UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
FORM 10-K
(Mark One) | |||
[X] | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE | ||
SECURITIES EXCHANGE ACT OF 1934 |
For the fiscal year ended: February 1, 2003
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 0-21296
PACIFIC SUNWEAR OF CALIFORNIA, INC.
California | 95-3759463 | |
(State or other jurisdiction of | (I.R.S. Employer | |
incorporation or organization) | Identification No.) | |
3450 E. Miraloma Avenue, Anaheim, California | 92806 | |
(Address of principal executive offices) | (Zip Code) |
Registrants telephone number, including area code: (714) 414-4000
Securities Registered Pursuant to Section 12(b) of the Act: NONE
Securities Registered Pursuant to Section 12(g) of the Act:
Common Stock, $.01 par value
Preferred Stock Purchase Rights
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes [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 the registrants 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 August 3, 2002 was approximately $556 million. 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 March 24, 2003 the registrant had 49,545,251 shares of Common Stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Part III incorporates information by reference from the definitive Proxy Statement for the 2002 Annual Meeting of Shareholders, to be filed with the Commission no later than 120 days after the end of the registrants fiscal year covered by this Form 10-K.
PART I
ITEM 1. BUSINESS
Pacific Sunwear of California, Inc. and its wholly owned subsidiaries (the Company or the Registrant) is a leading specialty retailer of everyday casual apparel, accessories and footwear designed to meet the needs of active teens and young adults. The Company operates three nationwide, primarily mall-based chains of retail stores under the names Pacific Sunwear (also known as PacSun), Pacific Sunwear (PacSun) Outlet, and d.e.m.o. PacSun and PacSun Outlet stores specialize in board-sport inspired casual apparel, footwear and related accessories catering to teenagers and young adults. d.e.m.o. specializes in hip-hop music inspired casual apparel and related accessories catering to teenagers and young adults. In addition, the Company operates a website through a wholly owned subsidiary that sells PacSun merchandise online, provides content and community for its target customers and provides information about the Company.
As of the close of the year ended February 1, 2003 (fiscal 2002), the Company operated 612 PacSun stores, 72 PacSun Outlet stores and 107 d.e.m.o. stores for a total of 791 stores in 48 states and Puerto Rico. As of March 24, 2003, the Company operated 619 PacSun stores, 73 PacSun Outlet stores and 107 d.e.m.o. stores for a total of 799 stores in 48 states and Puerto Rico.
The Company, a California corporation, was incorporated in August 1982.
The Companys executive offices are located at 3450 East Miraloma Avenue, Anaheim, California 92806; the telephone number is (714) 414-4000; the Companys internet address is www.pacsun.com. Through the Companys website, the Company makes available free of charge, as soon as reasonably practicable after such information has been filed or furnished to the Securities and Exchange Commission (the Commission), its annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (the Exchange Act).
Store Formats
PacSun stores - The Companys original and primary store format, located primarily in regional malls, offers a selection of board-sport inspired casual apparel, footwear and related accessories to satisfy the casual wardrobe needs of its customers. PacSun targets customers between the ages of 12 and 22. Within each merchandise classification, PacSun stores offer a broad selection, with the goal of being viewed by its customers as the dominant retailer in its niche. PacSun stores average approximately 3,500 square feet in size. The Company currently seeks locations of approximately 4,000 square feet for its new PacSun stores. At the end of fiscal 2002, the Company operated 612 PacSun stores containing a total of 2,102,822 square feet.
PacSun Outlet - These stores average approximately 4,100 square feet and are located in value-oriented outlet malls, both open-air and enclosed. This format carries a selection similar to the PacSun mall stores, with an emphasis on value pricing. The merchandise offerings at PacSun Outlets consist primarily of off-price branded merchandise, private brand merchandise and a smaller selection of full-priced branded merchandise. At the end of fiscal 2002, the Company operated 72 PacSun Outlet stores containing a total of 293,511 square feet.
d.e.m.o. - d.e.m.o. stores, located in regional malls, average approximately 2,400 square feet and offer a broad assortment of hip-hop music inspired casual apparel and related accessories. d.e.m.o. targets customers between the ages of 16 and 24. d.e.m.o. stores have no merchandise overlap with PacSun or PacSun Outlet stores, and many d.e.m.o. stores are located in the same malls as PacSun stores. At the end of fiscal 2002, the Company operated 107 d.e.m.o. stores containing a total of 251,010 square feet.
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Strategy
The Companys mission is to be the leading lifestyle retailer of casual fashion apparel, footwear and accessories for teens. The Companys target customers are young men and women between the ages of 12 and 24. The Company believes its customers want to stay current with or ahead of fashion trends and continually seek newness in their everyday wear. The Company offers a complete wardrobe selection representing fashion trends considered timely by the Companys target customers. The key elements of the Companys strategy are as follows:
Offer Popular Name Brands Supplemented by Private Brands. In each of its store formats, the Company offers a carefully edited selection of popular name brands supplemented by private brands, with the goal of being seen by its teenage and young adult customers as the source for wardrobe choices appropriate to their lifestyle. The Company believes that its merchandising strategy differentiates its stores from competitors who may offer 100% private labels or greater than 80% name brands or seek to serve a wider customer base and age range. See Merchandising.
Promote the PacSun and d.e.m.o. Brand Images. The Company promotes the PacSun and d.e.m.o. brands through national print advertising in major magazines that target teens and young adults. In the past, the Company has sponsored sporting events consistent with the PacSun brand image and lifestyle and has conducted PacSun television advertising campaigns. The Companys current promotional efforts are focused exclusively on national print advertising, a trend that we expect to continue through the year ending January 31, 2004 (fiscal 2003). The Company also maintains a private label credit card through a third party to promote the PacSun brand image and lifestyle.
Actively Manage Merchandise Trends. The Company does not attempt to dictate fashion, but instead devotes considerable effort to identifying emerging fashion trends and brand names. By using focus groups, listening to its customers and store employees, monitoring sell-through trends, testing small quantities of new merchandise in a limited number of stores, and maintaining domestic and international sourcing relationships, the Company enhances its ability to identify and respond to emerging fashion trends and brand names as well as develop new private brand styles in order to capitalize on existing fashion trends.
Maintain Strong Vendor Relationships. The Company views its vendor relationships as important to its success, and promotes frequent personal interaction with its vendors. The Company believes many of its vendors view PacSun stores, PacSun Outlets and d.e.m.o. stores as important distribution channels, in many cases as one of their largest customers, which enhance their own brand image in the eyes of the customer.
Provide Attentive Customer Service. The Company is committed to offering courteous, professional and non-intrusive customer service. The Company strives to give its young customers the same level of respect that is generally given to adult customers at other retail stores, and to provide friendly and informed customer service for parents. Responding to the expressed preferences of its customers, the Company trains its employees to greet each customer, to give prompt and courteous assistance when asked, and to thank customers after purchases are made, but to refrain from giving extensive unsolicited advice. PacSun and PacSun Outlet stores display large assortments of name brands and private brands, merchandised by category. d.e.m.o. merchandise is displayed by brand together with vendor logo signage. Additionally, the stores provide a friendly and social atmosphere for teens with appropriate background music, while also providing a comfortable environment for parents and other adults. The Company believes the combination of its attentive customer service and its unique store environments is key to its success.
Store Growth Strategy. The Company intends to continue its store growth through the opening of new stores under its three formats. During fiscal 2003, the Company plans to open approximately 75 net new stores among its three formats. The Company also plans to expand or relocate approximately 30 existing smaller PacSun stores during fiscal 2003. See Expansion.
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Internet Strategy. The Company sells merchandise over the internet at www.pacsun.com. The website offers a selection of the same merchandise carried in the PacSun stores. In addition, the website offers content including videos, contests, advice columns and lifestyle articles. The Company maintains a substantial database of e-mail names that it uses for marketing purposes. The Company also advertises its website as a shopping destination on major internet portals as well as markets its website in its PacSun stores using in-store signage, merchandise bags and receipts. The Companys internet strategy benefits from the Companys nationwide retail presence of its stores and the strong brand recognition of PacSun, a loyal and internet-savvy customer base, the participation of PacSuns key brands and the ability to return merchandise to PacSun stores.
Merchandising
Merchandise. PacSun, PacSun Outlet and d.e.m.o. stores offer a broad selection of casual apparel, related accessories and, within PacSun and PacSun Outlet stores, footwear for young men (guys) and young women (girls), with the goal of being viewed by their customers as the dominant retailer for their lifestyle.
The following table sets forth the Companys merchandise assortment as a percentage of net sales for the periods shown:
Fiscal Year Ended | ||||||||||||
Feb. 1, | Feb. 2, | Feb. 4, | ||||||||||
2003 | 2002 | 2001 | ||||||||||
Guys apparel |
41 | % | 46 | % | 50 | % | ||||||
Girls apparel |
31 | 28 | 26 | |||||||||
Accessories |
18 | 17 | 16 | |||||||||
Footwear |
10 | 9 | 8 | |||||||||
Total |
100 | % | 100 | % | 100 | % | ||||||
The Company offers many name brands best known by its target customers. PacSun offers a wide selection of well-known board-sport inspired name brands, such as Quiksilver, Hurley and Billabong. d.e.m.o. offers well-known name brands sought by its target customers, such as Sean John, Enyce, J. Lo and Phat Farm/Baby Phat. In addition, the Company continuously adds and supports up-and-coming new brands in both PacSun and d.e.m.o. No vendor accounted for more than 9% of total net sales during fiscal 2002.
The Company supplements its name brand offerings with private brands. The Company believes that offering high-quality private brands contributes to its status as a key fashion resource for the casual lifestyle and differentiates the Company from its competitors. In addition, private brands provide the Company an opportunity to broaden its customer base by providing merchandise of comparable quality to brand name merchandise at lower prices, to capitalize on emerging fashion trends when branded merchandise is not available in sufficient quantities, and to exercise a greater degree of control over the flow of its merchandise. The Companys private brand merchandise is designed internally by a product design group in collaboration with the Companys buying staff. The sourcing group oversees the manufacture and delivery of the private brand merchandise, with manufacturing done on a contract basis domestically, in Asia and in Mexico. Private brand merchandise sales accounted for 33% and 34% of the Companys net sales in fiscal 2002 and fiscal 2001, respectively.
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Vendor and Contract Manufacturer Relationships. The Company views its vendor relationships as important to its success and promotes frequent personal interaction with its vendors. The Company believes many of its vendors view PacSun stores, PacSun Outlets and d.e.m.o. stores as important distribution channels, in many cases as one of their largest customers, which enhance their own brand image in the eyes of the customer. The Companys vendor base currently includes more than 100 vendors. The Company maintains strong and interactive relationships with its vendors, many of whose philosophies of controlled distribution and merchandise development are consistent with the Companys strategy. The Company generally purchases merchandise from vendors who prefer distributing through specialty retailers, small boutiques and, in some cases, better department stores, rather than distributing their merchandise through mass-market channels.
To encourage the design and development of new merchandise, the Company frequently shares ideas regarding fashion trends and merchandise sell-through information with its vendors. The Company also suggests merchandise design and fabrication to certain vendors. The Company encourages the development of new vendor relationships by attending trade shows and through its weekly Open-house Wednesday program, during which new vendors are encouraged to make presentations of their merchandise to the Companys buying staff. A number of the Companys key vendors have been introduced to the Company through this program.
The Company has cultivated its private brand sources with a view toward high-quality merchandise, production reliability and consistency of fit. The Company sources its private brand merchandise both domestically and internationally in order to benefit from the lower costs associated with foreign manufacturing and the shorter lead times associated with domestic manufacturing.
The Companys business is dependent upon its ability to offer current season, brand name apparel at competitive prices and in adequate quantities. Some of the Companys vendors have limited resources, production capacities and operating histories and some have intentionally limited the distribution of their merchandise. The inability or unwillingness on the part of key vendors to expand their operations to keep pace with the anticipated growth of PacSun stores, PacSun Outlets and d.e.m.o. stores, or the loss of one or more key vendors or private brand sources for any reason, could have a material adverse effect on the Companys business.
Purchasing, Allocation and Distribution. The Companys merchandising department oversees the purchasing and allocation of the Companys merchandise. The Companys buyers are responsible for reviewing branded merchandise lines from new and existing vendors, identifying emerging fashion trends, and selecting branded and private label merchandise styles in quantities, colors and sizes to meet inventory levels established by management. The Companys planning and allocation department is responsible for management of inventory levels by store and by class, allocation of merchandise to stores and inventory replenishment based upon information generated by the Companys merchandise management information systems. These systems provide the planning department with current inventory levels at each store and for the Company as a whole, as well as current selling history within each store by merchandise classification and by style. See Information Systems.
All merchandise is delivered to the Companys distribution facility, where it is inspected, received into the Companys computer system, allocated to stores, ticketed when necessary, and boxed for distribution to the Companys stores. Each store is typically shipped merchandise three to five times a week, providing it with a steady flow of new merchandise. The Company uses a national and a regional small package carrier to ship merchandise to its stores and occasionally uses air freight during peak selling periods.
In January 2002, the Company completed construction of and relocated to its current corporate offices and distribution center located in Anaheim, California. The Company believes the current facilities are capable of servicing at least 1,200 stores.
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Stores
Locations. The Company has expanded from 11 stores in California at the end of fiscal 1986 to 791 stores in 48 states and Puerto Rico at the end of fiscal 2002. The table below sets forth the number of stores located in each state as of the end of fiscal 2002:
PacSun | PacSun | |||||||||||||||||||||||||||
State | PacSun | Outlets | d.e.m.o | Total | State | PacSun | Outlets | d.e.m.o | Total | |||||||||||||||||||
Alabama | 9 | 2 | 11 | Nebraska | 4 | 4 | ||||||||||||||||||||||
Alaska | 3 | 3 | Nevada | 4 | 1 | 5 | ||||||||||||||||||||||
Arizona | 12 | 2 | 1 | 15 | New Hampshire | 4 | 1 | 5 | ||||||||||||||||||||
California | 70 | 12 | 21 | 103 | New Jersey | 20 | 2 | 6 | 28 | |||||||||||||||||||
Colorado | 10 | 2 | 2 | 14 | New Mexico | 2 | 2 | |||||||||||||||||||||
Connecticut | 9 | 1 | 10 | New York | 27 | 6 | 4 | 37 | ||||||||||||||||||||
Delaware | 3 | 1 | 4 | North Carolina | 16 | 2 | 3 | 21 | ||||||||||||||||||||
Florida | 47 | 6 | 14 | 67 | North Dakota | 4 | 4 | |||||||||||||||||||||
Georgia | 17 | 1 | 5 | 23 | Ohio | 31 | 2 | 5 | 38 | |||||||||||||||||||
Hawaii | 5 | 1 | 6 | Oklahoma | 4 | 4 | ||||||||||||||||||||||
Idaho | 3 | 3 | Oregon | 5 | 2 | 7 | ||||||||||||||||||||||
Illinois | 19 | 1 | 4 | 24 | Pennsylvania | 38 | 3 | 7 | 48 | |||||||||||||||||||
Indiana | 14 | 2 | 3 | 19 | Rhode Island | 2 | 2 | |||||||||||||||||||||
Iowa | 7 | 7 | South Carolina | 6 | 2 | 3 | 11 | |||||||||||||||||||||
Kansas | 5 | 5 | South Dakota | 2 | 2 | |||||||||||||||||||||||
Kentucky | 6 | 1 | 7 | Tennessee | 8 | 2 | 10 | |||||||||||||||||||||
Louisiana | 8 | 4 | 12 | Texas | 39 | 3 | 5 | 47 | ||||||||||||||||||||
Maine | 2 | 2 | 1 | 5 | Utah | 8 | 1 | 9 | ||||||||||||||||||||
Maryland | 13 | 2 | 5 | 20 | Vermont | 3 | 1 | 4 | ||||||||||||||||||||
Massachusetts | 19 | 1 | 3 | 23 | Virginia | 15 | 2 | 1 | 18 | |||||||||||||||||||
Michigan | 23 | 3 | 4 | 30 | Washington | 13 | 1 | 14 | ||||||||||||||||||||
Minnesota | 12 | 1 | 2 | 15 | West Virginia | 7 | 7 | |||||||||||||||||||||
Mississippi | 2 | 2 | Wisconsin | 13 | 13 | |||||||||||||||||||||||
Missouri | 9 | 2 | 11 | Puerto Rico | 7 | 1 | 1 | 9 | ||||||||||||||||||||
Montana | 3 | 3 | Total | 612 | 72 | 107 | 791 | |||||||||||||||||||||
Store Expansion. During fiscal 2002, the Company opened 73 net new stores, which included 63 PacSun stores, four PacSun Outlet stores and six d.e.m.o. stores. In addition, the Company expanded or relocated 30 PacSun stores during fiscal 2002. During fiscal 2003, the Company plans to open approximately 75 net new stores, of which approximately 61 will be PacSun stores, approximately four will be PacSun Outlet stores and approximately ten will be d.e.m.o. stores. The Company also plans to expand or relocate approximately 30 existing smaller PacSun stores during fiscal 2003. The Company has identified regional malls in major metropolitan areas nationwide and in Puerto Rico for potential new stores subject to financial return and site selection criteria. As of the date of this filing, approximately 50% of the leases for the approximately 75 net new stores the Company expects to open in fiscal 2003 have been executed.
