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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended: July 31, 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: 0-028176
Whitehall Jewellers, Inc.
(Exact name of registrant as specified in its charter)
Delaware 36-1433610
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
155 N. Wacker Drive, Suite 500, Chicago, IL 60606
(Address of principal executive offices) (zip code)
312/782-6800
(Registrant's telephone number, including area code)
(Former name, former address and former fiscal
year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act). Yes [X] No [ ]
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date.
The number of shares of the Registrant's common stock, $.001 par value
per share, outstanding as of August 31, 2003 was 14,214,422 and the number of
shares of the Registrant's Class B common stock, $1.00 par value per share,
outstanding as of August 31, 2003 was 142.
WHITEHALL JEWELLERS, INC.
INDEX TO FORM 10-Q
FOR THE QUARTER ENDED JULY 31, 2003
PART 1 - FINANCIAL INFORMATION
Item 1. Financial Statements
Statements of Operations for the three months and six months
ended July 31, 2003 and 2002 (unaudited)
Balance Sheets - July 31, 2003, January 31, 2003 and July 31,
2002 (unaudited)
Statements of Cash Flows for the six months ended July 31,
2003 and 2002(unaudited)
Notes to Financial Statements
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Item 4. Controls and Procedures
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
Item 4. Submission of Matters to a Vote of Security Holders
Item 5. Other Information
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
(b) Reports on Form 8-K
2
PART 1 - FINANCIAL INFORMATION
Item 1. Financial Statements
Whitehall Jewellers, Inc.
Statements of Operations
for the three months and six months ended July 31, 2003 and 2002
(unaudited, in thousands, except for per share data)
Three months ended Six months ended
July 31, 2003 July 31, 2002 July 31, 2003 July 31, 2002
------------- ------------- ------------- -------------
Net sales $ 72,732 $ 76,243 $141,881 $150,831
Cost of sales (including buying and occupancy
expenses) 48,623 49,703 94,675 97,079
-------- -------- -------- --------
Gross profit 24,109 26,540 47,206 53,752
Selling, general and administrative expenses 27,251 25,251 53,943 50,878
-------- -------- -------- --------
Income (loss) from operations (3,142) 1,289 (6,737) 2,874
Interest expense 1,564 1,111 2,472 2,123
-------- -------- -------- --------
Income(loss)before income taxes (4,706) 178 (9,209) 751
Income tax (benefit) expense (1,835) 64 (3,590) 268
-------- -------- -------- --------
Net income (loss) $ (2,871) $ 114 $ (5,619) $ 483
======== ======== ======== ========
Basic earnings per share:
Net income (loss) $ (0.20) $ 0.01 $ (0.40) $ 0.03
======== ======== ======== ========
Weighted average common share and common
share equivalents 14,215 14,807 14,210 14,719
======== ======== ======== ========
Diluted earnings per share:
Net income (loss) $ (0.20) $ 0.01 $ (0.40) $ 0.03
======== ======== ======== ========
Weighted average common share and common
share equivalents 14,215 15,594 14,210 15,476
======== ======== ======== ========
The accompanying notes are an integral part of the financial statements.
3
Whitehall Jewellers, Inc.
Balance Sheets
(unaudited, in thousands)
July 31, January 31, July 31,
2003 2003 2002
--------- ----------- ---------
ASSETS
Current Assets:
Cash $ 1,399 $ 2,048 $ 2,128
Accounts receivable, net 333 1,621 2,042
Merchandise inventories 206,149 197,859 169,380
Other current assets 1,979 1,239 1,265
Prepaid income tax 4,477 --- 300
Deferred financing costs 261 510 510
Deferred income taxes, net 2,085 2,172 2,461
--------- --------- ---------
Total current assets 216,683 205,449 178,086
Property and equipment, net 63,604 61,634 62,941
Goodwill 5,662 5,662 5,662
Deferred financing costs 781 213 468
--------- --------- ---------
Total assets $ 286,730 272,958 $ 247,157
========= ========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Revolver loan $ 86,375 $ 94,490 $ 61,694
Term loan, current --- 4,500 5,750
Accounts payable 57,051 24,726 32,119
Customer deposits 3,355 3,454 3,655
Accrued payroll 3,036 3,282 4,989
Income taxes payable --- 3,261 ---
Other accrued expenses 15,902 13,207 17,945
--------- --------- ---------
Total current liabilities 165,719 146,920 126,152
Term loan --- --- 1,500
Subordinated debt 640 640 640
Deferred income taxes, net 3,879 3,607 1,868
Other long-term liabilities 3,338 3,138 2,907
--------- --------- ---------
Total liabilities 173,576 154,305 133,067
--------- --------- ---------
Commitments and contingencies
Stockholders' equity:
Common stock 18 18 18
Class B common stock --- --- ---
Additional paid-in capital 105,830 105,795 105,633
Accumulated earnings 43,158 48,777 39,354
--------- --------- ---------
149,006 154,590 145,005
--------- --------- ---------
Less:
Treasury stock, at cost (3,815,900, 3,822,637 and
3,357,646 shares, respectively) (35,852) (35,937) (30,915)
--------- --------- ---------
Total stockholders' equity, net 113,154 118,653 114,090
--------- --------- ---------
Total liabilities and stockholders' equity $ 286,730 $ 272,958 $ 247,157
========= ========= =========
The accompanying notes are an integral part of the financial statements.
