasurer and Secretary Retail Group Director since 1992 James F. Wimpress, Jr. Senior Vice President Robert E.M. Nourse(C) Store Operations Private Investor Former President and David W. Gruehn Chief Executive Officer Vice President The Bombay Company, Inc. Information Systems Director since 1993 William S. Kotch III Ron G. Stegall(A) Vice President President Real Estate Arlington Equity Partners, Inc. Director since 1999 Jeff P. Krainess Vice President Lawrence H. Titus, Jr.(A) Planning and Allocation Co-Founder of Gadzooks (retired) Paula Y. Masters Director since 1983 Vice President General Merchandising Manager A Audit Committee C Compensation Committee Stephen R. Puterbaugh Vice President Human Resources
SHAREHOLDER INFORMATION A COPY OF FORM 10-K, EXCLUDING EXHIBITS, AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION MAY BE OBTAINED WITHOUT CHARGE UPON WRITTEN REQUEST TO INVESTOR RELATIONS AT THE COMPANY'S HEADQUARTERS. COPIES OF EXHIBITS ARE AVAILABLE UPON PAYMENT OF A $125.00 FEE TO COVER THE COSTS OF REPRODUCTION. CORPORATE HEADQUARTERS 4121 International Parkway Carrollton, Texas 75007 (972) 307-5555 (972) 662-4290 Fax WEBSITE www.gadzooks.com Gadzooks and the Gadzooks logo are registered trademarks and service marks of Gadzooks, Inc. Gaditude is a registered service mark of Gadzooks, Inc. ANNUAL MEETING The Annual Meeting of Gadzooks, Inc. will be held at 9:30 a.m., on Thursday, June 17, 1999, at the Company's headquarters. TRANSFER AGENT AND REGISTRAR ChaseMellon Shareholder Services, L.L.C. Overpeck Centre 85 Challenger Road Ridgefield Park, NJ 07660 (800) 635-9270 www.chasemellon.com CORPORATE COUNSEL Akin, Gump, Strauss, Hauer & Feld, L.L.P. Dallas, Texas INDEPENDENT ACCOUNTANTS PricewaterhouseCoopers LLP Dallas, Texas COMMON STOCK Listed on The Nasdaq Stock Market(SM) Symbol: GADZ SHARE PRICE DATA The following table sets forth, for the quarterly periods indicated, the high and low closing prices per share of the common stock as reported on The Nasdaq Stock Market:
1998 1997 ------------ ----------- Fiscal Quarters HIGH LOW HIGH LOW - --------------- ---- --- ---- --- First Quarter 29.38 20.88 36.25 24.25 Second Quarter 28.69 10.50 36.00 16.81 Third Quarter 11.56 6.03 25.75 15.38 Fourth Quarter 8.94 5.69 30.50 19.31
On April 1, 1999 the closing sales price on The Nasdaq Stock Market was $7.25. As of March 31, 1999, the approximate number of common shareholders of record was 107, although the Company believes that the actual number of beneficial owners is significantly higher. The Company presently intends to retain earnings for use in its business and therefore does not anticipate declaring a cash dividend in the near future. Certain statements contained in this Annual Report (other than historical information) are forward-looking statements that involve risks and uncertainties. Reference is made to the "Risk Factors" section of the Company's most recent annual report on Form 10-K filed with the U.S. Securities and Exchange Commission for factors that, among others, could cause the actual results of the Company to differ materially from those contained in the forward-looking statements. 27 - -------------------------------------------------------------------------------- STORE LOCATIONS There are currently 317 Gadzooks stores in 32 states.