The Companys site selection strategy is to locate its stores primarily in regional malls serving markets that meet its demographic criteria, including average household income and population density. The Company also considers mall sales per square foot, the performance of other retail tenants serving teens and young adult customers, anchor tenants and occupancy costs. The Company currently seeks PacSun store locations of approximately 4,000 square feet and d.e.m.o. store locations of approximately 2,200-2,400 square feet
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primarily in high-traffic locations within regional malls. The Company currently seeks PacSun Outlet store locations of approximately 4,000 square feet primarily in high-traffic value-oriented outlet malls, both open-air and enclosed.
The Companys average cost to build a new store in fiscal 2002, including leasehold improvements, furniture and fixtures, and landlord allowances, was approximately $285,000 for PacSun stores, approximately $210,000 for PacSun Outlet stores, and approximately $225,000 for d.e.m.o. stores. The average cost of expanding or relocating a PacSun store was approximately $430,000 and approximately $360,000 in fiscal 2002 and fiscal 2001, respectively. The average total cost to build new stores and relocate or expand stores will vary in the future depending on various factors, including square footage, changes in store design, local construction costs and landlord allowances. The Companys average cost for initial inventory for new stores opened in fiscal 2002 was approximately $118,000 for PacSun stores, approximately $150,000 for PacSun Outlet stores, and approximately $77,000 for d.e.m.o. stores. The Companys initial inventory for new stores will vary in the future depending on various factors, including store concept and square footage.
The Companys continued growth depends upon its ability to open and operate stores on a profitable basis. The Companys ability to expand successfully will be dependent upon a number of factors, including sufficient demand for the Companys merchandise in its existing and new markets, the ability of the Company to locate and obtain favorable store sites, negotiate acceptable lease terms, obtain adequate merchandise supply, and hire and train qualified management and other employees.
Store Operations. Each store has a manager, one or more co-managers or assistant managers, and approximately six to twelve part-time sales associates. Approximately seven to twelve stores are managed by a district manager and approximately six to nine district managers report to a regional manager. Regional, district, store managers and store co-managers participate in a bonus program based on achieving predetermined levels of sales and inventory shrinkage. Company stores are open during mall shopping hours. The Company has well-established store operating policies and procedures and an extensive four-week in-store training program for new store managers and co-managers. The Company places great emphasis on its loss prevention program in order to control inventory shrinkage. This program includes the installation of electronic article surveillance systems in all stores, education of store personnel on loss prevention, and monitoring of returns, voids and employee sales. Since fiscal 1991, the Company has achieved an inventory shrinkage rate of 1.3% or less of net sales in each fiscal year.
Information Systems
The Companys merchandise, financial and store computer systems are fully integrated and operate using primarily IBM equipment. The software, which is primarily provided by one of the largest vendors to the retail trade, is regularly upgraded or modified as needs arise or change. The Companys information systems provide management, buyers and planners comprehensive data that helps them identify emerging trends and manage inventories. The systems include purchase order management, electronic data interchange, open order reporting, open-to-buy, receiving, distribution, merchandise allocation, basic stock replenishment, inter-store transfers, inventory and price management. Weekly best/worst item sales reports are used by management to enhance the timeliness and effectiveness of purchasing and markdown decisions. Merchandise purchases are based on planned sales and inventories and are frequently revised to reflect changes in demand for a particular item or classification.
All of the Companys stores have a point-of-sale system operating on IBM in-store computer hardware. The system features bar-coded ticket scanning, automatic price look-up, dial-out check and credit authorization and automatic nightly transmittal of data between the store and the Companys corporate offices. Each of the regional and district managers uses a laptop computer and can instantly access appropriate or relevant Company-wide information, including actual and budgeted sales by store, district and region, transaction information and payroll data. The Company believes its management information systems are adequate to support its planned expansion at least through fiscal 2003.
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Competition
The retail apparel, footwear and accessory business is highly competitive. PacSun stores, PacSun Outlets and d.e.m.o. stores compete on a national level with certain leading department stores and national chains that offer the same or similar brands and styles of merchandise. The Companys stores also compete with a wide variety of regional and local specialty stores, such as Abercrombie and Fitch, American Eagle Outfitters, The Gap, Old Navy, Wet Seal and Hot Topic. Many of the Companys competitors are larger and have significantly greater resources than the Company. The Company believes the principal competitive factors in its industry are fashion, merchandise assortment, quality, price, store location, environment and customer service.
Trademarks and Service Marks
The Company is the owner in the United States of the marks Pacific Sunwear of California, PacSun, Pacific Sunwear, and d.e.m.o. The Company also uses and has registered, or has a pending registration on, a number of other marks. The Company has also registered many of its marks outside of the United States. The Company believes its rights in its marks are important to its business and intends to maintain its marks and the related registrations.
Employees
At February 1, 2003, the Company had approximately 9,400 employees, of whom approximately 6,500 were part-time. Of the total employees, approximately 400 were employed at the Companys corporate headquarters and distribution center. A significant number of seasonal employees are hired during peak selling periods. None of the Companys employees is represented by a labor union, and the Company believes that its relationships with its employees are good.
EXECUTIVE OFFICERS OF THE REGISTRANT
Set forth below are the names, ages and titles of persons serving as executive officers of the Company as of March 24, 2003:
Executive Officers | Age | Position | ||||
Greg H. Weaver | 49 | Chairman of the Board and Chief Executive Officer | ||||
Timothy M. Harmon | 51 | President and Chief Merchandising Officer | ||||
Carl W. Womack | 51 | Senior Vice President, Chief Financial Officer | ||||
and Secretary |
Set forth below is certain information with respect to the executive officers of the Company:
Greg H. Weaver, who joined the Company in July 1987, has served as Chairman of the Board and Chief Executive Officer since November 1997. He served as President and Chief Executive Officer from October 1996 to November 1997 and as a director since February 1996. Prior to October 1996, Mr. Weaver served in various senior level executive positions since joining the Company. Prior to joining the Company, he was employed for 13 years by Jaeger Sportswear Ltd. in both operational and merchandising capacities for the U.S. and Canadian stores.
Timothy M. Harmon, who joined the Company in September 1991, has served as President and Chief Merchandising Officer from November 1997. Prior to November 1997, he served in various senior level executive merchandising positions since joining the Company. Prior to joining the Company, Mr. Harmon served in various merchandising positions at Wideworld/MTV Sportswear, a domestic apparel
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manufacturer, Chauvin International, an import apparel manufacturer, Anchor Blue, a teen apparel retailer, and Federated Department Stores.
Carl W. Womack, who joined the Company in May 1986, has served as Senior Vice President and Chief Financial Officer since October 1994. He served as Vice President of Finance and Chief Financial Officer from May 1986 to September 1994. He has served as Secretary of the Company since November 1992. Prior to joining the Company, Mr. Womack served in several positions in public and private accounting. Mr. Womack is a certified public accountant.
ITEM 2. PROPERTIES
In January 2002, the Company completed construction of and relocated to its current corporate office and distribution center located in Anaheim, California. The Companys facilities encompass approximately 550,000 square feet. The Company believes the current facilities are capable of servicing at least 1,200 stores.
The Company continues to lease its former facilities of approximately 267,000 square feet under two separate leases. The Company has exercised its option to terminate the smaller of the two leases, covering approximately 91,000 square feet, effective July 31, 2003. The remaining lease, which encompasses approximately 176,000 square feet, expires in February 2008. The Company is currently seeking a tenant to sublease the remaining square footage of its former facilities for the remainder of the lease (see note 10 to the consolidated financial statements).
The majority of the Companys stores are leased with initial lease terms ranging from approximately eight to ten years. Substantially all leases for the Companys stores provide for percentage rent, in excess of specified minimums, based upon net sales.
ITEM 3. LEGAL PROCEEDINGS
On September 17, 2001 a former Pacific Sunwear employee filed a putative class action lawsuit against Pacific Sunwear which alleges that Pacific Sunwear has not properly paid wages to its California-based store managers, co-managers and assistant managers working in PacSun stores. The action, Auden v. Pacific Sunwear of California, Inc., Case No. 01CC00383, was filed in the California Superior Court for the County of Orange. The complaint in the action seeks both monetary and injunctive relief. Pacific Sunwear has filed an answer in the action denying the allegations and raising affirmative defenses. No class has been certified at this time.
On May 3, 2002 a former Pacific Sunwear employee filed a putative class action lawsuit against Pacific Sunwear in the California Superior Court for the County of Orange, alleging claims substantially similar to the claims alleged in the Auden case described above. In the case, Adams v. Pacific Sunwear of California, Inc., Case No. 02CC00120, the plaintiff alleges that Pacific Sunwear has not properly paid wages to its California store managers and co-managers working in d.e.m.o. stores. The complaint in the action seeks monetary and injunctive relief. Pacific Sunwear has filed an answer in the action denying the allegations and raising affirmative defenses. No class has been certified at this time.
The Company is involved from time to time in litigation incidental to its business. Management believes that the outcome of current litigation will not have a material adverse effect upon the results of operations or financial condition of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the Companys shareholders during the fourth quarter of the fiscal year covered by this report.
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PART II
ITEM 5. MARKET FOR REGISTRANTS COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Companys common stock trades on the NASDAQ National Market under the symbol PSUN. The following table sets forth for the quarterly periods indicated the high and low bid prices per share of the common stock as reported by NASDAQ (as adjusted to reflect the Companys 3-for-2 stock split in December 2002):
Fiscal 2002 | High | Low | Fiscal 2001 | High | Low | |||||||||||||
1st Quarter | $ | 17.87 | $ | 13.38 | 1st Quarter | $ | 23.92 | $ | 13.33 | |||||||||
2nd Quarter | 16.57 | $ | 10.81 | 2nd Quarter | $ | 17.37 | $ | 11.91 | ||||||||||
3rd Quarter | 16.79 | $ | 10.82 | 3rd Quarter | $ | 12.69 | $ | 7.63 | ||||||||||
4th Quarter | 20.11 | $ | 15.23 | 4th Quarter | $ | 16.21 | $ | 10.03 |
As of March 24, 2003, the number of holders of record of common stock of the Company was approximately 300, and the number of beneficial holders of the common stock was in excess of 5,500.
The Company has never declared or paid any dividends on its common stock and does not intend to pay any dividends on its common stock in the foreseeable future. In addition, the Companys current credit facility prohibits the payment of cash dividends on its capital stock.
ITEM 6. SELECTED FINANCIAL DATA
The selected balance sheet and income statement data as of February 1, 2003, and February 2, 2002, and for each of the three fiscal years in the period ended February 1, 2003, are derived from audited consolidated financial statements of the Company included herein and should be read in conjunction with such financial statements. Such data and the selected consolidated operating data below should be read in conjunction with Managements Discussion and Analysis of Financial Condition and Results of Operations included in this report. The consolidated balance sheet data as of February 4, 2001 (fiscal 2000), January 30, 2000, and January 31, 1999, and the consolidated income statement data for each of the two fiscal years in the period ended January 30, 2000, are derived from audited consolidated financial statements of the Company, which are not included herein.
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Fiscal Year Ended (1) | ||||||||||||||||||||
Feb. 1, | Feb. 2, | Feb. 4, | Jan. 30, | Jan. 31, | ||||||||||||||||
2003 | 2002 | 2001 | 2000 | 1999 | ||||||||||||||||
(in thousands, except per share and selected operating data) | ||||||||||||||||||||
Consolidated Income Statement Data: |
||||||||||||||||||||
Net sales |
$ | 846,393 | $ | 684,840 | $ | 589,438 | $ | 436,808 | $ | 321,125 | ||||||||||
Cost of goods sold (including buying,
distribution and occupancy costs) |
562,710 | 464,660 | 391,816 | 284,187 | 212,859 | |||||||||||||||
Gross margin |
283,683 | 220,180 | 197,622 | 152,621 | 108,266 | |||||||||||||||
Selling, general and administrative expenses |
202,445 | 175,898 | 133,999 | 96,117 | 70,369 | |||||||||||||||
Operating income |
81,238 | 44,282 | 63,623 | 56,504 | 37,897 | |||||||||||||||
Net interest expense/(income) |
594 | (470 | ) | (1,344 | ) | (916 | ) | (977 | ) | |||||||||||
Income before income tax expense |
80,644 | 44,752 | 64,967 | 57,420 | 38,874 | |||||||||||||||
Income tax expense |
30,967 | 17,186 | 25,213 | 22,119 | 15,369 | |||||||||||||||
Net income |
$ | 49,677 | $ | 27,566 | $ | 39,754 | $ | 35,301 | $ | 23,505 | ||||||||||
Net income per share, diluted (2) |
$ | 0.99 | $ | 0.56 | $ | 0.81 | $ | 0.73 | $ | 0.49 | ||||||||||
Weighted average shares outstanding, diluted (2) |
50,098 | 49,659 | 48,822 | 48,285 | 48,350 | |||||||||||||||
Selected Consolidated Operating Data: |
||||||||||||||||||||
Stores open at end of period |
791 | 718 | 589 | 450 | 342 | |||||||||||||||
Stores opened during period |
85 | 135 | 142 | 111 | 74 | |||||||||||||||
Stores closed during period |
12 | 6 | 3 | 3 | 4 | |||||||||||||||
Capital expenditures (000s) |
$ | 40,423 | $ | 92,936 | $ | 61,869 | $ | 40,219 | $ | 31,603 | ||||||||||
Average net sales per gross square foot (3) (4) |
$ | 330 | $ | 321 | $ | 368 | $ | 398 | $ | 403 | ||||||||||
Average net sales per store (000s) (3) (4) |
$ | 1,102 | $ | 1,031 | $ | 1,082 | $ | 1,084 | $ | 1,034 | ||||||||||
Square footage of gross store space |
2,647,343 | 2,319,149 | 1,764,123 | 1,254,373 | 888,507 | |||||||||||||||
Comparable store net sales increase/
(decrease) (4) (5) |
9.7 | % | (2.5 | )% | 3.5 | % | 7.8 | % | 8.6 | % | ||||||||||
Consolidated Balance Sheet Data: |
||||||||||||||||||||
Working capital |
$ | 109,305 | $ | 78,899 | $ | 79,799 | $ | 67,351 | $ | 47,545 | ||||||||||
Total assets |
399,743 | 355,440 | 277,453 | 209,342 | 147,775 | |||||||||||||||
Long-term debt |
1,102 | 24,597 | | | | |||||||||||||||
Shareholders equity |
$ | 302,391 | $ | 247,955 | $ | 213,131 | $ | 161,826 | $ | 116,697 |
(1) | Except for the fiscal year ended February 4, 2001, which included 53 weeks, all fiscal years presented included 52 weeks. Effective February 1, 2002, the Company changed its fiscal year end from the Sunday closest to the end of January to the Saturday closest to the end of January. As a result, the last day of fiscal 2001 was Saturday, February 2, 2002. | |
(2) | Adjusted to give effect to the three-for-two stock splits effected as of December 18, 2002, June 8, 1999, and June 8, 1998. | |
(3) | For purposes of calculating these amounts, the number of stores and the amount of square footage reflect the number of months during the period that new stores and closed stores were open. | |
(4) | These amounts have been adjusted to exclude the fifty-third week in the fiscal year ended February 4, 2001. | |
(5) | Stores are deemed comparable stores on the first day of the first month following the one-year anniversary of their opening. In conjunction with the expansion or relocation of certain stores to a larger format with a square footage increase of 15% or more, the Company excludes each such stores net sales results from the first day of the month of its expansion or relocation. Each of these stores is deemed a comparable store on the first day of the first month following the one-year anniversary of its expansion or relocation. In conjunction with the conversion of certain PacSun stores to the d.e.m.o. format, the Company excludes each such stores net sales results from the first day of the month of its conversion. Each of these stores is deemed a comparable store on the first day of the first month following the one-year anniversary of its conversion to the d.e.m.o. format. |
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ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the Consolidated Financial Statements and Notes thereto of the Company included elsewhere in this Form 10-K. The following Managements Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements that involve risks and uncertainties. The Companys actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including those set forth under Cautionary Note Regarding Forward-Looking Statements and Risk Factors in this section.
Critical Accounting Policies
The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America necessarily requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements as well as the reported revenues and expenses during the reported period. Actual results could differ from these estimates. The accounting policies that the Company believes are the most critical to aid in fully understanding and evaluating reported financial results include the following:
Revenue Recognition - Sales are recognized upon purchase by customers at the Companys retail store locations or through the Companys website. The Company has recorded reserves of $.5 million to estimate sales returns by customers based on historical sales return results. Actual return rates have historically been within managements expectations and the reserves established. However, in the unlikely event that the actual rate of sales returns by customers increased significantly, the Companys operational results could be adversely affected.