4
Whitehall Jewellers, Inc.
Statements of Cash Flows
for the six months ended July 31, 2003 and 2002
(unaudited, in thousands)
Six months ended
----------------
July 31, 2003 July 31, 2002
------------- -------------
Cash flows from operating activities:
Net income (loss) $ (5,619) $ 483
Adjustments to reconcile net income (loss) to net cash provided by (used
in) operating activities:
Depreciation and amortization 6,028 5,544
Loss on disposition of assets 409 24
Write-off of deferred loan cost 516 ---
Changes in assets and liabilities:
Decrease(increase)in accounts receivable, net 1,288 (853)
(Increase)decrease in merchandise
inventories, net of gold consignment (8,290) 4,551
(Increase) in other current assets (740) (292)
(Increase) in prepaid income tax (4,477) (300)
Increase in deferred income taxes 359 99
(Decrease) in customer deposits (99) (308)
Increase(decrease) in accounts payable 21,413 (20,866)
(Decrease) in income taxes payable (3,261) (3,226)
Increase(decrease) increase in accrued liabilities 2,649 (2,754)
--------- ---------
Net cash provided by (used in) operating activities 10,176 (17,898)
Cash flows from investing activities:
Capital expenditures (8,125) (4,339)
--------- ---------
Net cash used in investing activities (8,125) (4,339)
Cash flows from financing activities:
Borrowing on revolver loan 363,810 439,385
Repayment of revolver loan (371,925) (412,968)
Repayment of term loan (4,500) (2,500)
Proceeds from exercise of stock options 75 1,407
Proceeds under employee stock purchase plan 45 10
Financing costs (1,117) ---
Increase(decrease) in outstanding checks, net 10,912 (3,710)
--------- ---------
Net cash (used in) provided by financing activities (2,700) 21,624
--------- ---------
Net change in cash and cash equivalents (649) (613)
Cash and cash equivalents at beginning of period 2,048 2,741
--------- ---------
Cash and cash equivalents at end of period $ 1,399 $ 2,128
========= =========
The accompanying notes are an integral part of the financial statements.
5
Whitehall Jewellers, Inc.
Notes to Financial Statements
1. DESCRIPTION OF OPERATIONS
The financial statements of Whitehall Jewellers, Inc. (the "Company")
include the results of the Company's chain of specialty retail fine jewelry
stores. The Company operates exclusively in one business segment, specialty
retail jewelry. The Company has a national presence with 383 stores as of July
31, 2003, located in 38 states, operating in regional or superregional shopping
malls. The consolidated financial statements include the accounts and
transactions of the Company and its subsidiaries. Intercompany accounts and
transactions have been eliminated.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis for Presentation
The accompanying Balance Sheet as of January 31, 2003 was derived from
the audited financial statements for the year ended January 31, 2003. The
accompanying unaudited Balance Sheets as of July 31, 2003 and 2002, and the
Statements of Income and Cash Flows for the three and six months ended July 31,
2003 and 2002 have been prepared in accordance with generally accepted
accounting principles for interim financial information. The interim financial
statements reflect all adjustments (consisting only of normal recurring
accruals) which are, in the opinion of management, necessary for a fair
presentation of financial position, results of operations and cash flows for the
interim periods presented. The interim financial statements should be read in
the context of the Financial Statements and footnotes thereto included in the
Whitehall Jewellers, Inc. Annual Report on Form 10-K for the fiscal year ended
January 31, 2003. References in the following notes to years and quarters are
references to fiscal years and fiscal quarters.