* ALABAMA Huntsville Mobile Montgomery ARKANSAS Fayetteville Fort Smith Jonesboro Little Rock (2) FLORIDA Fort Myers Jacksonville Orlando (3) Pensacola Tallahassee Tampa (2) GEORGIA Athens Atlanta (7) Augusta Macon ILLINOIS Bloomington Carbondale Champaign Chicago (13) Fairview Heights/ St. Louis Moline Peoria Rockford Springfield INDIANA Elkhart Evansville Fort Wayne Indianapolis Lafayette Merrillville Muncie South Bend Terre Haute IOWA Cedar Rapids (2) Council Bluffs Davenport Des Moines (3) Dubuque Fort Dodge Iowa City Sioux City KANSAS Hays Hutchinson Manhattan Salina Topeka Wichita (2) KENTUCKY Ashland Bowling Green Elizabethtown Florence/Cincinnati Owensboro Lexington Louisville (2) Paducah LOUISIANA Alexandria Baton Rouge (2) Bossier City Houma Lafayette Lake Charles Monroe New Orleans (3) Shreveport MARYLAND Baltimore (2) Frederick MASSACHUSETTS Boston (5) MICHIGAN Ann Arbor Battlecreek Detroit (4) Flint Grand Rapids Holland Jackson Monroe Port Huron Portage Saginaw MINNESOTA Mankato Minneapolis/ St.Paul (3) St.Cloud MISSISSIPPI Biloxi Hattiesburg Jackson Meridian Tupelo MISSOURI Columbia Jefferson City Joplin Kansas City (3) Springfield St. Louis (3) NEBRASKA Grand Island Lincoln Omaha (2) NEW HAMPSHIRE Manchester Salem NEW JERSEY Freehold Livingston Mays Landing Paramus Deptford/Philadelphia Rockaway Wayne NEW MEXICO Albuquerque (2) Las Cruces Santa Fe NEW YORK Albany (2) Nanuet Rochester (3) Staten Island Syracuse (2) NORTH CAROLINA Charlotte (2) Concord Fayetteville Greensboro Hickory High Point Raleigh-Durham (3) Winston-Salem OHIO Cincinnati (2) Cleveland (4) Columbus Dayton (2) Heath Lancaster Lima Mansfield New Philadelphia Niles St. Clairsville Sandusky Toledo Youngstown Zanesville OKLAHOMA Enid Lawton Norman Oklahoma City (4) Shawnee Tulsa (2) PENNSYLVANIA Altoona Erie Harrisburg Johnstown Lancaster Philadelphia (2) Scranton State College SOUTH CAROLINA Charleston (2) Columbia (2) Greenville Myrtle Beach Spartanburg SOUTH DAKOTA Sioux Falls TENNESSEE Chattanooga Clarksville Jackson Johnson City Kingsport Knoxville (2) Memphis (3) Nashville (3) TEXAS Abilene Amarillo Austin (2) Beaumont College Station Corpus Christi Dallas/Fort Worth (9) Denton El Paso (3) Harlingen Houston (12) Killeen Laredo Longview Lubbock McAllen Midland Odessa Port Arthur San Angelo San Antonio (4) Sherman Temple Texarkana Tyler Victoria Waco Wichita Falls VIRGINIA Charlottesville Chesapeake Christiansburg Danville Dulles/Washington, DC Fredericksburg Harrisonburg Manassas Newport News Norfolk Roanoke Springfield Virginia Beach Winchester WEST VIRGINIA Bridgeport Charleston (2) Morgantown Parkersburg WISCONSIN Appleton Eau Claire Green Bay Madison (2) Milwaukee (4) Wausau * As of April 22, 1999 28 [GADZOOKS LOGO] 4121 INTERNATIONAL PARKWAY CARROLLTON, TEXAS 75007 www.gadzooks.com [RECYCLE LOGO] Printed entirely on recycled paper EX-23 3 CONSENT OF PRICEWATERHOUSECOOPERS, LLP 1 EXHIBIT 23 CONSENT OF INDEPENDENT ACCOUNTANTS We hereby consent to the incorporation by reference in the Registration Statements on Form S-8 (Nos. 33-98038, 333-12097, 333-50639, 333-60869 and 333-68205) of Gadzooks, Inc. of our report dated March 8, 1999, except as to the second paragraph of Note 6, which is as of April 5, 1999, appearing on page 23 of the Annual Report to Shareholders which is incorporated in this Annual Report on Form 10-K. /s/ PricewaterhouseCoopers LLP Dallas, Texas April 28, 1999 EX-27 4 FINANCIAL DATA SCHEDULE
5 1,000 YEAR JAN-30-1999 NOV-01-1998 JAN-30-1999 16,353 0 3,002 0 34,404 55,746 44,592 13,896 86,442 24,117 0 0 0 89 59,942 60,031 208,203 208,203 157,729 157,729 0 0 0 484 97 387 0 0 0 387 0.04 0.04
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