Inventory Valuation - Merchandise inventories are stated at the lower of cost (first-in, first-out method) or market. Cost is determined using the retail inventory method. At any one time, inventories include items that have been marked down to managements best estimate of their fair market value. Management bases the decision to mark down merchandise upon the age of the item and its current rate of sale. To the extent that management estimates differ from actual results, additional markdowns may have to be recorded, which could reduce the Companys gross margins and operating results.
Long-Lived Assets - In the normal course of business, the Company acquires tangible and intangible assets. The Company periodically evaluates the recoverability of the carrying amount of its long-lived assets (including property, plant and equipment, and other intangible assets) whenever events or changes in circumstances indicate that the carrying amount of an asset may not be fully recoverable. An impairment is assessed when the undiscounted expected future cash flows derived from an asset or asset group are less than its carrying amount. Impairments are recognized in operating earnings. The Company uses its best judgment based on the most current facts and circumstances surrounding its business when applying these impairment rules to determine the timing of the impairment test, the undiscounted cash flows used to assess impairments, and the fair value of a potentially impaired asset. Changes in assumptions used could have a significant impact on the Companys assessment of recoverability. Numerous factors, including changes in the Companys business, industry segment, and global economy, could significantly impact managements decision to retain, dispose of, or idle certain of its long-lived assets.
Goodwill and Other Intangible Assets - The Company evaluates the recoverability of goodwill at least annually based on a two-step impairment test. The first step compares the fair value of each reporting unit with its carrying amount, including goodwill. If the carrying amount exceeds fair value, then the second step of the impairment test is performed to measure the amount of any impairment loss. Fair value is determined based on estimated future cash flows, discounted at a rate that approximates the Companys cost of capital. Such estimates are subject to change and the Company may be required to recognize impairment losses in the future.
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Income Taxes - Current income tax expense is the amount of income taxes expected to be payable for the current year. A deferred income tax asset or liability is established for the expected future consequences of temporary differences in the financial reporting and tax bases of assets and liabilities. The Company considers future taxable income and ongoing prudent and feasible tax planning in assessing the value of its deferred tax assets. If the Company determines that it is more likely than not that these assets will not be realized, the Company would reduce the value of these assets to their expected realizable value, thereby decreasing net income. Evaluating the value of these assets is necessarily based on the Companys judgment. If the Company subsequently determined that the deferred tax assets, which had been written down, would be realized in the future, the value of the deferred tax assets would be increased, thereby increasing net income in the period when that determination was made.
Corporate Rent Reserve - During fiscal 2001, the Company recorded a $1.4 million charge to accrue for rent expense associated with the Companys former corporate offices, which remain unused at the end of fiscal 2002. The current accrual at March 24, 2003 of $1.3 million is approximately the amount of rent expense for one year, within which time the Company currently believes a tenant will be identified to sublease the premises. To the extent managements estimate relating to the Companys ability to sublease these premises within one year changes, additional charges may be recorded in the future up to the net remaining obligation under the lease depending on the facts and circumstances in existence at the time. As of February 1, 2003, the aggregate net remaining obligation under this lease was approximately $6.7 million.
Litigation - The Company is involved from time to time in litigation incidental to its business. Management believes that the outcome of current litigation will not have a material adverse effect upon the results of operations or financial condition of the Company and, from time to time, may make provisions for potential litigation losses. Depending on the actual outcome of pending litigation, charges in excess of any provisions could be recorded in the future that may have an adverse effect on the Companys operating results (see Note 7 to the consolidated financial statements).
Results of Operations
The following table sets forth selected income statement data of the Company expressed as a percentage of net sales for the fiscal years indicated. The discussion that follows should be read in conjunction with the table below:
As a Percentage of Net Sales, | ||||||||||||
Fiscal Year Ended | ||||||||||||
Feb. 1, | Feb. 2, | Feb. 4, | ||||||||||
2003 | 2002 | 2001 | ||||||||||
Net sales |
100.0 | % | 100.0 | % | 100.0 | % | ||||||
Cost of goods sold (including buying, distribution
and occupancy costs) |
66.5 | 67.8 | 66.5 | |||||||||
Gross margin |
33.5 | 32.2 | 33.5 | |||||||||
Selling, general and administrative expenses |
23.9 | 25.7 | 22.7 | |||||||||
Operating income |
9.6 | 6.5 | 10.8 | |||||||||
Interest expense/(income), net |
0.1 | (0.1 | ) | (0.2 | ) | |||||||
Income before income tax expense |
9.5 | 6.6 | 11.0 | |||||||||
Income tax expense |
3.6 | 2.6 | 4.3 | |||||||||
Net income |
5.9 | % | 4.0 | % | 6.7 | % | ||||||
Number of stores open at end of period |
791 | 718 | 589 |
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Fiscal 2002 Compared to Fiscal 2001
Net Sales
Net sales increased to $846.4 million in fiscal 2002 from $684.8 million in fiscal 2001, an increase of $161.6 million, or 23.6%. Of this $161.6 million increase, $61.0 million was attributable to a 9.7% increase in comparable store net sales in fiscal 2002 compared to the comparable 52-week period ended February 2, 2002, $50.6 million was attributable to net sales generated by 85 new stores opened in fiscal 2002 not yet included in the comparable store base, $40.9 million was attributable to net sales generated by new stores opened in fiscal 2001 not yet included in the comparable store base, $13.7 million was attributable to other non-comparable store sales, and $1.4 million was due to the change in the Companys fiscal year end from the Sunday closest to the end of January to the Saturday closest to the end of January effective for fiscal 2001, which resulted in an additional shopping day in fiscal 2002 as compared to fiscal 2001. Offsetting these increases was a $6.0 million decrease in net sales attributable to the closing of twelve stores during fiscal 2002 and six stores during fiscal 2001. Other non-comparable sales consist of sales from stores that have been expanded or relocated and not yet included in the comparable store base as well as merchandise sold over the internet. Of the 9.7% increase in comparable store net sales in fiscal 2002, PacSun and PacSun Outlet comparable store net sales increased 9.4% and d.e.m.o. comparable store net sales increased 12.4%. The increase in comparable store net sales within PacSun and PacSun Outlet was primarily attributable to increases in comparable store net sales of footwear, juniors, and accessories. The increase in comparable store net sales within d.e.m.o. was primarily attributable to increases in comparable store net sales of juniors and accessories merchandise. Stores are deemed comparable stores on the first day of the first month following the one-year anniversary of their opening or expansion/relocation. Average retail prices of merchandise sold remained relatively unchanged in fiscal 2002 compared to fiscal 2001 and had no significant impact on the net sales increase for fiscal 2002.
Gross Margin
Gross margin, after buying, distribution and occupancy costs, increased to $283.7 million in fiscal 2002 from $220.2 million in fiscal 2001, an increase of $63.5 million, or 28.8%. As a percentage of net sales, gross margin was 33.5% for fiscal 2002 compared to 32.2% for fiscal 2001. Of this 1.3% increase, occupancy costs and buying costs each decreased by .4% as a percentage of net sales compared to fiscal 2001, primarily due to leveraging these costs over higher total sales, distribution costs as a percentage of net sales decreased .3% due to freight and labor efficiencies in the new distribution center as well as leveraging these costs over higher total sales, and .2% was due to an increase in net merchandise margins as a percentage of sales, primarily due to a higher initial markup partially offset by a higher markdown rate.
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased to $202.4 million in fiscal 2002 from $175.9 million in fiscal 2001, an increase of $26.5 million, or 15.1%. As a percentage of net sales, these expenses decreased to 23.9% from 25.7%. Of this 1.8% net decrease, .8% was attributable to decreased advertising expenses as a percentage of net sales, primarily due to the elimination of television advertising and a sports game sponsorship in fiscal 2002, .6% was due to a decrease in store closing expenses as a percentage of net sales, and .4% was attributable to a decrease in store payroll expenses as a percentage of net sales, primarily due to the operating leverage associated with a 9.7% increase in comparable store net sales. Selling, general and administrative expenses include provisions made by the Company for the wage and hour litigation pending against the Company (see Item 3. Legal Proceedings and Note 7 to the consolidated financial statements).
Net Interest Expense/Income
Net interest expense was $.6 million in fiscal 2002 compared to interest income of $.5 million in fiscal 2001, a decrease of $1.1 million. This decrease was primarily the result of interest expense arising from a construction loan related to the construction of the Companys new corporate offices and distribution center in fiscal 2002 as well as lower average cash balances during fiscal 2002 as compared to fiscal 2001.
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Income Tax Expense
Income tax expense was $31.0 million in fiscal 2002 compared to $17.2 million in fiscal 2001. The effective income tax rate in fiscal 2002 and fiscal 2001 was 38.4%.
Fiscal 2001 Compared to Fiscal 2000
Net Sales
Net sales increased to $684.8 million in fiscal 2001 from $589.4 million in fiscal 2000, an increase of $95.4 million, or 16.2%. Of this $95.4 million increase, $69.9 million was attributable to net sales generated by 135 new stores opened in fiscal 2001 not yet included in the comparable store base, $40.2 million was attributable to net sales generated by new stores opened in fiscal 2000 not yet included in the comparable store base and $8.3 million was attributable to other non-comparable store sales. Offsetting these increases was a $13.0 million decrease in net sales attributable to a 2.5% decrease in comparable store net sales in fiscal 2001 compared to the comparable 52-week period ended February 3, 2001, a $6.1 million decrease in net sales attributable to the one less week in fiscal 2001 (fiscal 2001 had 52 weeks and fiscal 2000 had 53 weeks), a $2.5 million decrease in net sales attributable to the closing of six stores during fiscal 2001 and three stores during fiscal 2000 and a $1.4 million decrease due to the change in the Companys fiscal year end from the Sunday closest to the end of January to the Saturday closest to the end of January effective for fiscal 2001. Other non-comparable sales consist of sales from stores that have been expanded or relocated and not yet included in the comparable store base as well as merchandise sold over the internet. Of the 2.5% decrease in comparable store net sales in fiscal 2001, PacSun and PacSun Outlet comparable store net sales decreased 2.8% and d.e.m.o. comparable store net sales increased 1.6%. Stores are deemed comparable stores on the first day of the first month following the one-year anniversary of their opening or expansion/relocation. Average retail prices of merchandise sold remained relatively unchanged in fiscal 2001 compared to fiscal 2000 and had no significant impact on the net sales increase for fiscal 2001.
Gross Margin
Gross margin, after buying, distribution and occupancy costs, increased to $220.2 million in fiscal 2001 from $197.6 million in fiscal 2000, an increase of $22.6 million, or 11.4%. As a percentage of net sales, gross margin was 32.2% for fiscal 2001 compared to 33.5% for fiscal 2000. Of this 1.3% decrease, occupancy costs for fiscal 2001 increased 1.4% as a percentage of net sales compared to fiscal 2000, primarily due to the 2.5% decrease in comparable store net sales in fiscal 2001 as well as opening 135 new stores in fiscal 2001. Occupancy costs as a percentage of net sales for new stores are generally higher than for mature stores. Offsetting this increase was a .1% decrease in buying and distribution costs as a percentage of net sales in fiscal 2001 compared to fiscal 2000.
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased to $175.9 million in fiscal 2001 from $134.0 million in fiscal 2000, an increase of $41.9 million, or 31.3%. As a percentage of net sales, these expenses increased to 25.7% from 22.7%. Of this 3.0% net increase, 1.6% was due to an increase in store payroll and other store selling expenses, primarily as a result of lower comparable store net sales as well as opening 135 new stores in fiscal 2001. Store payroll and other store selling expenses as a percentage of net sales for new stores are generally higher than for mature stores. In addition, .6% was due to the one-time non-cash charge of $4.2 million related to the disposal of most of the materials handling equipment in the Companys former distribution center. Of the remaining increase of .8%, .3% was due to an increase in general and administrative expenses, .2% was due to an increase in store closing expenses, .2% was due to the Companys charge to accrue for rent expense for the Companys former corporate office and distribution center that became unused when the Company moved into its new corporate office and distribution center at the end of fiscal 2001 and .1% was due to an increase in advertising expenses.
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Net Interest Income
Net interest income was $.5 million in fiscal 2001 compared to $1.3 million in fiscal 2000, a decrease of $.8 million. This decrease was primarily the result of lower average cash balances and lower interest rates during fiscal 2001 as compared to fiscal 2000.
Income Tax Expense
Income tax expense was $17.2 million in fiscal 2001 compared to $25.2 million in fiscal 2000. The effective income tax rate in fiscal 2001 was 38.4% compared to 38.8% in fiscal 2000.
Liquidity and Capital Resources
The Company has financed its operations from internally generated cash flow, short-term and long-term borrowings and equity financing. The Companys primary capital requirements have been for the construction of new stores, remodeling, expansion, or relocation of selected stores, financing of inventories and, in fiscal 2001, construction of the Companys new corporate offices and distribution center.
Net cash provided by operating activities for fiscal 2002, fiscal 2001 and fiscal 2000 was $76.6 million, $58.4 million and $52.0 million, respectively. The $18.2 million increase in cash provided by operations in fiscal 2002 as compared to fiscal 2001 was attributable to an increase in net income of $22.1 million, an increase in accrued liabilities of $12.3 million, and an increase in depreciation and amortization of $5.3 million. Offsetting these increases were a $14.9 million decrease in accounts payable, a $3.2 million decrease in losses on fixed asset disposals, a $3.0 million decrease in accrued income taxes and deferred income taxes, and other items netting to a decrease of $.4 million. Working capital at the end of fiscal 2002, fiscal 2001 and fiscal 2000 was $109.3 million, $78.9 million and $79.8 million, respectively. The $30.4 million increase in working capital at February 1, 2003, as compared to February 2, 2002, was attributable to an increase in inventories of $20.9 million, an increase in cash of $13.3 million, a decrease in accounts payable of $9.0 million, and other items netting to an increase of $4.0 million. Offsetting these increases in working capital was a $16.8 million increase in accrued liabilities. The Companys average store inventories vary throughout the year and increase in advance of the peak selling periods of spring break, back-to-school and Christmas. The increase in inventories at February 1, 2003, was primarily related to the 9.7% comparable store net sales increase as well as opening 85 new stores and expanding/relocating 30 stores that have in excess of 50% larger average square footage than their previous locations. The decrease in accounts payable of $9.0 million at February 1, 2003, as compared to February 2, 2002, was primarily attributable to increased efficiencies in the Companys new distribution center in fiscal 2002 as compared to fiscal 2001 when the Company started up operations in its new distribution center which delayed payments in some cases. Accounts payable as a percentage of inventory decreased to 23.1% at February 1, 2003, as compared to 36.6% at February 2, 2002. The increase in accrued liabilities of $16.8 million at February 1, 2003, as compared to February 2, 2002, was primarily attributable to increased payroll and bonus accruals.
Net cash used in investing activities in fiscal 2002, fiscal 2001 and fiscal 2000 was $40.4 million, $92.9 million and $61.9 million, respectively, which was used for investment in property and equipment. Of the $40.4 million of net cash used for investment in property and equipment in fiscal 2002, $29.4 million was used for 85 new stores and 30 expansions/relocations opened in fiscal 2002, $4.4 million was used for the initial construction costs of new stores and expansions/relocations to be opened in fiscal 2003, $4.4 million was used for maintenance capital expenditures on existing stores, and $2.2 million was used for other capital expenditures including computer hardware and software. Property and equipment expenditures were significantly lower in fiscal 2002 as compared to fiscal 2001, primarily due to the Companys construction of its new corporate facilities during fiscal 2001.
Net cash used in financing activities in fiscal 2002 was $22.9 million as compared to cash provided by financing activities in fiscal 2001 and fiscal 2000 of $28.7 million and $6.4 million, respectively. Of the $22.9 million of net cash used in financing activities in fiscal 2002, $25.5 million was due to the repayment
16
of the Companys construction loan and $.8 million was due to principal payments under capital lease obligations, offset by $3.4 million in proceeds received from the exercise of stock options.
The Company has a credit facility with a bank, which expires March 31, 2004. The credit facility provides for a $45.0 million line of credit (the Credit Line) to be used for cash advances, commercial letters of credit and shipside bonds, and an additional $25.0 million line of credit (the Construction Facility) which was used to finance the construction of the Companys current corporate office and distribution center. On August 30, 2002, the Company repaid the outstanding balance of $25.0 million related to the Construction Facility using available cash generated from operations. Interest on the Credit Line is payable monthly at the banks prime rate (4.25% at February 1, 2003) or at optional interest rates that are primarily dependent upon the London Inter-bank Offered Rates for the time period chosen. The Companys weighted average interest rate on its outstanding borrowings was 3.67% at February 1, 2003. At February 1, 2003, the Company had no borrowings outstanding under the Credit Line and $10.3 million outstanding in letters of credit. The credit facility subjects the Company to various restrictive covenants, including maintenance of certain financial ratios, and prohibits payment of cash dividends on common stock. At February 1, 2003, the Company was in compliance with all of the covenants.