Merchandise Inventories
Merchandise inventories are stated principally at the lower of weighted
average cost or market. Cost is reduced to reflect certain allowances and
discounts received from vendors. Periodic payments from vendors in the form of
buydowns, volume or other purchase discounts that are evidenced by signed
agreements are reflected in the carrying value of the inventory when earned and
as a component of cost of sales, buying and occupancy as the merchandise is
sold. To the extent the Company's agreements with vendors specify co-op
advertising, the Company has historically classified such credits as a reduction
to advertising expense in selling, general and administrative expenses. Emerging
Issues Task Force Issue No. 02-16, "Accounting by a Customer (Including a
Reseller) for Certain Consideration Received from a Vendor" ("EITF 02-16"),
which was effective for all arrangements entered into after December 31, 2002,
requires vendor allowances to be classified as a reduction to inventory cost
unless evidence exists supporting an alternative classification. The Company has
recorded such vendor allowances earned pursuant to its 2003 vendor trade
agreement as a reduction of inventory cost. The total amount of these allowances
as of July 31, 2003 and 2002 was approximately $2,115,000 and $1,531,000,
respectively.
The Company also obtains merchandise from vendors under various
consignment agreements. The consigned inventory and related contingent
obligations associated with holding and safekeeping such consigned inventory are
not reflected in the Company's financial statements. At the time of sale of
consigned merchandise to customers, the Company records the purchase liability
and the related consignor cost of such merchandise in cost of sales.
6
Stock-Based Compensation
The Financial Accounting Standards Board issued Statement No. 148
("SFAS 148"), "Accounting for Stock-Based Compensation-Transition and
Disclosure," during 2002. SFAS 148 amends Statement No. 123 ("SFAS 123"),
"Accounting for Stock-Based Compensation," to provide alternative methods of
transition for a voluntary change to the fair value based method of accounting
for stock-based employee compensation and amends the disclosure requirements to
require prominent disclosures in both annual and interim financial statements
about the method of accounting for stock-based employee compensation and the
effect of the method used on reported results. The Company adopted the
disclosure requirements of SFAS 148 as of January 31, 2003.
The Company accounts for stock-based compensation according to
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees," which results in no charge to earnings when options are issued at
fair market value.
The following table illustrates the effect on net income and earnings
per share for the three and six months ended July 31, 2003 and 2002, if the
Company had applied the fair value recognition provisions of SFAS 123, as
amended by SFAS 148, to stock-based employee compensation.
Three months ended Six months ended
July 31, 2003 July 31, 2002 July 31, 2003 July 31, 2002
------------------------------------ ------------------------------------
(in thousands, except for per share amounts)
-----------------------------------------------------------------------------------
Net income (loss), as reported $ (2,871) $ 114 $ (5,619) $ 483
Deduct: Total stock-based
employee compensation expense
determined under fair value
based method, net of related tax effects 265 508 532 1,077
---------------------------------- ---------------------------------
Pro forma net (loss) $ (3,136) $ (394) $ (6,151) $ (594)
================================== =================================
Earnings per share:
Basic-as reported $ (0.20) $ 0.01 $ (0.40) $ 0.03
================================== =================================
Basic-pro forma $ (0.22) $ (0.03) $ (0.43) $ (0.04)
================================== =================================
Diluted-as reported $ (0.20) $ 0.01 $ (0.40) $ 0.03
================================== =================================
Diluted-pro forma $ (0.22) $ (0.03) $ (0.43) $ (0.04)
================================== =================================
7
For purposes of pro forma net income and earnings per share calculation
in accordance with SFAS 123, for each option granted during the three and six
months ended July 31, 2003 and 2002 the fair value is estimated using the
Black-Scholes option-pricing model. The assumptions used are as follows:
For the three months ended For the six months ended
July 31, 2003 July 31, 2002 July 31, 2003 July 31, 2002
-----------------------------------------------------------------------------------
Risk-free interest rate 3.0% 4.4% 3.0% 4.6%
Dividend yield 0 0 0 0
Option life 5.5 years 5.5 years 5.5 years 5.5 years
Volatility 60% 62% 61% 62%
Accounting for Costs Associated with Exit or Disposal Activities
In June 2002, the Financial Accounting Standards Board issued Statement
No. 146 ("SFAS 146"), "Accounting for Costs Associated with Exit or Disposal
Activities." SFAS 146 requires that costs associated with disposal or exit
activities after December 31, 2002 be recorded at fair value in the period the
liability is incurred. The Company adopted SFAS 146 effective January 1, 2003.
During the six months ended July 31, 2003, the Company closed 6 stores
resulting in a charge of $24,000 related to closing costs, net of reversal of
$225,000 in prior period accruals for store closing costs and minimum rent. In
addition, the Company recorded $374,000 of accelerated depreciation expense in
connection with these store closings.
Accounting for Guarantees
In November 2002, the Financial Standards Accounting Board issued FASB
Interpretation No. 45 ("FIN 45"), "Guarantor's Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of
Others," an interpretation of FASB Statements No. 5, 57 and 107 and rescission
of FASB Interpretation No. 34. The Company has adopted the guidance of FIN 45
and has reflected the required disclosures in its financial statements
commencing with the financials statements for the year ended January 31, 2003.
3. ACCOUNTS RECEIVABLE, NET
As of July 31, 2003, January 31, 2003 and July 31, 2002, accounts
receivable consisted of:
July 31, 2003 January 31, 2003 July 31, 2002
------------- ---------------- -------------
(in thousands)
Accounts receivable $ 805 $ 2,165 $ 2,682
Less: allowance for doubtful
accounts (472) (544) (640)
-------- ------- --------
Accounts receivable, net $ 333 $ 1,621 $ 2,042
======== ======= ========
8
4. INVENTORY
As of July 31, 2003, January 31, 2003 and July 31, 2002, merchandise
inventories consisted of:
July 31, 2003 January 31, 2003 July 31, 2002
------------- ---------------- -------------
(in thousands)
Raw Materials $ 11,171 $ 7,657 $ 6,846
Finished Goods 194,978 190,202 162,534
--------- ---------- ---------
Merchandise Inventories $ 206,149 $ 197,859 $ 169,380
========= ========== =========
Raw materials primarily consist of diamonds, precious gems,
semi-precious gems and gold. Included within finished goods inventory are
allowances for inventory shrink and scrap costs of $2,286,000, $3,150,000, and
$2,771,000 as of July 31, 2003, January 31, 2003 and July 31, 2002,
respectively. As of July 31, 2003, January 31, 2003 and July 31, 2002,
consignment inventories held by the Company that were not included in the
balance sheets total $76,777,000, $74,924,000, and $68,520,000, respectively.
In addition, gold consignments of $23,298,000 are not included in the
Company's balance sheets as of July 31, 2002 (see Note 6, Financing
Arrangements) as the title to such gold has passed to the consignor and is
subject to the same risk of physical loss as other inventory held on consignment
by the Company. On August 22, 2002, the Company purchased 66,500 troy ounces of
gold at an average gold price of $307.56 per ounce for a total of approximately
$20.5 million. The Company delivered the gold to its banks and extinguished all
existing Company gold consignment obligations to the banks under the Credit
Agreement (see Note 6). The purchase had the effect of increasing the weighted
average cost of gold available for retail sale by the Company and will result in
a higher weighted average cost of sales in future periods. The Company estimated
subsequent cost of sales as a result of this transaction to be approximately
$1.5 million greater based on the effect of the transaction on the weighted
average cost of gold product in its inventory prior to this purchase.
Approximately $282,000 and $562,000 of this increase in cost of sales is
reflected in the three and six months ended July 31, 2003, respectively. This
purchase increased the Company's inventory by $20.5 million and was funded by
revolver loan borrowings. The total amount available to borrow under the
Company's Credit Agreement is unchanged.
Certain merchandise procurement, distribution and warehousing costs
were allocated to inventory. As of July 31, 2003, January 31, 2003 and July 31,
2002, the amounts included in inventory were $3,608,000, $3,364,000 and
$3,302,000, respectively.
5. ACCOUNTS PAYABLE
Accounts payable includes outstanding checks, which were $17,424,000,
$6,512,000 and $3,430,000 as of July 31, 2003, January 31, 2003 and July 31,
2002, respectively.
6. FINANCING ARRANGEMENTS
Effective July 29, 2003, the Company entered into a Second Amended and
Restated Revolving Credit, Term Loan and Gold Consignment Agreement (the "Credit
Agreement") with certain members of its prior bank group which
9
provides for a total facility of up to $125.0 million through July 28, 2007.
Interest rates and the commitment fee charged on the unused portion of the
facility float based upon the Company's financial performance as calculated
quarterly.
Under this Credit Agreement, the banks have a collateral security
interest in substantially all of the assets of the Company. The Credit Agreement
contains certain restrictions, including restrictions on investments, payment of
dividends, assumption of additional debt, acquisitions and divestitures. The
Credit Agreement also requires the Company to maintain a specified ratio of the
sum of earnings before interest, taxes, depreciation and amortization plus
minimum store rent to the sum of minimum store rent plus cash interest expense
if the Company's borrowing availability drops below a certain level.
Revolver Loan
The revolving loan facility under the Credit Agreement is available up
to a maximum of $125.0 million, including amounts consigned under the gold
consignment facility, and is limited by a borrowing base computed based on the
value of the Company's inventory and accounts receivables. Availability under
the revolver is based on amounts outstanding thereunder, including the value of
consigned gold which fluctuates based on gold prices. Interest rates and
commitment fees on the unused facility float based on the Company's quarterly
financial performance.