The Company has minimum annual rental commitments under existing store leases, the lease for its former corporate offices and distribution center, capital leases for computer equipment, and other long-term debt obligations for multi-year computer maintenance contracts. The Companys financial obligations under these arrangements are approximately $76 million in fiscal 2003 and similar amounts thereafter. The Company leases all of its retail store locations under operating leases. The Company leases equipment, from time to time, under capital leases. In addition, at any time, the Company is contingently liable for open letters of credit with foreign suppliers of merchandise. There were $10.3 million of open letters of credit outstanding as of February 1, 2003. As of February 1, 2003, the Companys future financial commitments under these arrangements are as follows:
Payments Due by Period | ||||||||||||||||||||
Contractual Obligations | Less than 1 | 1-3 | 3-5 | More than | ||||||||||||||||
(in millions) | Total | year | years | years | 5 years | |||||||||||||||
Operating lease obligations |
$ | 583.7 | $ | 73.2 | $ | 146.8 | $ | 147.0 | $ | 216.7 | ||||||||||
Capital lease obligations |
4.0 | 1.7 | 2.1 | 0.2 | | |||||||||||||||
Long-term debt obligations |
2.1 | 0.9 | 1.2 | | | |||||||||||||||
Letters of credit |
10.3 | 10.3 | | | | |||||||||||||||
Total |
$ | 600.1 | $ | 86.1 | $ | 150.1 | $ | 147.2 | $ | 216.7 |
The Companys average cost to build a new store in fiscal 2002, including leasehold improvements, furniture and fixtures and landlord allowances, was approximately $285,000 for PacSun stores, approximately $210,000 for PacSun Outlet stores, and approximately $225,000 for d.e.m.o. stores. The average cost of expanding or relocating a PacSun store was approximately $430,000 and approximately $360,000 in fiscal 2002 and fiscal 2001, respectively. The average total cost to build new stores and relocate or expand stores will vary in the future, depending on various factors, including square footage, changes in store design, local construction costs and landlord allowances. The Companys average initial inventory, at cost, for new stores opened in fiscal 2002 was approximately $118,000 for PacSun stores, approximately $150,000 for PacSun Outlet stores and approximately $77,000 for d.e.m.o. stores. The Companys initial inventory for new stores will vary in the future depending on various factors, including store concept and square footage.
During fiscal 2003, the Company plans to open approximately 75 net new stores, of which approximately 61 will be PacSun stores, approximately four will be PacSun Outlet stores and approximately ten will be d.e.m.o. stores. The Company also plans to expand or relocate approximately 30 existing smaller PacSun stores. In fiscal 2003, capital expenditures are expected to be approximately $46 million, of which approximately $41 million will be for opening approximately 75 net new stores and for approximately 30 expansions/relocations, and approximately $5 million will be used for other capital expenditures including maintenance capital on existing stores and computer hardware and software.
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The Company reviews the operating performance of its stores on an ongoing basis to determine which stores, if any, to expand, relocate or close. Most leases contain cancellation or kick-out clauses in the Companys favor that relieve the Company of any future obligation under a lease if specified sales levels are not achieved by a specified date. The Company closed twelve stores in fiscal 2002 and anticipates closing approximately eleven stores in fiscal 2003.
The Company relies primarily on internally generated cash flows to finance its operations. In addition, to the extent necessary, the Company relies on its credit facility to finance operations and provide additional resources for capital expenditures. Management believes that the Companys working capital, cash flows from operating activities and credit facility will be sufficient to meet the Companys operating and capital expenditure requirements for the next twelve months.
The Companys success is largely dependent upon its ability to gauge the fashion tastes of its customers and provide merchandise that satisfies customer demand. Any inability to provide appropriate merchandise in sufficient quantities in a timely manner could have a material adverse effect on the Companys business, operating results, cash flows from operations and financial condition. Any economic downturn that affects the retail industry as a whole could also adversely affect the Companys business, operating results, cash flows from operations and financial condition.
A significant decrease in the Companys operating results could adversely affect the Companys ability to maintain required financial ratios under the Companys credit facility. Required financial ratios include total liabilities to tangible net worth ratio, limitations on capital expenditures and achievement of certain rolling four-quarter EBITDA requirements. If these financial ratios are not maintained, the bank will have the option to require immediate repayment of all amounts outstanding under the credit facility. The most likely result would require the Company to either renegotiate certain terms of the credit agreement, obtain a waiver from the bank, or obtain a new credit agreement with another bank, which may contain different terms. As of February 1, 2003, the Company had no borrowings outstanding under its credit facility.
New Accounting Pronouncements
Goodwill and Other Intangible Assets On February 3, 2002, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 142, Goodwill and Intangible Assets, which revises the accounting for purchased goodwill and intangible assets. Under SFAS No. 142, goodwill and intangible assets with indefinite lives are no longer amortized but are tested for impairment annually and also in the event of an impairment indicator. The Company completed the required transitional impairment test and the annual test and determined that no impairment existed. Any subsequent impairment losses will be reflected in operating income. With the adoption of SFAS No. 142, the Company discontinued amortization of goodwill. Had amortization of goodwill not been recorded in fiscal 2001 and fiscal 2000, net income would have increased by $.2 million in each fiscal year, net of taxes, and diluted earnings per share would have increased by $.01 in fiscal 2000 due to rounding.
Accounting for the Impairment or Disposal of Long-Lived Assets In August 2001, the Financial Accounting Standards Board (FASB) issued SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, which supersedes previous guidance on financial accounting and reporting for the impairment or disposal of long-lived assets and for segments of a business to be disposed of. The Company adopted SFAS No. 144 effective February 3, 2002. Upon adoption of SFAS No. 144, the Company reviewed long-lived assets and determined that no impairment existed. Under SFAS No. 144, long-lived assets, including amortizing intangible assets, will be tested for impairment whenever events or changes in circumstances indicate that the carrying value of such assets may not be recoverable.
Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections In April 2002, the FASB issued SFAS No. 145, Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections. SFAS No. 145 amended certain provisions of SFAS No. 13 and requires the fair value recognition of guarantee obligations under which the Company may become secondarily liable. The Company adopted SFAS No. 145 during fiscal 2002. The adoption of SFAS No. 145 resulted in the recognition of a $.5 million liability related to the
18
Companys guarantee of an assignees performance under a lease obligation (see Note 7 to the consolidated financial statements).
Accounting for Costs Associated with Exit or Disposal Activities In June, 2002 the FASB issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities, which addresses financial accounting and reporting for costs associated with exit or disposal activities and supersedes Emerging Issues Task Force (EITF) Issue 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring). SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. Under Issue 94-3, a liability for an exit cost as defined in EITF Issue 94-3 was recognized at the date of an entitys commitment to an exit plan. SFAS No. 146 also establishes that the liability should initially be measured and recorded at fair value. The Company will adopt the provisions of SFAS No. 146 for exit or disposal activities that are initiated after December 31, 2002.
Guarantors Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees and Indebtedness of Others In November 2002, the FASB issued FASB Interpretation No. 45 (FIN 45), Guarantors Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees and Indebtedness of Others. FIN 45 elaborates on the disclosures to be made by the guarantor in its interim and annual financial statements about its obligations under certain guarantees that it has issued. It also requires that a guarantor recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. The initial recognition and measurement provisions of this interpretation are applicable on a prospective basis to guarantees issued or modified after December 31, 2002; while the provisions of the disclosure requirements are effective for financial statements of interim or annual reports ending after December 15, 2002. The Company adopted the disclosure provisions of FIN 45 during fiscal 2002. The Company is currently evaluating the recognition provisions of FIN 45 but expects that they will not have a material adverse impact on the Companys financial position or results of operations upon adoption.
Accounting for Stock-Based Compensation - Transition and Disclosure - an amendment of FASB Statement No. 123 In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based Compensation Transition and Disclosure. SFAS No. 148 amends SFAS No. 123, Accounting for Stock-Based Compensation, to provide alternative methods for voluntary transition to SFAS No.123s fair value method of accounting for stock-based employee compensation (the fair value method). SFAS No. 148 also requires disclosure of the effects of an entitys accounting policy with respect to stock-based employee compensation on reported net income (loss) and earnings (loss) per share in annual and interim financials statements. The Company is required to follow the prescribed disclosure format and has provided the additional disclosures required by SFAS No. 148 for the year ended February 1, 2003 (see Notes 1 and 9) and must also provide the disclosures in its quarterly reports containing condensed financial statements for interim periods beginning with the quarterly period ending May 3, 2003.
Consolidation of Variable Interest Entities In January 2003, the FASB issued FASB Interpretation No. 46 (FIN 46), Consolidation of Variable Interest Entities. In general, a variable interest entity is a corporation, partnership, trust, or any other legal structure used for business purposes that either (a) does not have equity investors with voting rights or (b) has equity investors that do not provide sufficient financial resources for the entity to support its activities. FIN 46 requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. The consolidation requirements of FIN 46 apply immediately to variable interest entities created after January 31, 2003. The consolidation requirements apply to older entities in the first fiscal year or interim period beginning after June 15, 2003. Certain of the disclosure requirements apply in all financial statements issued after January 31, 2003, regardless of when the variable interest entity was established. The Company does not currently have any variable interest entities and expects that the adoption of the provisions of FIN 46 will not have a material impact on the Companys financial position or results of operations.
19
Inflation
The Company does not believe that inflation has had a material effect on the results of operations in the recent past. There can be no assurance that the Companys business will not be affected by inflation in the future.
Seasonality and Quarterly Results
The Companys business is seasonal by nature, with the Christmas and back-to-school periods historically accounting for the largest percentage of annual net sales. The Companys first quarter historically accounts for the smallest percentage of annual net sales. In each of fiscal 2002 and fiscal 2001, excluding sales generated by new and relocated/expanded stores, the Christmas and back-to-school periods together accounted for approximately 36% of the Companys annual net sales and a higher percentage of the Companys operating income. In fiscal 2002, excluding net sales generated by new and relocated/expanded stores, approximately 43% of the Companys annual net sales occurred in the first half of the fiscal year and approximately 57% in the second half. The Companys quarterly results of operations may also fluctuate significantly as a result of a variety of factors, including the timing of store openings; the amount of revenue contributed by new stores; the timing and level of markdowns; the timing of store closings, expansions and relocations; competitive factors; and general economic conditions.
Cautionary Note Regarding Forward-Looking Statements and Risk Factors
This report on Form 10-K contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Exchange Act, and the Company intends that such forward-looking statements be subject to the safe harbors created thereby. The Company is hereby providing cautionary statements identifying important factors that could cause the Companys actual results to differ materially from those projected in forward-looking statements of the Company herein. Any statements that express, or involve discussions as to, expectations, beliefs, plans, objectives, assumptions, future events or performance (often, but not always through the use of words or phrases such as will result, expects to, will continue, anticipates, plans, intends, estimated, projects and outlook) are not historical facts and may be forward-looking and, accordingly, such statements involve estimates, assumptions and uncertainties which could cause actual results to differ materially from those expressed in the forward-looking statements. All forward-looking statements included in this report are based on information available to the Company as of the date hereof, and the Company assumes no obligation to update or revise any such forward-looking statements to reflect events or circumstances that occur after such statements are made. Such uncertainties include, among others, the following factors:
Merchandising/Fashion Sensitivity. The Companys success is largely dependent upon its ability to gauge the fashion tastes of its customers and to provide merchandise that satisfies customer demand in a timely manner. The Companys failure to anticipate, identify or react appropriately in a timely manner to changes in fashion trends could have a material adverse effect on the Companys business, financial condition and results of operations. Misjudgments or unanticipated fashion changes could also have a material adverse effect on the Companys image with its customers. See Item 1. Business - Merchandising.
Private Label Merchandise. Sales from private label merchandise accounted for approximately 33% and 34% of net sales in fiscal 2002 and fiscal 2001, respectively. The Company may increase the percentage of net sales in private label merchandise in the future, although there can be no assurance that the Company will be able to achieve increases in private label merchandise sales as a percentage of net sales. Because the Companys private label merchandise generally carries higher merchandise margins than its other merchandise, the Companys failure to anticipate, identify and react in a timely manner to fashion trends with its private label merchandise, particularly if the percentage of net sales derived from private label merchandise increases, may have a material adverse effect on the Companys business, financial condition and results of operations. See Item 1. Business - Merchandising.
20
Fluctuations in Comparable Store Net Sales Results. The Companys comparable store net sales results have fluctuated significantly in the past on a monthly, quarterly, and annual basis, and are expected to continue to fluctuate in the future. A variety of factors affect the Companys comparable store net sales results, including changes in fashion trends, changes in the Companys merchandise mix, calendar shifts of holiday periods, actions by competitors, weather conditions and general economic conditions. The Companys comparable store net sales results for any particular fiscal month, fiscal quarter or fiscal year in the future may decrease. As a result of these or other factors, the Companys future comparable store net sales results are likely to have a significant effect on the market price of the Companys common stock.
Expansion and Management of Growth. PacSuns continued growth depends to a significant degree on its ability to open and operate stores on a profitable basis and on managements ability to manage the Companys planned expansion. During fiscal 2003, the Company plans to open approximately 75 net new stores, of which approximately 61 will be PacSun stores, approximately four will be PacSun Outlet stores and approximately ten will be d.e.m.o. stores. The Companys planned expansion is dependent upon a number of factors, including the ability of the Company to locate and obtain favorable store sites, negotiate acceptable lease terms, obtain adequate supplies of merchandise and hire and train qualified management level and other employees. Factors beyond the Companys control may also affect the Companys ability to expand, including general economic and business conditions affecting consumer spending. There can be no assurance that the Company will achieve its planned expansion or that such expansion will be profitable nor that the Company will be able to manage its growth effectively. Any failure to manage growth could have a material adverse effect on the Companys business, financial condition and results of operations.
Reliance on Key Personnel. The continued success of the Company is dependent to a significant degree upon the services of its key personnel, particularly its executive officers. The loss of the services of any member of senior management could have a material adverse effect on the Companys business, financial condition and results of operations. The Companys success in the future will also be dependent upon the Companys ability to attract and retain qualified personnel. The Companys inability to attract and retain qualified personnel in the future could have a material adverse effect on the Companys business, financial condition and results of operations.
Dependence on Single Distribution Facility. The Companys distribution functions for all of its stores and for internet sales are handled from a single facility in Anaheim, California. Any significant interruption in the operation of the distribution facility due to natural disasters, accidents, system failures or other unforeseen causes would have a material adverse effect on the Companys business, financial condition and results of operations. There can be no assurance that the Companys new corporate office and distribution center will be adequate to support the Companys future growth.
Stores in the d.e.m.o. Format. Comparable store net sales results for d.e.m.o. stores did not meet managements expectations during the first half of fiscal 2002 (+.9%) or during fiscal 2001 (+1.6%). Although comparable store net sales results improved significantly for d.e.m.o. stores during the second half of fiscal 2002, the Company is not certain that d.e.m.o. stores will achieve acceptable levels of sales or profitability in the future. Negative comparable store net sales results for d.e.m.o. stores may have a material adverse effect on the Companys business, financial condition and results of operations and may result in a greater number of store closings.
Internet Sales. The Companys internet operations are subject to numerous risks, including unanticipated operating problems, reliance on third party computer hardware and software providers, system failures and the need to invest in additional computer systems. There can be no assurance that the internet operations will achieve sales and profitability levels that justify the Companys investment therein. The internet operations also involve other risks that could have a material adverse effect on the Company, including (i) difficulties with hiring, retention and training of key personnel to conduct the Companys internet operations, (ii) diversion of sales from PacSun stores, (iii) rapid technological change, (iv) liability for online content and (v) risks related to the failure of the computer systems that operate the web site and its related support systems, including computer viruses, telecommunication failures and electronic break-ins and similar disruptions. In addition, the internet operations involve risks which are beyond the Companys control that could have a material adverse effect on the Company, including (i) price competition involving
21
the items the Company intends to sell, (ii) the entry of the Companys vendors into the internet business, in direct competition with the Company, (iii) the level of merchandise returns experienced by the Company, (iv) governmental regulation, (v) online security breaches, (vi) credit card fraud and (vii) competition and general economic conditions and economic conditions specific to the internet, online commerce and the apparel industry.
Economic Impact of Terrorist Attacks or War/Threat of War. The majority of the Companys stores are located in regional shopping malls. In response to the terrorist attacks of September 11, 2001, security has been heightened in public areas. Any further threat of terrorist attacks or actual terrorist events, particularly in public areas, could lead to lower customer traffic in regional shopping malls. In addition, local authorities or mall management could close regional shopping malls in response to any immediate security concern. For example, on September 11, 2001, a substantial number of the Companys stores were closed early due to closure of the malls in response to the terrorist attacks. Mall closures, as well as lower customer traffic due to security concerns, could result in decreased sales. Additionally, war or the threat of war could significantly diminish consumer spending, resulting in decreased sales for the Company. Decreased sales would have a material adverse effect on the Companys business, financial condition and results of operations.