The interest rates for borrowings under the Credit Agreement are, at
the Company's option, based on Eurodollar rates or the banks' prime rate.
Interest is payable monthly for prime borrowings and upon maturity for
Eurodollar borrowings.
Gold Consignment Facility
The Company has the opportunity to enter into gold consignments with
certain third party financial institutions. At this time the Company has no
obligations under the gold consignment facility. The Company provides the third
party financial institution with title to a certain number of troy ounces of
gold held in the Company's existing merchandise inventory in exchange for cash
at the current market price of gold. The Company then consigns the gold from the
third party financial institution, pursuant to a gold consignment agreement.
This agreement entitles the Company to use the gold in the ordinary course of
its business. The gold consignment facility is a transfer of title in specified
quantities of the gold content of the Company's inventory (a non-financial
asset) to a financial institution in exchange for cash. The Company continues to
bear responsibility for damage to the inventory, as is the case in all of its
consigned inventory arrangements with its other vendors.
The Company has accounted for the transaction as a reduction in its
inventories, as it has transferred title to the gold to the financial
institution. Similar to other consigned inventories in the possession of the
Company (for which the Company bears risk of loss but does not possess title),
the value of the inventory is not included in the assets of the Company. The
terms of the gold consignment agreement require the Company to deliver the
specified quantities of consigned gold back to the third party financial
institution at the end of the facility (which currently expires in 2007).
Physical delivery can be made from the Company's inventory or from gold acquired
by the Company in the open market. As an alternative to physical delivery of
these specific troy ounces of gold, the Company can elect to
10
purchase the consigned quantities at the current market price for gold on that
date.
As of July 31, 2002, the Company sold and simultaneously consigned
66,500 troy ounces of gold for $20.3 million under the gold consignment facility
based upon the market price of gold. The facility provides for the sale of a
maximum 115,000 troy ounces or $40.0 million. Under the agreement, the Company
pays consignment fees based on the London Interbank Bullion Rates payable
monthly. Consignment rates and commitment fees on the unused portion of the gold
consignment facility float based upon the Company's quarterly financial
performance. On August 22, 2002, the Company purchased 66,500 troy ounces of
gold at an average gold price of $307.56 per ounce for a total of $20.5 million.
The Company delivered gold to its banks and extinguished all existing Company
gold obligations under the Credit Agreement.
7. DEFERRED FINANCING COSTS
In conjunction with the Company's refinancing of its prior credit
agreement with certain members of its prior bank group, deferred financing costs
of $516,000 related to the prior credit facility were written off in the second
quarter of fiscal 2003. Costs associated with the second amended and restated
credit facility totaling $1.0 million are being amortized over the term of the
Credit Agreement.
8. DILUTIVE SHARES THAT WERE OUTSTANDING DURING THE PERIOD
The following table summarizes the reconciliation of the numerators and
denominators for the basic and diluted EPS computations at July 31, 2003 and
2002.
Three months ended Six Months Ended
July 31, 2003 July 31, 2002 July 31, 2003 July 31, 2002
------------- ------------- ------------- -------------
(in thousands, except per share amounts)
Net income (loss) $ (2,871) $ 114 $ (5,619) $ 483
Weighted average shares for
basic EPS 14,215 14,807 14,210 14,719
Incremental shares upon
conversions:
Stock options --- 787 --- 757
Weighted average shares for
diluted EPS 14,215 15,594 14,210 15,476
Stock options excluded from the
calculation of diluted earnings
per share due to their
antidilutive effect on the
calculations 1,408 356 2,412 354
9. RECLASSIFICATIONS
Certain Balance Sheet amounts from prior periods were reclassified to
conform to the current year presentation. These reclassifications had no impact
on earnings.
11
10. COMMITMENTS AND CONTINGENCIES
On July 25, 2002, the Company was named a defendant in a wage hour
class action suit filed in California by three former store managers. The case
is based principally upon the allegation that store managers employed by the
Company in California should have been classified as non-exempt for overtime
purposes. In April 2003, the parties reached a preliminary agreement to settle
the matter resulting in a pre-tax charge of $1,000,000, inclusive of the
plaintiffs' attorneys' fees, interest, penalties, administrative costs and other
Company costs. This settlement covers the period from July 25, 1998 through the
date of final settlement approval by the court. The final settlement agreement
was preliminarily approved on August 1, 2003 and notices have been sent to class
members. Class members have until October 17, 2003 to opt out of the settlement.
The Company is unable to predict the outcome or potential exposure of this case,
if any, at this time.
The Company was named a defendant in a wage hour suit filed in
California by a former employee on May 6, 2003. The case is based principally
upon the allegation that the amount of overtime paid to certain California
employees was less than the amount actually earned. The suit asserts a claim for
$1,000,000. The Company intends to defend the case vigorously. The Company is
unable to predict the outcome or potential exposure of this case, if any, at
this time.
The Company has been named as one of 14 defendants in a lawsuit filed
August 13, 2003 in the United States District Court for the Southern District of
New York, styled Capital Factors, Inc. v. Cosmopolitan Gem Corp., et al., No. 03
Civ. 6097. The case is brought by Capital Factors, Inc. ("Capital"), which
provided financing to defendant Cosmopolitan Gem Corp. ("Cosmopolitan"), an
entity with which the Company has certain consignment and other commercial
arrangements. The complaint alleges that Cosmopolitan defrauded Capital into
advancing funds to Cosmopolitan by misrepresenting Cosmopolitan's finances and
the profitability of its operations, and that the Company, along with other
persons and entities, including other jewelry retailers, aided and abetted or
participated in the alleged fraud. The complaint asserts against the Company
claims under common law and the Racketeer Influenced and Corrupt Organizations
Act ("RICO"). Capital seeks aggregate damages from the defendants of
$30,000,000, with trebling under RICO, plus unspecified punitive damages. The
Company intends to defend the lawsuit vigorously. The Company is unable to
predict the outcome or potential exposure of this case, if any, at this time.
Subsequent to the filing of the complaint, the Company was informed by the SEC
that it has opened an informal inquiry into the allegations contained in the
lawsuit and is seeking information from a number of parties, including the
Company, relating to this matter. The Company intends to cooperate fully with
any request for information it may receive from the SEC.
The Company is subject to other claims and litigation in the normal
course of business. It is the opinion of management that additional liabilities,
if any, resulting from these other claims and litigation are not expected to
have a material adverse effect on the Company's financial condition or results
of operations.
12
PART I - FINANCIAL INFORMATION
Item 2 - Management's Discussion and Analysis of Financial Condition and Results
of Operations
Results of Operations for the Three Months Ended July 31, 2003
Net sales for the second quarter of fiscal 2003 decreased $3.5 million,
or 4.6%, to $72.7 million from $76.2 million in the second quarter of fiscal
2002. Comparable store sales decreased $5.3 million, or 7.2%, in the second
quarter of fiscal 2003 from the second quarter of fiscal 2002. Additionally,
there was a sales decrease of $1.3 million related to closed stores. These
decreases were partially offset by sales from new stores of $3.1 million. The
total number of merchandise units sold decreased by approximately 2.5% in the
second quarter of fiscal 2003 from the second quarter of fiscal 2002 while the
average price per merchandise sale declined to $285 in fiscal 2003 from $291 in
fiscal 2002. The slower economy and lower consumer confidence contributed to a
negative impact on sales. Credit sales as a percentage of net sales increased
slightly in the second quarter of fiscal 2003 compared to the second quarter of
fiscal 2002. The Company opened three new stores and closed five stores in the
second quarter of fiscal 2003 increasing the number of stores open to 383 as of
July 31, 2003 compared to 374, as of July 31, 2002.
Gross profit for the second quarter of fiscal 2003 decreased $2.4
million, or 9.2%, to $24.1 million from $26.5 million in the same period in
fiscal 2002. Gross profit as a percentage of net sales decreased to 33.1% in the
second quarter of fiscal 2003 from 34.8% in the second quarter of fiscal 2002.
The reduction in gross profit margin was primarily impacted by store occupancy
expense, including store-closing costs ($0.4 million), which increased at a rate
higher than the increase in sales. Gross profit rate was also negatively
impacted by an increase mix of watch sales which carry a lower margin than
certain other merchandise categories as well as the competitive pricing
environment.
Selling, general and administrative expenses for the second quarter of
fiscal 2003 increased $2.0 million, or 7.9%, to $27.3 million from $25.3 million
in the second quarter of fiscal 2002. As a percentage of net sales, selling,
general and administrative expenses increased to 37.5% in the second quarter of
fiscal 2003 from 33.1% in the second quarter of fiscal 2002. The dollar increase
was primarily related to higher other expense ($1.6 million), higher advertising
expense ($0.4 million) and higher personnel expense ($0.3 million) which were
partially offset by lower credit expense ($0.3 million). The increase in other
expenses is primarily due to the increase in the number of stores and increases
in professional fees, but was partially offset by lower expenses in existing
stores resulting from centralized control of the consumption of supplies and
services along with reductions in negotiated rates for those items. Advertising
expense increased due to a new promotional initiative in 2003. Prior to the
adoption of EITF 02-16, management had expected that the impact of the
promotional initiatives would be offset by advertising co-op allowances. Payroll
costs increased primarily due to the increased number of stores, but were offset
by measures taken to reduce payroll hours and control labor rates in existing
stores.