Reliance on Foreign Sources of Production. The Company purchases merchandise directly in foreign markets for its private label brands. In addition, the Company purchases merchandise from domestic vendors, some of which is manufactured overseas. The Company does not have any long-term merchandise supply contracts and its imports are subject to existing or potential duties, tariffs and quotas. The Company faces competition from other companies for production facilities and import quota capacity. The Company also faces a variety of other risks generally associated with doing business in foreign markets and importing merchandise from abroad, such as: (i) political instability; (ii) imposition of new legislation relating to import quotas that may limit the quantity of goods which may be imported into the United States from countries in a region that the Company does business; (iii) imposition of duties, taxes, and other charges on imports; and (iv) local business practice and political issues, including issues relating to compliance with domestic or international labor standards which may result in adverse publicity. New initiatives may be proposed that may have an impact on the trading status of certain countries and may include retaliatory duties or other trade sanctions which, if enacted, would increase the cost of products purchased from suppliers in countries that the Company does business with. The inability of the Company to rely on its foreign sources of production due to any of the factors listed above could have a material adverse effect on the Companys business, financial condition and results of operations.
Credit Facility Financial Covenants. A significant decrease in the Companys operating results could adversely affect the Companys ability to maintain required financial ratios under the Companys credit facility. Required financial ratios include total liabilities to tangible net worth ratio, limitations on capital expenditures and achievement of certain rolling four-quarter EBITDA requirements. If these financial ratios are not maintained, the bank will have the option to require immediate repayment of all amounts outstanding under the credit facility. The most likely result would require the Company to either renegotiate certain terms of the credit agreement, obtain a waiver from the bank, or obtain a new credit agreement with another bank, which may contain different terms.
Stock Options. A number of publicly traded companies have recently announced that they will begin expensing stock option grants to employees. In addition, the FASB and the Commission have indicated that possible rule changes requiring expensing of stock options may be adopted in the near future. Currently, the Company includes such expenses on a pro forma basis in the notes to the Companys annual financial statements in accordance with accounting principles generally accepted in the United States of America but does not include stock option expenses in the Companys reported financial statements. If accounting standards are changed to require the Company to expense stock options, the Companys reported earnings will decrease and its stock price could decline.
Litigation. The Company is involved from time to time in litigation incidental to its business. Management believes that the outcome of current litigation will not have a material adverse effect upon the results of operations or financial condition of the Company. However, managements assessment of the
22
Companys current litigation could change in light of the discovery of facts with respect to legal actions pending against the Company not presently known to the Company or determinations by judges, juries or other finders of fact which do not accord with managements evaluation of the possible liability or outcome of such litigation.
Volatility of Stock Price. The market price of the Companys common stock has fluctuated substantially in the past and there can be no assurance that the market price of the common stock will not continue to fluctuate significantly. Future announcements or management discussions concerning the Company or its competitors, internet sales results, d.e.m.o. sales and profitability results, quarterly variations in operating results or comparable store net sales, changes in earnings estimates by analysts or changes in accounting policies, among other factors, could cause the market price of the common stock to fluctuate substantially. In addition, stock markets have experienced extreme price and volume volatility in recent years. This volatility has had a substantial effect on the market prices of securities of many smaller public companies for reasons frequently unrelated to the operating performance of the specific companies. See Item 5. Market for Registrants Common Equity and Related Stockholder Matters.
*************
The Company cautions that the risk factors described above could cause actual results or outcomes to differ materially from those expressed in any forward-looking statements of the Company made by or on behalf of the Company. Further, management cannot assess the impact of each such factor on the Companys business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
To the extent the Company borrows under its credit facility, the Company is exposed to market risk related to changes in interest rates. At February 1, 2003, there were no borrowings outstanding under the Companys credit facility. Based on the weighted average interest rate of 3.67% on the Companys credit facility during the 52 weeks ended February 1, 2003, if interest rates on the credit facility were to increase by 10%, and to the extent borrowings were outstanding, for every $1,000,000 outstanding on the Companys credit facility, net income would be reduced by approximately $3,000 per year. See Summary of Significant Accounting Policies and Nature of Business. The Company is not a party with respect to derivative financial instruments.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Information with respect to this item is set forth in Index to Financial Statements.
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 Registrants definitive Proxy Statement to be filed with the Commission not later than 120 days after the end of the Registrants fiscal year.
23
ITEM 11. EXECUTIVE COMPENSATION
Information with respect to this item is incorporated by reference from the Registrants definitive Proxy Statement to be filed with the Commission not later than 120 days after the end of the Registrants fiscal year.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information with respect to this item is incorporated by reference from the Registrants definitive Proxy Statement to be filed with the Commission not later than 120 days after the end of the Registrants fiscal year.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information with respect to this item is incorporated by reference from the Registrants definitive Proxy Statement to be filed with the Commission not later than 120 days after the end of the Registrants fiscal year.
ITEM 14. CONTROLS AND PROCEDURES
In the 90-day period before the filing of this report, the Chief Executive Officer and Chief Financial Officer of the Company (collectively, the certifying officers) have evaluated the effectiveness of the Companys disclosure controls and procedures (as such term is defined in Rules 13a-14(c) and 15d-14(c) under the Exchange Act). These disclosure controls and procedures are designed to ensure that the information required to be disclosed by the Company in its periodic reports filed with the Commission is recorded, processed, summarized and reported within the time periods specified by the Commissions rules and forms, and that the information is communicated to the certifying officers on a timely basis.
The certifying officers concluded, based on their evaluation, that the Companys disclosure controls and procedures are effective for the Company, taking into consideration the size and nature of the Companys business and operations.
No significant changes in the Companys internal controls or in other factors were detected that could significantly affect the Companys internal controls subsequent to the date when the internal controls were evaluated.
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) | 1. |
The financial statements listed in the Index to Consolidated Financial Statements at
page F-1 are filed as a 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 Index to Exhibits.
|
||
(b) | Reports on Form 8-K - None. |
24
SIGNATURES
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 March 27, 2003 on its behalf by the undersigned, thereunto duly authorized.
PACIFIC SUNWEAR OF CALIFORNIA, INC.
By: | /s/ GREG H. WEAVER | |
|
Each person whose signature appears below hereby authorizes Greg H. Weaver and Carl W. Womack 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/ |
GREG H. WEAVER
Greg H. Weaver |
Chairman of the Board and Chief Executive Officer (Principal Executive Officer) | March 27, 2003 | ||
/s/ |
CARL W. WOMACK
Carl W. Womack |
Sr. Vice President and Chief Financial Officer (Principal Financial and Accounting Officer) | March 27, 2003 | ||
/s/ | JULIUS JENSEN III | Director | March 27, 2003 | ||
|
|||||
Julius Jensen III | |||||
/s/ | PEARSON C. CUMMIN III | Director | March 27, 2003 | ||
|
|||||
Pearson C. Cummin III | |||||
/s/ | PETER L. HARRIS | Director | March 27, 2003 | ||
|
|||||
Peter L. Harris | |||||
/s/ | SALLY FRAME KASAKS | Director | March 27, 2003 | ||
|
|||||
Sally Frame Kasaks | |||||
/s/ | PETER STARRETT | Director | March 27, 2003 | ||
|
|||||
Peter Starrett | |||||
/s/ | THOMAS M. MURNANE | Director | March 27, 2003 | ||
|
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Thomas M. Murnane |
25
CERTIFICATIONS
I, Greg H. Weaver, certify that:
1. I have reviewed this annual report on Form 10-K of Pacific Sunwear of California, Inc.;
2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;
4. The registrants other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in the Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) | designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; | ||
b) | evaluated the effectiveness of the registrants disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the Evaluation Date); and | ||
c) | presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; |
5. The registrants other certifying officers and I have disclosed, based on our most recent evaluation, to the registrants auditors and the audit committee of registrants board of directors (or persons performing the equivalent functions):
a) | all significant deficiencies in the design or operation of internal controls which could adversely affect the registrants ability to record, process, summarize and report financial data and have identified for the registrants auditors any material weaknesses in internal controls; and | ||
b) | any fraud, whether or not material, that involves management or other employees who have a significant role in the registrants internal controls; and |
6. The registrants other certifying officers and I have indicated in this annual report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
Date: March 27, 2003
/s/ GREG H. WEAVER
Greg H. Weaver
Chairman of the Board and Chief Executive Officer
26
I, Carl W. Womack, certify that:
1. I have reviewed this annual report on Form 10-K of Pacific Sunwear of California, Inc.;
2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;
4. The registrants other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in the Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) | designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; | ||
b) | evaluated the effectiveness of the registrants disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the Evaluation Date); and | ||
c) | presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; |
5. The registrants other certifying officers and I have disclosed, based on our most recent evaluation, to the registrants auditors and the audit committee of registrants board of directors (or persons performing the equivalent functions):
a) | all significant deficiencies in the design or operation of internal controls which could adversely affect the registrants ability to record, process, summarize and report financial data and have identified for the registrants auditors any material weaknesses in internal controls; and | ||
b) | any fraud, whether or not material, that involves management or other employees who have a significant role in the registrants internal controls; and |
6. The registrants other certifying officers and I have indicated in this annual report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
Date: March 27, 2003
/s/ CARL W. WOMACK
Carl W. Womack
Senior Vice President, Chief Financial Officer and Secretary
27
PACIFIC SUNWEAR OF CALIFORNIA, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED FEBRUARY 1, 2003, FEBRUARY 2, 2002, AND FEBRUARY 4, 2001:
CONSOLIDATED FINANCIAL STATEMENTS:
Independent Auditors Report | F-2 | ||
Consolidated Balance Sheets as of February 1, 2003, and February 2, 2002 | F-3 | ||
Consolidated Statements of Income and Comprehensive Income for each of the
three fiscal years in the period ended February 1, 2003 |
F-4 | ||
Consolidated Statements of Shareholders Equity for each of three fiscal years
in the period ended February 1, 2003 |
F-5 | ||
Consolidated Statements of Cash Flows for each of the three fiscal years in the period ended February 1, 2003 | F-6 | ||
Notes to Consolidated Financial Statements | F-7 |
F-1
INDEPENDENT AUDITORS REPORT
The Board of Directors and Shareholders
Pacific Sunwear of California, Inc.
Anaheim, California
We have audited the accompanying consolidated balance sheets of Pacific Sunwear of California, Inc. and its wholly owned subsidiaries as of February 1, 2003 and February 2, 2002, and the related consolidated statements of income and comprehensive income, shareholders equity, and cash flows for each of the three fiscal years in the period ended February 1, 2003. These financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards 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. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Pacific Sunwear of California, Inc. and its wholly owned subsidiaries as of February 1, 2003, and February 2, 2002, and the results of their operations and their cash flows for each of the three fiscal years in the period ended February 1, 2003, in conformity with accounting principles generally accepted in the United States of America.
As discussed in Note 1 to the financial statements, the Company changed its method of accounting for goodwill and other intangible assets during the year ended February 1, 2003 as a result of adopting Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets, effective February 3, 2002.
DELOITTE & TOUCHE LLP
Costa Mesa, California
March 11, 2003
F-2
PACIFIC SUNWEAR OF CALIFORNIA, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share amounts)
February 1, | February 2, | |||||||||||
2003 | 2002 | |||||||||||
ASSETS |
||||||||||||
CURRENT ASSETS: |
||||||||||||
Cash and cash equivalents (Note 1) |
$ | 36,438 | $ | 23,136 | ||||||||
Accounts receivable |
2,916 | 3,044 | ||||||||||
Merchandise inventories |
123,433 | 102,512 | ||||||||||
Prepaid expenses, includes $9,664 and $8,410 of
prepaid rent, respectively |
14,871 | 11,856 | ||||||||||
Deferred taxes current (Note 6) |
4,975 | 4,282 | ||||||||||
Total current assets |
182,633 | 144,830 | ||||||||||
PROPERTY AND EQUIPMENT (Note 1): |
||||||||||||
Land |
12,156 | 12,156 | ||||||||||
Buildings and building improvements |
26,680 | 26,475 | ||||||||||
Leasehold improvements |
111,431 | 102,075 | ||||||||||
Furniture, fixtures and equipment |
148,377 | 125,706 | ||||||||||
Total property and equipment |
298,644 | 266,412 | ||||||||||
Less accumulated depreciation and amortization |
(97,131 | ) | (71,412 | ) | ||||||||
Net property and equipment |
201,513 | 195,000 | ||||||||||
OTHER ASSETS: |
||||||||||||
Goodwill (Notes 1 and 3) |
6,492 | 6,492 | ||||||||||
Deferred compensation and other assets (Notes 2 and 9) |
9,105 | 7,807 | ||||||||||
Deferred taxes noncurrent (Note 6) |
| 1,311 | ||||||||||
Total other assets |
15,597 | 15,610 | ||||||||||
Total assets |
$ | 399,743 | $ | 355,440 | ||||||||
LIABILITIES AND SHAREHOLDERS EQUITY |
||||||||||||
CURRENT LIABILITIES: |
||||||||||||
Line
of credit (Note 4) |
$ | | $ | | ||||||||
Current
portion of long-term debt (Notes 4 and 7) |
829 | 425 | ||||||||||
Current portion of capital lease obligations (Note 7) |
1,521 | 834 | ||||||||||
Accounts payable |
28,456 | 37,493 | ||||||||||
Accrued liabilities (Notes 5 and 10) |
34,522 | 17,743 | ||||||||||
Income taxes payable (Note 6) |
8,000 | 9,436 | ||||||||||
Total current liabilities |
73,328 | 65,931 | ||||||||||
LONG-TERM LIABILITIES: |
||||||||||||
Long-term debt (Notes 4 and 7) |
1,102 | 24,597 | ||||||||||
Long-term capital lease obligations (Note 7) |
2,236 | 731 | ||||||||||
Deferred compensation (Note 9) |
7,097 | 7,439 | ||||||||||
Deferred rent |
10,574 | 8,759 | ||||||||||
Deferred taxes (Note 6) |
3,015 | | ||||||||||
Other long-term liabilities |
| 28 | ||||||||||
Total long-term liabilities |
24,024 | 41,554 | ||||||||||
Commitments and contingencies (Note 7) |
||||||||||||
SHAREHOLDERS EQUITY (Notes 8 and 9): |
||||||||||||
Preferred stock, $.01 par value; 5,000,000 shares authorized; none
issued and outstanding |
| | ||||||||||
Common stock, $.01 par value; 113,906,250 shares authorized;
49,488,764 and 49,155,753 shares issued and outstanding, respectively (Note 1) |
495 | 492 | ||||||||||
Additional paid-in capital |
93,008 | 88,252 | ||||||||||
Retained earnings |
208,888 | 159,211 | ||||||||||
Total shareholders equity |
302,391 | 247,955 | ||||||||||
Total liabilities and shareholders equity |
$ | 399,743 | $ | 355,440 | ||||||||
See notes to consolidated financial statements
F-3
PACIFIC SUNWEAR OF CALIFORNIA, INC.