Interest expense increased $0.5 million to $1.6 million in the second
quarter of fiscal 2003 from $1.1 million in the second quarter of fiscal 2002,
resulting from the write off of $516,000 of deferred financing fees related to
the refinancing of the prior credit facility with certain members of the prior
bank group and higher average borrowings partially offset by lower average
interest rates.
13
Income taxes decreased $1.9 million resulting in a benefit of $1.8
million in the second quarter of fiscal 2003 compared to an expense of $0.1
million in the second quarter of fiscal 2002, reflecting an effective annual tax
rate of 39.0% and 35.8% in the second quarter of fiscal 2003 and 2002,
respectively. The Company's annual effective tax rate was 38.1% for fiscal 2002.
Net loss of $2.9 million in the second fiscal quarter of 2003, compared
to net income of $0.1 million in the second quarter of fiscal 2002, resulted
from the factors discussed individually above.
Results of Operations for the Six Months Ended July 31, 2003
Net sales for the six months ended July 31, 2003 decreased $9.0
million, or 5.9%, to $141.9 million from $150.8 million in the six months ended
July 31, 2002. Comparable store sales decreased $11.7 million, or 7.9%, in the
first six months of fiscal 2003 from the same period in fiscal 2002. These
decreases were partially offset by sales from new stores of $5.5 million.
Additionally, there were sales decreases of $2.8 million primarily related to
closed stores. The total number of merchandise units sold increased slightly in
the first six months of fiscal 2003 from the first six months of fiscal 2002 and
the average price per merchandise sale declined to $281 in fiscal 2003 from $300
in fiscal 2002. The slower economy and lower consumer confidence had a negative
impact on sales. Credit sales as a percentage of net sales increased slightly in
the first six months of fiscal 2003 compared to the first six months of fiscal
2002. The Company opened 19 new stores and closed six stores in the first six
months of fiscal 2003 increasing the number of stores open to 383 as of July 31,
2003 compared to 374 as of July 31, 2002.
Gross profit for the first six months of fiscal 2003 decreased $6.5
million, or 12.2%, to $47.2 million from $53.8 million compared to the same
period in fiscal 2002. Gross profit as a percentage of sales decreased to 33.2%
from 35.6% in the same period of fiscal 2002. The reduction in gross profit
margin was primarily impacted by store occupancy expense, including
store-closing costs ($0.4 million), which increased at a rate higher than the
increase in sales. Gross profit rate was also negatively impacted by an increase
mix of watch sales which carry a lower margin than certain other merchandise
categories as well as the competitive pricing environment.
Selling, general and administrative expenses for the six months ended
increased $3.1 million, or 6.0% to $53.9 million from $50.9 million for the
first six months of fiscal 2002. As a percentage of net sales, selling, general
and administrative expenses increased to 38.0% in the first half of fiscal 2003
from 33.7% in the first half of fiscal 2002. The dollar increase was primarily
related to higher other expense ($1.9 million), higher advertising expense ($0.8
million) and higher personnel expense ($0.8 million), which were partially
offset by lower credit expense ($0.4 million). The increase in other expenses is
primarily due to the increase in the number of stores and increases in
professional fees, but was partially offset by lower expenses in existing stores
resulting from centralized control of the consumption of supplies and services
along with reductions in negotiated rates for those items. Advertising expense
increased due to a new promotional initiative in 2003. Prior to the adoption of
EITF 02-16, management had expected that the impact of the promotional
initiatives would be offset by advertising co-op allowances. Payroll costs
increased primarily due to the increased number of stores, but were offset by
measures taken to reduce payroll hours and control labor rates in existing
stores.
Interest expense increased $0.4 million to $2.5 million in the first
six months of fiscal 2003 from $2.1 million in the first six months of fiscal
14
2002, resulting from the write-off of $516,000 of deferred financing fees
related to the refinancing of the prior credit facility with certain members of
the prior bank group and higher average borrowings partially offset by average
lower interest rates.
Income taxes decreased $3.9 million resulting in a benefit of $3.6
million in the first half of fiscal 2003 compared to an expense of $0.3 million
in the prior period, reflecting an effective annual tax rate of 39.0% and 35.7%,
respectively. The Company's annual effective tax rate was 38.1% for fiscal 2002.
Net loss of $5.6 million in the six months ended July 31, 2003,
compared to net income of $0.5 million in the six months ended July 31, 2002,
resulted from the factors discussed individually above.