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
(in thousands, except share and per share amounts)
Fiscal Year Ended | ||||||||||||
February 1, | February 2, | February 4, | ||||||||||
2003 | 2002 | 2001 | ||||||||||
Net sales |
$ | 846,393 | $ | 684,840 | $ | 589,438 | ||||||
Cost of goods sold, including buying,
distribution and occupancy costs |
562,710 | 464,660 | 391,816 | |||||||||
Gross margin |
283,683 | 220,180 | 197,622 | |||||||||
Selling, general and administrative expenses |
202,445 | 175,898 | 133,999 | |||||||||
Operating income |
81,238 | 44,282 | 63,623 | |||||||||
Interest expense/(income), net |
594 | (470 | ) | (1,344 | ) | |||||||
Income before income tax expense |
80,644 | 44,752 | 64,967 | |||||||||
Income tax expense (Note 6) |
30,967 | 17,186 | 25,213 | |||||||||
Net income |
$ | 49,677 | $ | 27,566 | $ | 39,754 | ||||||
Comprehensive income (Note 1) |
$ | 49,677 | $ | 27,566 | $ | 39,754 | ||||||
Net income per share, basic (Note 1) |
$ | 1.01 | $ | 0.56 | $ | 0.83 | ||||||
Net income per share, diluted (Note 1) |
$ | 0.99 | $ | 0.56 | $ | 0.81 | ||||||
Weighted average shares outstanding, basic
(Note 1) |
49,287,680 | 49,021,791 | 47,842,611 | |||||||||
Weighted average shares outstanding,
diluted (Note 1) |
50,097,994 | 49,658,699 | 48,822,429 | |||||||||
See notes to consolidated financial statements
F-4
PACIFIC SUNWEAR OF CALIFORNIA, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS EQUITY
(in thousands, except share amounts)
Common | Common | Additional | ||||||||||||||||||
Stock | Stock | Paid-in | Retained | |||||||||||||||||
Shares | Amount | Capital | Earnings | Total | ||||||||||||||||
BALANCE, January 31, 2000 |
47,194,127 | $ | 472 | $ | 69,461 | $ | 91,891 | $ | 161,824 | |||||||||||
Exercise of stock options and shares
sold under employee stock purchase plan and restricted stock grant (Note 9) |
1,468,026 | 15 | 6,431 | | 6,446 | |||||||||||||||
Restricted stock award, vesting of shares
(Note 9) |
| | 290 | | 290 | |||||||||||||||
Tax benefits related to exercise of
stock options (Note 9) |
| | 4,816 | | 4,816 | |||||||||||||||
Net income |
| | | 39,754 | 39,754 | |||||||||||||||
BALANCE, February 4, 2001 |
48,662,153 | 487 | 80,998 | 131,645 | 213,130 | |||||||||||||||
Exercise of stock options and shares
sold under employee stock purchase plan
and restricted stock grant (Note 9) |
493,600 | 5 | 4,256 | | 4,261 | |||||||||||||||
Restricted stock award, vesting of
shares (Note 9) |
| | 290 | | 290 | |||||||||||||||
Tax benefits related to exercise of stock
options (Note 9) |
| | 2,708 | | 2,708 | |||||||||||||||
Net income |
| | | 27,566 | 27,566 | |||||||||||||||
BALANCE, February 2, 2002 |
49,155,753 | 492 | 88,252 | 159,211 | 247,955 | |||||||||||||||
Exercise of stock options and shares
sold under employee stock
purchase plan
(Note 9) |
333,803 | 3 | 3,441 | | 3,444 | |||||||||||||||
Cancellation of fractional shares due to
3-for-2 stock split (Note 1) |
(792 | ) | | (14 | ) | | (14 | ) | ||||||||||||
Restricted stock award, vesting of
shares (Note 9) |
| | 291 | | 291 | |||||||||||||||
Tax benefits related to exercise of
stock options (Note 9) |
| | 1,038 | | 1,038 | |||||||||||||||
Net income |
| | | 49,677 | 49,677 | |||||||||||||||
BALANCE, February 1, 2003 |
49,488,764 | $ | 495 | $ | 93,008 | $ | 208,888 | $ | 302,391 | |||||||||||
See notes to consolidated financial statements
F-5
PACIFIC SUNWEAR OF CALIFORNIA, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Fiscal Year Ended | ||||||||||||||||
February 1, | February 2, | February 4, | ||||||||||||||
2003 | 2002 | 2001 | ||||||||||||||
CASH FLOWS FROM OPERATING ACTIVITIES: |
||||||||||||||||
Net income |
$ | 49,677 | $ | 27,566 | $ | 39,754 | ||||||||||
Adjustments to reconcile net income to net cash provided by
operating activities: |
||||||||||||||||
Depreciation and amortization |
32,453 | 27,146 | 19,871 | |||||||||||||
Loss on disposal of equipment (Note 10) |
4,240 | 7,451 | 1,440 | |||||||||||||
Change in operating assets and liabilities: |
||||||||||||||||
Accounts receivable |
128 | (290 | ) | (576 | ) | |||||||||||
Merchandise inventories |
(20,921 | ) | (19,819 | ) | (22,691 | ) | ||||||||||
Prepaid expenses |
(1,949 | ) | (1,669 | ) | (3,144 | ) | ||||||||||
Deferred compensation and other assets |
231 | (127 | ) | 633 | ||||||||||||
Accounts payable |
(9,037 | ) | 5,861 | 11,519 | ||||||||||||
Accrued liabilities |
16,751 | 4,492 | (623 | ) | ||||||||||||
Income taxes payable and deferred taxes |
3,235 | 6,203 | 4,474 | |||||||||||||
Deferred rent |
1,815 | 1,548 | 1,379 | |||||||||||||
Net cash provided by operating activities |
76,623 | 58,362 | 52,036 | |||||||||||||
CASH FLOWS FROM INVESTING ACTIVITIES: |
||||||||||||||||
Investment in property and equipment |
(40,423 | ) | (92,936 | ) | (61,869 | ) | ||||||||||
Net cash used in investing activities |
(40,423 | ) | (92,936 | ) | (61,869 | ) | ||||||||||
CASH FLOWS FROM FINANCING ACTIVITIES: |
||||||||||||||||
(Repayments)/borrowings under long-term debt obligations |
(25,504 | ) | 24,998 | | ||||||||||||
Principal payments under capital lease obligations |
(824 | ) | (519 | ) | (58 | ) | ||||||||||
Cash paid in lieu of fractional shares due to 3-for-2 stock split |
(14 | ) | | | ||||||||||||
Proceeds from exercise of stock options |
3,444 | 4,260 | 6,445 | |||||||||||||
Net cash (used in)/provided by financing activities |
(22,898 | ) | 28,739 | 6,387 | ||||||||||||
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS: |
13,302 | (5,835 | ) | (3,446 | ) | |||||||||||
CASH AND CASH EQUIVALENTS, beginning of fiscal year |
23,136 | 28,971 | 32,417 | |||||||||||||
CASH AND CASH EQUIVALENTS, end of fiscal year |
$ | 36,438 | $ | 23,136 | $ | 28,971 | ||||||||||
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION |
||||||||||||||||
Cash paid during the period for: |
||||||||||||||||
Interest, including $428 of capitalized interest paid in fiscal 2001 |
$ | 944 | $ | 515 | $ | 12 | ||||||||||
Income taxes |
$ | 27,732 | $ | 10,983 | $ | 20,739 |
Supplemental disclosures of non-cash transactions: During the fiscal years ended February 1, 2003, February 2, 2002 and February 4, 2001, the Company recorded an increase to additional paid-in capital of $1,038, $2,708 and $4,816, respectively, related to tax benefits associated with the exercise of nonqualified stock options. During the fiscal years ended February 1, 2003, February 2, 2002 and February 4, 2001, the Company recorded an increase to additional paid-in capital of $291, $290 and $290, respectively, related to the issuance of stock to satisfy certain deferred compensation liabilities. During the year ended February 1, 2003, the Company purchased a prepaid three-year computer maintenance agreement under a long-term debt obligation for $2,413. During the years ended February 1, 2003, February 2, 2002 and February 4, 2001, the Company acquired property pursuant to capital lease obligations in the amount of $3,016, $493 and $1,650, respectively. Additionally, during the year ended February 2, 2002, the Company financed the purchase of a vehicle for $24.
See notes to consolidated financial statements
F-6
PACIFIC SUNWEAR OF CALIFORNIA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Fiscal Years Ended February 1, 2003, February 2, 2002 and February 4, 2001
(all amounts in thousands, except share and per share amounts, unless otherwise indicated)
1. | SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND NATURE OF BUSINESS |
Nature of Business Pacific Sunwear of California, Inc. and its wholly-owned subsidiaries (the Company) is a leading specialty retailer of everyday casual apparel, footwear and accessories designed to meet the needs of active teens and young adults. The Company operates three nationwide, primarily mall-based chains of retail stores, under the names Pacific Sunwear (as well as PacSun), Pacific Sunwear Outlet and d.e.m.o. Pacific Sunwear and Pacific Sunwear Outlet stores specialize in board-sport inspired casual apparel, footwear and related accessories catering to teenagers and young adults. d.e.m.o. specializes in hip-hop music inspired casual apparel and related accessories catering to teenagers and young adults. In addition, the Company operates a website through a wholly-owned subsidiary which sells PacSun merchandise online, provides content and community for its target customers, and provides information about the Company.
The Companys fiscal year is a 52- or 53-week period ending near January 31. Fiscal 2002 was a 52-week period ended February 1, 2003. Fiscal 2001 was a 52-week period ended February 2, 2002. Fiscal 2000 was a 53-week period ended February 4, 2001.
Principles of Consolidation The consolidated financial statements include the accounts of Pacific Sunwear of California, Inc. and its wholly-owned subsidiaries, Pacific Sunwear Stores Corp. and ShopPacSun.com Corp. All intercompany transactions have been eliminated in consolidation.
Basis of Presentation The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America.
Use of Estimates The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America necessarily requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements as well as the reported revenues and expenses during the reporting period. Actual results could differ from these estimates.
Fair Value of Financial Instruments Statement of Financial Accounting Standards (SFAS) No. 107, Disclosures about Fair Value of Financial Instruments, requires management to disclose the estimated fair value of certain assets and liabilities defined by SFAS No. 107 as financial instruments. Financial instruments are generally defined by SFAS No. 107 as cash, evidence of ownership interest in an entity, or a contractual obligation that both conveys to one entity a right to receive cash or other financial instruments from another entity and imposes on the other entity the obligation to deliver cash or other financial instruments to the first entity. At February 1, 2003, management believes that the carrying amounts of cash, receivables and payables approximate fair value because of the short maturity of these financial instruments.
Cash and Cash Equivalents The Company considers all highly liquid financial instruments, if any, purchased with an original maturity of three months or less to be cash equivalents.
Merchandise Inventories Merchandise inventories are stated at the lower of cost (first-in, first-out method) or market. Cost is determined using the retail inventory method. At any one time, inventories include items that have been marked down to managements best estimate of their fair market value. Management bases the decision to mark down merchandise upon the age of the item and its current rate of sale. To the extent that management estimates differ from actual results, additional markdowns may have to be recorded, which could reduce the Companys gross margins and operating results. The Companys success is largely dependent upon its ability to gauge the fashion tastes of its customers and provide merchandise that satisfies customer demand. Any inability to provide appropriate merchandise in sufficient quantities in a timely manner could increase future markdown rates.
Property and Equipment Leasehold improvements and furniture, fixtures and equipment are stated at cost. Amortization of leasehold improvements is computed on the straight-line method over the lesser of their estimated useful lives or the life of the lease (generally 10 years). Depreciation on furniture, fixtures and equipment is computed on the straight-line method over five years.
The Company completed construction of and moved into a new corporate office and distribution center in January 2002. The total cost of the completed facilities, including purchased land, was $54.5 million. Of the $54.5 million total cost, $26.5 million was
F-7
buildings, $12.2 million was land, $12.2 million was a new materials handling system and $3.6 million was furniture, fixtures and equipment.
Change in Accounting for Goodwill and Other Intangible Assets On February 3, 2002, the Company adopted SFAS No. 142, Goodwill and Intangible Assets, which revises the accounting for purchased goodwill and intangible assets. Under SFAS No. 142, goodwill and intangible assets with indefinite lives are no longer amortized but are tested for impairment annually and also in the event of an impairment indicator. The Company completed the required transitional impairment test and the annual test and determined that no impairment existed. Any subsequent impairment losses will be reflected in operating income. With the adoption of SFAS No. 142, the Company discontinued amortization of goodwill (see Note 3).
The Company evaluates the recoverability of goodwill at least annually based on a two-step impairment test. The first step compares the fair value of each reporting unit with its carrying amount, including goodwill. If the carrying amount exceeds fair value, then the second step of the impairment test is performed to measure the amount of any impairment loss. Fair value is determined based on estimated future cash flows, discounted at a rate that approximates the Companys cost of capital. Such estimates are subject to change and the Company may be required to recognize impairment losses in the future.
Other Long-Lived Assets In August 2001, the Financial Accounting Standards Board (FASB) issued SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, which supersedes previous guidance on financial accounting and reporting for the impairment or disposal of long-lived assets and for segments of a business to be disposed of. The Company adopted SFAS No. 144 effective February 3, 2002. Upon adoption of SFAS No. 144, the Company reviewed long-lived assets and determined that no impairment existed. Under SFAS No. 144, long-lived assets, including amortizing intangible assets, will be tested for impairment whenever events or changes in circumstances indicate that the carrying value of such assets may not be recoverable.
Corporate Rent Reserve During fiscal 2001, the Company recorded a $1.4 million charge to accrue for rent expense associated with the Companys former corporate offices, which remain unused at the end of fiscal 2002. The current accrual of $1.3 million is approximately the amount of rent expense for one year, within which time the Company currently believes a tenant will be identified to sublease the premises. To the extent managements estimates relating to the Companys ability to sublease these premises within one year changes, additional charges may be recorded in the future up to the net remaining obligation under the lease depending on the facts and circumstances in existence at that time. As of February 1, 2003, the aggregate net remaining obligation under this lease was approximately $6.7 million.
Litigation The Company is involved from time to time in litigation incidental to its business. Management believes that the outcome of current litigation will not have a material adverse effect upon the results of operations or financial condition of the Company and, from time to time, may make provisions for potential litigation losses. Depending on the actual outcome of pending litigation, charges in excess of any provisions could be recorded in the future which may have an adverse affect on the Companys operating results (see Note 7).
Income Taxes Current income tax expense is the amount of income taxes expected to be payable for the current year. A deferred income tax asset or liability is established for the expected future consequences of temporary differences in the financial reporting and tax bases of assets and liabilities. The Company considers future taxable income and ongoing prudent and feasible tax planning in assessing the value of its deferred tax assets. If the Company determines that it is more likely than not that these assets will not be realized, the Company would reduce the value of these assets to their expected realizable value, thereby decreasing net income. Evaluating the value of these assets is necessarily based on the Companys judgment. If the Company subsequently determined that the deferred tax assets, which had been written down, would be realized in the future, the value of the deferred tax assets would be increased, thereby increasing net income in the period when that determination was made.
Deferred Rent The Company averages any defined rental escalations over the term of the related lease in order to provide level recognition of rent expense.
Stock Split On December 18, 2002, the Company effected a three-for-two stock split. Shareholders equity has been restated to give retroactive recognition to the stock split in prior periods by reclassifying the par value ($164) of the additional shares arising from the split from additional paid-in capital to common stock. Additionally, all share and per share amounts have been restated to give effect to the stock split.
Revenue Recognition Sales are recognized upon purchase by customers at the Companys retail store locations or through the Companys website. The Company has recorded reserves to estimate sales returns by customers based on historical sales return results. Actual return rates have historically been within managements expectations and the reserves established. However, in the unlikely event that the actual rate of sales returns by customers increased significantly, the Companys operational results could be adversely affected.
F-8
Advertising Costs Costs associated with the production of advertising, such as photography, design, creative talent, editing and other costs, are expensed the first time the advertising takes place. Costs associated with placing advertising that has been produced, such as television and magazine advertising, are expensed when the advertising takes place. Advertising costs were $8,897, $12,967 and $10,766 in fiscal 2002, 2001 and 2000, respectively.
Earnings per Share The Company reports earnings per share in accordance with the provisions of SFAS No. 128, Earnings Per Share. Basic earnings per common share is computed using the weighted average number of shares outstanding. Diluted earnings per common share is computed using the weighted average number of shares outstanding adjusted for the incremental shares attributed to outstanding options to purchase common stock. Incremental shares of 810,314, 636,908, and 979,818 in fiscal 2002, 2001 and 2000, respectively, were used in the calculation of diluted earnings per common share. Options to purchase 1,355,599, 1,585,185 and 1,132,794 shares of common stock in fiscal 2002, 2001 and 2000, respectively, were not included in the computation of diluted earnings per common share because the option exercise price was greater than the average market price of the common stock during the respective period.
Stock-Based Compensation The Company accounts for stock-based compensation in accordance with Accounting Principles Board (APB) Opinion No. 25. In March 2000, the FASB issued Interpretation No. 44 of APB Opinion No. 25, Accounting for Certain Transactions Involving Stock Compensation, which, among other things, addressed accounting consequences of a modification that reduces the exercise price of a fixed stock option award (otherwise known as repricing). The adoption of this interpretation did not impact the Companys consolidated financial statements.
SFAS No. 123, Accounting for Stock-Based Compensation, requires the disclosure of pro forma net income and earnings per share. Under SFAS No. 123, the fair value of stock-based awards to employees is calculated through the use of option-pricing models, even though such models were developed to estimate the fair value of freely tradable, fully transferable options without vesting restrictions, which significantly differ from the Companys stock option awards. These models also require subjective assumptions, including future stock price volatility and expected time to exercise, which greatly affect the calculated values. The Companys calculations were made using the Black-Scholes option-pricing model with the following weighted average assumptions: expected life, 5 years following vesting; stock volatility, 55.2% in fiscal 2002, 71.4% in fiscal 2001 and 104.1% in fiscal 2000; risk-free interest rates, 3.0% in fiscal 2002, 4.4% in fiscal 2001 and 4.85% in fiscal 2000; and no dividends during the expected term. The Companys calculations are based on a multiple-option valuation approach and forfeitures are recognized as they occur. If the computed fair values of the fiscal 2002, 2001 and 2000 awards had been amortized to expense over the vesting period of the awards, pro forma net income and earnings per share would have been reduced to the pro forma amounts indicated below:
Fiscal 2002 | Fiscal 2001 | Fiscal 2000 | |||||||||||
Net Income |
|||||||||||||
As reported |
$ | 49,677 | $ | 27,566 | $ | 39,754 | |||||||
Deduct: Total stock-based
employee compensation
expense determined under
fair value based method
for all awards, net of
related tax effects |
(5,589 | ) | (5,153 | ) | (4,631 | ) | |||||||
Pro forma |
$ | 44,088 | $ | 22,413 | $ | 35,123 | |||||||
Net Income Per Share, Basic |
|||||||||||||
As reported |
$ | 1.01 | $ | 0.56 | $ | 0.83 | |||||||
Deduct: Total stock-based
employee compensation
expense determined under
fair value based method
for all awards, net of
related tax effects |
(0.12 | ) | (0.10 | ) | (0.10 | ) | |||||||
Pro forma |
$ | 0.89 | $ | 0.46 | $ | 0.73 | |||||||
Net Income Per Share, Diluted |
|||||||||||||
As reported |
$ | 0.99 | $ | 0.56 | $ | 0.81 | |||||||
Deduct: Total stock-based
employee compensation
expense determined under
fair value based method
for all awards, net of
related tax effects |
(0.10 | ) | (0.10 | ) | (0.08 | ) | |||||||
Pro forma |
$ | 0.89 | $ | 0.46 | $ | 0.73 |
Comprehensive Income The Company reports comprehensive income in accordance with the provisions of SFAS No. 130, Reporting Comprehensive Income. SFAS No. 130 established standards for the reporting and display of comprehensive
F-9
income. Components of comprehensive income include net earnings (loss), foreign currency translation adjustments and gains/losses associated with investments available for sale. There was no difference between net income and comprehensive income for the years ended February 1, 2003, February 2, 2002 and February 4, 2001.
Segment Information The Company has one reportable segment representing the aggregation of its operating segments due to the similarities of economic and operating characteristics among the operating segments represented by the Companys three store formats.
Merchandise Risk The Companys success is largely dependent upon its ability to gauge the fashion tastes of its customers and provide merchandise that satisfies customer demand. Any inability to provide appropriate merchandise in sufficient quantities in a timely manner could have a material adverse effect on the Companys business, operating results and financial condition.
New Accounting Pronouncements In April 2002, the FASB issued SFAS No. 145, Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections. SFAS No. 145 amended certain provisions of SFAS No. 13 and requires the fair value recognition of guarantee obligations under which the Company may become secondarily liable. The Company adopted SFAS No. 145 during fiscal 2002. The adoption of SFAS No. 145 resulted in the recognition of a $.5 million liability related to the Companys guarantee of an assignees performance under a lease obligation (see Note 7 to the consolidated financial statements).
In June, 2002 the FASB issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities, which addresses financial accounting and reporting for costs associated with exit or disposal activities and supercedes Emerging Issues Task Force (EITF) Issue 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring). SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. Under Issue 94-3, a liability for an exit cost as defined in EITF Issue 94-3 was recognized at the date of an entitys commitment to an exit plan. SFAS No. 146 also establishes that the liability should initially be measured and recorded at fair value. The Company will adopt the provisions of SFAS No. 146 for exit or disposal activities that are initiated after December 31, 2002.
In November 2002, the FASB issued FASB Interpretation No. 45 (FIN 45), Guarantors Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees and Indebtedness of Others. FIN 45 elaborates on the disclosures to be made by the guarantor in its interim and annual financial statements about its obligations under certain guarantees that it has issued. It also requires that a guarantor recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. The initial recognition and measurement provisions of this interpretation are applicable on a prospective basis to guarantees issued or modified after December 31, 2002; while the provisions of the disclosure requirements are effective for financial statements of interim or annual reports ending after December 15, 2002. The Company adopted the disclosure provisions of FIN 45 during fiscal 2002. The Company is currently evaluating the recognition provisions of FIN 45 but expects that they will not have a material adverse impact on the Companys financial position or results of operations upon adoption.
In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based Compensation Transition and Disclosure. SFAS No. 148 amends SFAS No. 123, Accounting for Stock-Based Compensation, to provide alternative methods for voluntary transition to SFAS No. 123s fair value method of accounting for stock-based employee compensation (the fair value method). SFAS No. 148 also requires disclosure of the effects of an entitys accounting policy with respect to stock-based employee compensation on reported net income (loss) and earnings (loss) per share in annual and interim financials statements. The Company is required to follow the prescribed disclosure format and has provided the additional disclosures required by SFAS No. 148 for the year ended February 1, 2003 (see Notes 1 and 9) and must also provide the disclosures in its quarterly reports containing condensed financial statements for interim periods beginning with the quarterly period ending April 3, 2003.
In January 2003, the FASB issued FASB Interpretation No. 46 (FIN 46), Consolidation of Variable Interest Entities. In general, a variable interest entity is a corporation, partnership, trust, or any other legal structure used for business purposes that either (a) does not have equity investors with voting rights or (b) has equity investors that do not provide sufficient financial resources for the entity to support its activities. FIN 46 requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. The consolidation requirements of FIN 46 apply immediately to variable interest entities created after January 31, 2003. The consolidation requirements apply to older entities in the first fiscal year or interim period beginning after June 15, 2003. Certain of the disclosure requirements apply in all financial statements issued after January 31, 2003, regardless of when the variable interest entity was established. Since the Company does not currently have any variable interest entities, the Company expects that the adoption of the provisions of FIN 46 will not have a material impact on the Companys financial position or results of operations.
Reclassification Certain prior year amounts have been reclassified to conform to the current year presentation.
F-10
2. | DEFERRED COMPENSATION AND OTHER ASSETS |
Deferred compensation and other assets consist of the following:
February 1, | February 2, | |||||||
2003 | 2002 | |||||||
Deferred compensation |
$ | 7,565 | $ | 7,587 | ||||
Long-term computer maintenance
contracts |
1,359 | | ||||||
Other assets |
181 | 220 | ||||||
$ | 9,105 | $ | 7,807 | |||||
3. | GOODWILL |
On February 3, 2002, the Company adopted SFAS No. 142, Goodwill and Other Intangible Assets, which eliminated the amortization of goodwill and other intangible assets with indefinite useful lives. SFAS No. 142 requires, among other items, disclosure of the after-tax impact to reported net income and earnings per share of the adoption of the statement for all periods presented. The following table recognizes the after-tax impact to the Companys operating results of the adoption of SFAS No. 142 as if the non-amortization provisions of the standard had been in effect for all periods presented:
February 1, | February 2, | February 4, | |||||||||||
2003 | 2002 | 2001 | |||||||||||
For the Year Ended: | |||||||||||||
Reported net income |
$ | 49,677 | $ | 27,566 | $ | 39,754 | |||||||
Add back goodwill amortization (tax effected) |
| 192 | 192 | ||||||||||
Adjusted net income |
$ | 49,677 | $ | 27,758 | $ | 39,946 | |||||||
Basic earnings per share: |
|||||||||||||
Reported net income |
$ | 1.01 | $ | 0.56 | $ | 0.83 | |||||||
Add back goodwill amortization (tax
effected) |
0.00 | 0.01 | 0.00 | ||||||||||
Adjusted net income |
$ | 1.01 | $ | 0.57 | $ | 0.83 | |||||||
Diluted earnings per share: |
|||||||||||||
Reported net income |
$ | 0.99 | $ | 0.56 | $ | 0.81 | |||||||
Add back goodwill amortization (tax
effected) |
0.00 | 0.00 | 0.01 | ||||||||||
Adjusted net income |
$ | 0.99 | $ | 0.56 | $ | 0.82 | |||||||
4. | CREDIT FACILITY |
The Company has a credit facility with a bank, which expires March 31, 2004. The credit facility provides for a $45.0 million line of credit (the Credit Line) to be used for cash advances, commercial letters of credit and shipside bonds, and an additional $25.0 million line of credit (the Construction Facility) which was used to finance the construction of the Companys new corporate office and distribution center. On August 30, 2002, the Company repaid the outstanding balance of $25.0 million related to the Construction Facility using available cash generated from operations. Interest on the Credit Line is payable monthly at the banks prime rate (4.25% at February 1, 2003) or at optional interest rates that are primarily dependent upon the London Inter-bank Offered Rates for the time period chosen. The Companys weighted average interest rate on its outstanding borrowings was 3.67% at February 1, 2003. At February 1, 2003, the Company had no borrowings outstanding under the Credit Line and $10.3 million outstanding in letters of credit. The credit facility subjects the Company to various restrictive covenants, including maintenance of certain financial ratios, and prohibits payment of cash dividends on common stock. At February 1, 2003, the Company was in compliance with all of the covenants.
F-11
5. | ACCRUED LIABILITIES |
Accrued liabilities consist of the following:
February 1, | February 2, | |||||||
2003 | 2002 | |||||||
Accrued compensation and benefits |
$ | 14,420 | $ | 4,620 | ||||
Gift certificates and store merchandise credits |
5,967 | 4,160 | ||||||
Reserve for store expansion/relocation and
closing costs |
3,653 | 2,094 | ||||||
Sales tax payable |
2,290 | 1,647 | ||||||
Reserve for corporate rent old corporate
facilities (Note 10) |
1,263 | 1,396 | ||||||
Accrued medical insurance costs |
980 | 855 | ||||||
Other |
5,949 | 2,971 | ||||||
$ | 34,522 | $ | 17,743 | |||||
6. | INCOME TAXES |
The components of the income tax expense are as follows:
Fiscal Year Ended | ||||||||||||
February 1, | February 2, | February 4, | ||||||||||
2003 | 2002 | 2001 | ||||||||||
Current income taxes: |
||||||||||||
Federal |
$ | 23,938 | $ | 18,040 | $ | 22,001 | ||||||
State |
3,396 | 2,659 | 3,137 | |||||||||
27,334 | 20,699 | 25,138 | ||||||||||
Deferred income taxes: |
||||||||||||
Federal |
3,231 | (3,066 | ) | 19 | ||||||||
State |
402 | (447 | ) | 56 | ||||||||
3,633 | (3,513 | ) | 75 | |||||||||
$ | 30,967 | $ | 17,186 | $ | 25,213 | |||||||
A reconciliation of the income tax expense to the amount of income tax expense that would result from applying the federal statutory rate to income before income taxes is as follows:
Fiscal Year Ended | ||||||||||||
February 1, | February 2, | February 4, | ||||||||||
2003 | 2002 | 2001 | ||||||||||
Provision for income taxes at statutory rate |
$ | 28,225 | $ | 15,663 | $ | 22,738 | ||||||
State income taxes, net of federal income
tax benefit |
2,469 | 1,438 | 2,076 | |||||||||
Other |
273 | 85 | 399 | |||||||||
$ | 30,967 | $ | 17,186 | $ | 25,213 | |||||||
F-12
At February 1, 2003, the Companys current net deferred tax asset was $4,975 and long-term net deferred tax liability was $3,015. At February 2, 2002, the Companys current net deferred tax asset was $4,282 and long-term net deferred tax asset was $1,311. The major components of the Companys overall net deferred tax asset of $1,960 and $5,593 at February 1, 2003, and February 2, 2002, respectively, are as follows:
February 1, | February 2, | |||||||
2003 | 2002 | |||||||
Depreciation |
$ | (10,127 | ) | $ | (5,097 | ) | ||
Deferred rent |
4,198 | 3,497 | ||||||
Reserve for store expansion/relocation and
closing costs |
1,745 | 1,393 | ||||||
State income taxes |
468 | 121 | ||||||
Inventory cost capitalization |
2,189 | 1,917 | ||||||
Deferred compensation |
2,817 | 2,970 | ||||||
Other |
670 | 792 | ||||||
$ | 1,960 | $ | 5,593 | |||||
7. | COMMITMENTS AND CONTINGENCIES |
Operating Leases The Company leases its retail stores, former corporate offices and distribution facilities, and certain equipment under operating lease agreements expiring at various dates through January 2015. Substantially all of the leases require the Company to pay maintenance, insurance, property taxes and percentage rent ranging from 5% to 7% based on sales volumes over certain minimum sales levels.
Minimum future annual rental commitments under noncancellable leases are as follows:
Fiscal year ending: | ||||
January 31, 2004 |
$ | 73,162 | ||
January 29, 2005 |
73,512 | |||
January 28, 2006 |
73,307 | |||
February 3, 2007 |
74,366 | |||
February 2, 2008 |
72,616 | |||
Thereafter |
216,666 | |||
$ | 583,629 | |||
Rental expense, including common area maintenance, was $117,847, $91,480 and $71,175, of which $2,151, $1,062 and $1,085 was paid as percentage rent based on sales volume for the fiscal years ended February 1, 2003, February 2, 2002, and February 4, 2001, respectively.
Capital Leases During each of the fiscal years ended February 1, 2003, February 2, 2002, and February 4, 2001, the Company acquired computer equipment pursuant to capital lease obligations. The leases bear interest at average rates of 3.8%, 6.0% and 6.6%, respectively, and require monthly principal and interest payments of $90, $22 and $51, respectively, and expire at various dates through March 2006. The net book value of capital lease assets was $4,356 and $1,804, respectively, at February 1, 2003, and February 2, 2002. Future commitments under the capital lease obligation are as follows:
Fiscal year ending: | ||||
January 31, 2004 |
$ | 1,660 | ||
January 29, 2005 |
1,077 | |||
January 28, 2006 |
1,077 | |||
February 3, 2007 |
179 | |||
Total payments |
3,993 | |||
Less interest portion |
(236 | ) | ||
$ | 3,757 | |||
F-13
Letters of Credit The Company was contingently liable for $10.3 million in open letters of credit with foreign suppliers at February 1, 2003.
Other Long-Term Debt Obligations During the year ended February 1, 2003, the Company purchased a prepaid three-year computer maintenance agreement under a long-term debt obligation for $2,413. The debt obligation bears interest at 6.2% and requires quarterly principal and interest payments of $231 through March 2005. Future commitments under this long-term debt obligation are as follows:
Fiscal year ending: | ||||
January 31, 2004 |
$ | 927 | ||
January 29, 2005 |
927 | |||
January 28, 2006 |
231 | |||
Total payments |
2,085 | |||
Less interest portion |
(154 | ) | ||
$ | 1,931 | |||
Litigation On September 17, 2001 a former Pacific Sunwear employee filed a putative class action lawsuit against Pacific Sunwear which alleges that Pacific Sunwear has not properly paid wages to its California-based store managers, co-managers and assistant managers working in PacSun stores. The action, Auden v. Pacific Sunwear of California, Inc., Case No. 01CC00383, was filed in the California Superior Court for the County of Orange. The complaint in the action seeks both monetary and injunctive relief. Pacific Sunwear has filed an answer in the action denying the allegations and raising affirmative defenses. No class has been certified at this time.
On May 3, 2002 a former Pacific Sunwear employee filed a putative class action lawsuit against Pacific Sunwear in the California Superior Court for the County of Orange, alleging claims substantially similar to the claims alleged in the Auden case described above. In the case, Adams v. Pacific Sunwear of California, Inc., Case No. 02CC00120, the plaintiff alleges that Pacific Sunwear has not properly paid wages to its California store managers and co-managers working in d.e.m.o. stores. The complaint in the action seeks monetary and injunctive relief. Pacific Sunwear has filed an answer in the action denying the allegations and raising affirmative defenses. No class has been certified at this time.
The Company is involved from time to time in litigation incidental to its business. Management believes that the outcome of current litigation will not have a material adverse effect upon the results of operations or financial condition of the Company.
Indemnities, Commitments, and Guarantees During its normal course of business, the Company has made certain indemnities, commitments and guarantees under which it may be required to make payments in relation to certain transactions. These indemnities include those given to various lessors in connection with facility leases for certain claims arising from such facility or lease and indemnities to directors and officers of the Company to the maximum extent permitted under the laws of the State of California. The Company has issued guarantees in the form of standby letters of credit as security for merchandise shipments from overseas. There were $10.3 million of these letters of credit outstanding at February 1, 2003. The Company has also issued a guarantee within a sublease on one of its store locations under which the Company remains secondarily liable on the sublease should the sublessee default on its lease payments. The term of the sublease ends December 31, 2014. The Company has recorded $.5 million in accrued liabilities to recognize the estimated fair value of this guarantee, assuming that another sublessee would be found within one year should the original sublessee default. The aggregate rental payments remaining on the master lease agreement at February 1, 2003 was $6.5 million. The duration of these indemnities, commitments and guarantees varies, and in certain cases, is indefinite. The majority of these indemnities, commitments and guarantees do not provide for any limitation of the maximum potential future payments the Company could be obligated to make. The Company has not recorded any liability for these indemnities, commitments and guarantees in the accompanying consolidated balance sheets other than as noted.
The Company maintains a private label credit card through a third party to promote the PacSun brand image and lifestyle. The third party services the customer accounts and retains all risk and financial obligation associated with any outstanding balances on customer accounts. The Company has no financial obligation and does not provide any guarantee related to any outstanding balances resulting from the use of these private label credit cards by its customers.
F-14
8. | COMMON STOCK |
Stock Split During the fiscal year ended February 1, 2003, the Company effected a three-for-two stock split. Shareholders equity has been restated to give retroactive recognition to the stock split in prior periods by reclassifying the par value ($164) of the additional shares arising from the split from additional paid-in capital to common stock. Additionally, all share and per share amounts have been restated to give effect to the stock split.
Shareholder Rights Plan In December 1998, the Board of Directors approved the adoption of a Shareholder Rights Plan (the Rights Plan). The Rights Plan provides for the distribution to the Companys shareholders of one preferred stock purchase Right for each outstanding share of the Companys common stock. The Rights have an exercise price of $75 per Right, subject to subsequent adjustment. Initially, the Rights will trade with the Companys common stock, and will not be exercisable until the occurrence of certain takeover-related events, as defined. The Rights Plan provides that if a person or group acquires more than 15% of the Companys stock without prior approval of the Board of Directors, holders of the Rights will be entitled to purchase the Companys stock at half of market value. The Rights Plan also provides that if the Company is acquired in a merger or other business combination after a person or group acquires more than 15% of the Companys stock without prior approval of the Board of Directors, holders of the Rights will be entitled to purchase the acquirers stock at half of market value. The Rights were distributed to holders of the Companys common stock of record on December 29, 1998, as a dividend, and will expire, unless earlier redeemed, on December 29, 2008.
9. | STOCK OPTION AND RETIREMENT PLANS |
Under the Companys stock option plans, incentive and nonqualified options have been granted to employees and directors to purchase common stock at prices equal to the fair value of the Companys shares at the grant dates.
At February 1, 2003, outstanding incentive and nonqualified options had exercise prices ranging from $1.00 to $23.88 per share, with an average exercise price of $12.84, and generally begin vesting one year after the grant date. On the initial vesting date, 25% of the options vest and, thereafter, options generally continue to vest at 2.08% each calendar month. The options generally expire ten years from the date of grant or 90 days after employment or services are terminated.
At February 1, 2003, incentive and nonqualified options to purchase 5,793,031 shares were outstanding and 804,277 shares were available for future grant under the Companys stock option plans. During the years ended February 1, 2003, February 2, 2002, and February 4, 2001, the Company recognized tax benefits of $1,038, $2,708 and $4,816, respectively, resulting from the exercise of certain nonqualified stock options.
Stock option (incentive and nonqualified) activity for each of the three fiscal years ended February 1, 2003, was as follows:
Fiscal 2002 | Fiscal 2001 | Fiscal 2000 | |||||||||||
Beginning options outstanding |
4,798,684 | 4,129,734 | 4,792,199 | ||||||||||
Options granted |
1,525,058 | 1,638,750 | 857,250 | ||||||||||
Options canceled |
(236,188 | ) | (517,029 | ) | (223,860 | ) | |||||||
Options exercised |
(294,523 | ) | (452,771 | ) | (1,295,855 | ) | |||||||
Ending options outstanding |
5,793,031 | 4,798,684 | 4,129,734 | ||||||||||
Ending options exercisable |
3,051,233 | 2,325,670 | 2,026,509 | ||||||||||
Beginning weighted average
exercise price |
$ | 11.97 | $ | 11.68 | $ | 9.05 | |||||||
Options granted |
15.34 | 12.81 | 15.87 | ||||||||||
Options canceled |
14.86 | 15.57 | 13.21 | ||||||||||
Options exercised |
10.02 | 8.25 | 4.45 | ||||||||||
Ending weighted average
exercise price |
$ | 12.84 | $ | 11.97 | $ | 11.68 | |||||||
Ending weighted average
exercise price of
exercisable options |
$ | 11.39 | $ | 10.34 | $ | 9.25 | |||||||
Weighted average fair value
of options granted during
the fiscal year |
$ | 15.34 | $ | 7.86 | $ | 12.33 |
F-15
Additional information regarding options outstanding as of February 1, 2003, is as follows:
Options Outstanding | Options Exercisable | ||||||||||||||||||||||||||||
Number | Number | ||||||||||||||||||||||||||||
Outstanding | Weighted Average | Weighted | Exercisable | Weighted | |||||||||||||||||||||||||
Range of | as of Feb. 1, | Remaining | Average | as of Feb. 1, | Average | ||||||||||||||||||||||||
Exercise Prices | 2003 | Contractual Life | Exercise Price | 2003 | Exercise Price | ||||||||||||||||||||||||
$ | 1.00 |
- | $ | 9.89 | 1,313,503 | 4.72 | $ | 7.24 | 1,286,647 | $ | 7.20 | ||||||||||||||||||
10.03 |
- | 11.32 | 1,312,090 | 8.11 | 11.09 | 566,564 | 10.90 | ||||||||||||||||||||||
11.40 |
- | 14.23 | 1,229,628 | 8.43 | 13.91 | 230,628 | 13.59 | ||||||||||||||||||||||
14.24 |
- | 17.21 | 1,187,936 | 7.21 | 16.04 | 805,044 | 16.04 | ||||||||||||||||||||||
17.27 |
- | 23.88 | 749,874 | 9.09 | 18.89 | 162,350 | 20.13 | ||||||||||||||||||||||
$ | 1.00 |
- | $ | 23.88 | 5,793,031 | 7.35 | $ | 12.84 | 3,051,233 | $ | 11.39 | ||||||||||||||||||
During the year ended February 1, 1998, the Company granted a restricted stock award of 284,761 shares with a purchase price of $0.01 per share to its Chief Executive Officer. The 284,761 share award began vesting on March 31, 1999, with 25% of the shares vested at such time, and thereafter vested at 25% on each of March 31, 2000, 2001 and 2002, as, in each instance, at the applicable vesting date, certain cumulative earnings per share growth targets had been satisfied. The Company recorded $40, $240 and $240, respectively, of deferred compensation expense associated with this award during the years ended February 1, 2003, February 2, 2002 and February 4, 2001, respectively.
During the year ended January 30, 2000, the Company granted a restricted stock award of 75,000 shares with a purchase price of $0.01 per share to its Chief Executive Officer. The 75,000 share award began vesting on September 17, 2001, with 25% of the shares vested at such time, and thereafter will vest at 25% on each of September 17, 2002, 2003 and 2004, if, in each instance, at the applicable vesting date, certain cumulative earnings per share growth targets have been satisfied. The Company recorded $229 of deferred compensation expense associated with this award during the year ended February 4, 2001. During fiscal 2001, the Company reversed all previously recognized expenses of $317 associated with this award because the cumulative earnings per share growth targets had not been satisfied. No additional expenses have been recognized in association with this award because the cumulative earnings per share growth targets have not been met as of February 1, 2003.
During the year ended February 4, 2001, the Company granted a restricted stock award of 112,500 shares with a purchase price of $0.01 per share to its Chief Executive Officer. The 112,500 share award begins vesting on March 15, 2002, with 25% of the shares vested at such time, and thereafter will vest at 25% on each of March 15, 2003, 2004 and 2005, if, in each instance, at the applicable vesting date, certain cumulative earnings per share growth targets have been satisfied. The Company recorded $38 of deferred compensation expense associated with this award during the year ended February 4, 2001. During fiscal 2001, the Company reversed the previously recognized expense of $38 associated with this award because the cumulative earnings per share growth targets had not been satisfied. No additional expenses have been recognized in association with this award because the cumulative earnings per share growth targets have not been met as of February 1, 2003.
The Company accounts for its stock-based awards using the intrinsic value method in accordance with APB Opinion No. 25, Accounting for Stock Issued to Employees, and its related interpretations. Accordingly, no compensation expense has been recognized in the financial statements for employee stock arrangements, other than described above.
In fiscal 1997, the Company established the Pacific Sunwear of California, Inc. Employee Stock Purchase Plan (the ESPP), which provides a method for employees of the Company whereby they may voluntarily purchase common stock at a 10% discount from fair market value as of the beginning or the end of each purchasing period of six months, whichever is lower. The ESPP covers substantially all employees, except officers, who have three months of service with the Company. The ESPP is intended to constitute an employee stock purchase plan within the meaning of Section 423 of the Internal Revenue Code of 1986, as amended, and therefore the Company does not recognize compensation expense related to the ESPP. In fiscal 2002 and fiscal 2001, 39,394 and 40,830 shares were issued at an average price of $12.54 and $12.81, respectively, under the ESPP.
In fiscal 1995, the Company established the Pacific Sunwear of California, Inc. Executive Deferred Compensation Plan (the Executive Plan). The Executive Plan covers officers of the Company, and is funded by participant contributions and periodic discretionary contributions from the Company. For each of the three fiscal years in the period ended February 1, 2003, the Company made contributions of $206, $175 and $137, respectively, to the Executive Plan.
F-16
In fiscal 1992, the Company established the Pacific Sunwear of California, Inc. Employee Savings Plan (the 401(k) Plan). The 401(k) Plan is a defined contribution plan (401(k)) covering substantially all employees who have reached age 21 and have one year of service with the Company. The 401(k) Plan is funded by employee contributions and periodic discretionary contributions from the Company, which are subject to approval by the Companys Board of Directors. For each of the three fiscal years in the period ended February 1, 2003, the Company made contributions, net of forfeitures, of $328, $364 and $310, respectively, to the 401(k) Plan.
10. | CORPORATE RELOCATION-RELATED CHARGES |
During fiscal 2001, the Company recorded a non-cash charge of $2.5 million after tax ($4.2 million pre-tax), or $.08 per basic and diluted share, related to the disposal of most of the materials handling equipment in the Companys former distribution center as part of its relocation to its new distribution facility in Anaheim, California at the end of fiscal 2001. The $4.2 million pre-tax charge is included in selling, general and administrative expenses.
During fiscal 2001, the Company recorded a $1.4 million charge to accrue for rent expense associated with the Companys former corporate offices, which remain unused at the end of fiscal 2002. The current accrual of $1.3 million is approximately the amount of rent expense for one year, within which time the Company currently believes a tenant will be identified to sublease the premises. To the extent managements estimates relating to the Companys ability to sublease these premises within one year changes, additional charges may be recorded in the future up to the net remaining obligation under the lease depending on the facts and circumstances in existence at the time. As of February 1, 2003, the aggregate net remaining obligation under this lease is approximately $6.7 million.
11. | QUARTERLY FINANCIAL DATA (UNAUDITED) |
First | Second | Third | Fourth | |||||||||||||
Quarter | Quarter | Quarter | Quarter | |||||||||||||
Fiscal year ended February 1, 2003: |
||||||||||||||||
Net sales |
$ | 161,710 | $ | 190,854 | $ | 228,239 | $ | 265,590 | ||||||||
Gross margin |
49,166 | 60,605 | 78,915 | 94,997 | ||||||||||||
Operating income |
5,453 | 12,151 | 25,956 | 37,677 | ||||||||||||
Net income |
3,269 | 7,296 | 15,902 | 23,209 | ||||||||||||
Net income per share, basic |
$ | 0.07 | $ | 0.15 | $ | 0.32 | $ | 0.47 | ||||||||
Net income per share, diluted |
$ | 0.07 | $ | 0.15 | $ | 0.32 | $ | 0.46 | ||||||||
Wtd. avg. shares outstanding,
basic (Note 1) |
49,197,137 | 49,257,374 | 49,303,737 | 49,392,438 | ||||||||||||
Wtd. avg. shares outstanding,
diluted (Note 1) |
50,117,441 | 49,844,660 | 49,949,165 | 50,510,547 | ||||||||||||
Fiscal year ended February 2, 2002: |
||||||||||||||||
Net sales |
$ | 137,698 | $ | 156,509 | $ | 183,028 | $ | 207,605 | ||||||||
Gross margin |
41,957 | 48,178 | 60,786 | 69,259 | ||||||||||||
Operating income |
1,355 | 5,741 | 14,321 | 22,865 | ||||||||||||
Net income |
979 | 3,544 | 8,885 | 14,157 | ||||||||||||
Net income per share, basic |
$ | 0.02 | $ | 0.07 | $ | 0.18 | $ | 0.29 | ||||||||
Net income per share, diluted |
$ | 0.02 | $ | 0.07 | $ | 0.18 | $ | 0.28 | ||||||||
Wtd. avg. shares outstanding,
basic (Note 1) |
48,778,221 | 49,079,099 | 49,104,816 | 49,126,325 | ||||||||||||
Wtd. avg. shares outstanding,
diluted (Note 1) |
49,796,586 | 49,652,723 | 49,351,130 | 49,682,930 |
Earnings per basic and diluted shares outstanding are computed independently for each of the quarters presented and, therefore, may not sum to the totals for the year.
F-17
INDEX TO EXHIBITS
Exhibit Number | Description of Exhibit | |||
3.1 | Third Amended and Restated Articles of Incorporation of the
Company (1) |
|||
3.2 | Certificate of Amendment, dated December 17, 2002, of Third
Amended and Restated Articles of Incorporation of the Company |
|||
3.3 | Certificate of Correction, dated February 28, 2003, of Third
Amended and Restated Articles of Incorporation of the Company |
|||
3.4 | Certificate of Determination of Preferences of Series A Junior
Participating Preferred Stock of the Company (4) |
|||
3.5 | |
Second Amended and Restated Bylaws of the Company (1) |
||
3.6 | Amendment, dated March 25, 2003, to the Second Amended and
Restated Bylaws of the Company |
|||
4.1 | Specimen stock certificate (1) |
|||
10.1 | Form of Indemnity Agreement between the Company and each of
its executive officers and directors (1) * |
|||
10.2 | 1986-87 Stock Option Plan dated as of December 11, 1986, as
amended (the Option Plan) (1) * |
|||
10.3 | Amended and Restated 1992 Stock Award Plan dated June 8, 1999
(the Award Plan) (8) * |
|||
10.4 | Amended and Restated 1999 Stock Award Plan dated December 31,
2002 * |
|||
10.5 | Pacific Sunwear of California, Inc. Executive Deferred
Compensation Plan and Trust Agreement (2) * |
|||
10.6 | Amended and Restated Pacific Sunwear of California, Inc.
Employee Stock Purchase Plan dated December 31, 2002 * |
|||
10.7 | Restricted Stock Award Agreement dated September 18, 1996, by
and between the Company and Greg H. Weaver (8) * |
|||
10.8 | Restricted Stock Award Agreement dated September 17, 1999, by
and between the Company and Greg H. Weaver (7) * |
|||
10.9 | Restricted Stock Award Agreement dated January 3, 2001, by and
between the Company and Greg H. Weaver (8) * |
|||
10.10 | Amended and Restated Employment Agreement dated February 5,
2001, between the Company and Greg H. Weaver (8) * |
|||
10.11 | Severance Agreements, dated October 27, 1997, and November 6,
1996, by and between Pacific Sunwear of California, Inc. and
Timothy M. Harmon and Carl W. Womack, respectively (3) * |
1
Exhibit Number | Description of Exhibit | |||
10.12 | Standard Industrial Lease Net, dated September 30, 1997,
between the Company and Bank of America National Trust and
Savings Association, as amended, and Standard Industrial Lease
- - Net, dated January 12, 1998 between the Company and The
Realty Associates Fund IV, L.P., a Delaware limited
partnership, as amended for the Companys former corporate
headquarters and distribution center located in Anaheim,
California (3) |
|||
10.13 | Standard Sublease dated December 22, 1998, between the
Company and Bekins Moving and Storage Company, LLC (6) |
|||
10.14 | Rights Agreement, dated as of December 16, 1998, between the
Company and U.S. Stock Transfer Corporation (5) |
|||
10.15 | Business Loan Agreement, dated April 3, 2001, between the
Company and Bank of America N.A. (9) |
|||
10.16 | First Amendment to Business Loan Agreement, dated as of April
17, 2001, between the Company and Bank of America N.A. (9) |
|||
10.17 | Master Continuing and Unconditional Guaranty to Bank of
America N.A. from Pacific Sunwear Stores Corp. and
ShopPacSun.com Corp. (9) |
|||
10.18 | Second Amendment to Business Loan Agreement, dated as of
August 1, 2001, between the Company and Bank of America N.A.
(10) |
|||
10.19 | Third Amendment to Business Loan Agreement, dated as of August
19, 2002, between the Company and Bank of America N.A. (11) |
|||
10.20 | Fourth Amendment to Business Loan Agreement, dated as of
January 14, 2003, between the Company and Bank of America N.A |
|||
21 | Subsidiaries
of the Registrant |
|||
23.1 | Consent of Deloitte & Touche LLP |
|||
99.1 | Sarbanes-Oxley Act Section 906 Certifications |
(1) | Incorporated by reference from the Companys Form S-1 Registration Statement (No. 33-57860) as filed with the Securities and Exchange Commission on February 4, 1993. | |
(2) | Incorporated by reference from the Companys Annual Report on Form 10-K as filed with the Securities and Exchange Commission on March 17, 1995. | |
(3) | Incorporated by reference from the Companys Annual Report on Form 10-K as filed with the Securities and Exchange Commission on April 9, 1998. | |
(4) | Incorporated by reference from the Companys Current Report on Form 8-K as filed with the Securities and Exchange Commission on December 24, 1998. | |
(5) | Incorporated by reference from the Companys Form 8-A Registration Statement as filed with the Securities and Exchange Commission on December 24, 1998. | |
(6) | Incorporated by reference from the Companys Annual Report on Form 10-K as filed with the Securities and Exchange Commission on April 8, 1999. | |
(7) | Incorporated by reference from the Companys Annual Report on Form 10-K as filed with the Securities and Exchange Commission on April 6, 2000. |
2
(8) | Incorporated by reference from the Companys Annual Report on Form 10-K as filed with the Securities and Exchange Commission on March 30, 2001. | |
(9) | Incorporated by reference from the Companys Quarterly Report on Form 10-Q as filed with the Securities and Exchange Commission on June 8, 2001. | |
(10) | Incorporated by reference from the Companys Quarterly Report on Form 10-Q as filed with the Securities and Exchange Commission on September 14, 2001. | |
(11) | Incorporated by reference from the Companys Quarterly Report on Form 10-Q as filed with the Securities and Exchange Commission on September 11, 2002. | |
* | Management contract or compensatory plan or arrangement. |
3