Liquidity and Capital Resources
The Company's cash requirements consist principally of funding
inventory for existing stores, capital expenditures and working capital
associated with the Company's new stores. The Company's primary sources of
liquidity have been cash flow from operations and bank borrowings under the
Company's revolver.
The Company's inventory levels and working capital requirements have
historically been highest in advance of the Christmas season. The Company has
funded these seasonal working capital needs through borrowings under the
Company's revolver and increases in trade payables and accrued expenses. As of
July 31, 2003, the maximum availability under the new credit facility was $125.0
million based on the borrowing base formula, and the Company had $86.4 million
of outstanding borrowings under this credit facility.
The Company's cash flow provided by operating activities was $10.2
million in the first six months of 2003 compared to $17.9 million used in
operating activities in the first six months of fiscal 2002. Increases in
accounts payable ($21.4 million), accrued liabilities ($2.6 million),
depreciation and amortization ($6.0 million) and decreased accounts receivable
($1.3 million) were partially offset by increases in merchandise inventories
($8.3 million), decreased income tax payable ($3.3 million), increased prepaid
income tax ($4.5 million) and loss from operations ($5.6 million). The increase
in accounts payable in fiscal 2003 reflects the impact of timing of vendor
payments resulting from the Company's strategy to pay certain accounts payable
in advance in fiscal 2002 in order to earn additional cash discounts. The
increase in merchandise inventories primarily related to inventory for 19 new
store openings completed in the first six months of fiscal 2003.
The Company utilized cash in the first six months of 2003 primarily to
pay down revolver borrowings ($8.1 million), fund capital expenditures ($8.1
million) related to the opening of 19 new stores in the first six months of
2003, to repay the term loan ($4.5 million) and to pay financing costs ($1.0
million) associated with the second amended and restated credit facility.
Management expects that cash flow from operating activities and funds
available under its revolving credit facility should be sufficient to support
the Company's current new store expansion program and seasonal working capital
needs for the foreseeable future.
15
Inflation
Management believes that inflation generally has not had a material
effect on the Company's results of operations.
Accounting for Costs Associated with Exit or Disposal Activities
In June 2002, the Financial Accounting Standards Board issued Statement
No. 146 ("SFAS 146"), "Accounting for Costs Associated with Exit or Disposal
Activities." SFAS 146 requires that costs associated with disposal or exit
activities after December 31, 2002 be recorded at fair value in the period the
liability is incurred. The Company adopted SFAS 146 effective January 1, 2003,
which had no significant impact on its financial statements.
Accounting by a Customer for Certain Consideration Received from a Vendor
Merchandise inventories are stated principally at the lower of weighted
average cost or market. Cost is reduced to reflect certain allowances and
discounts received from vendors. Periodic payments from vendors in the form of
buy downs, volume or other purchase discounts that are evidenced by signed
agreements are reflected in the carrying value of the inventory when earned and
as a component of cost of sales, buying and occupancy as the merchandise is
sold. To the extent the Company's agreements with vendors specify co-op
advertising, the Company has historically classified such credits as a reduction
to advertising expense in selling, general and administrative expenses. Emerging
Issues Task Force Issue No. 02-16, "Accounting by a Customer (Including a
Reseller) for Certain Consideration Received from a Vendor" ("EITF 02-16"),
which was effective for all arrangements entered into after December 31, 2002,
requires vendor allowances to be classified as a reduction to inventory cost
unless evidence exists supporting an alternative classification. The Company has
recorded such vendor allowances earned pursuant to its 2003 vendor trade
agreements as a reduction of inventory cost. The total amount of these
allowances earned as of July 31, 2003 and 2002 was approximately $2,115,000 and
$1,531,000, respectively.
Accounting for Stock-Based Compensation
The Financial Accounting Standards Board issued Statement No. 148
("SFAS 148"), "Accounting for Stock-Based Compensation-Transition and
Disclosure," during 2002. SFAS 148 amends Statement No. 123, "Accounting for
Stock-Based Compensation," to provide alternative methods of transition for a
voluntary change to the fair value based method of accounting for stock-based
employee compensation and amends the disclosure requirements to require
prominent disclosures in both annual and interim financial statements about the
method of accounting for stock-based employee compensation and the effect of the
method used on reported results. The Company adopted the disclosure requirements
of SFAS 148 as of January 31, 2003.
16
Accounting for Guarantees
In November 2002, the Financial Standards Accounting Board issued FASB
Interpretation No. 45 ("FIN 45"), "Guarantor's Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of
Others," an interpretation of FASB Statements No. 5, 57 and 107 and rescission
of FASB Interpretation No. 34. The Company has adopted the guidance of FIN 45
and has reflected the required disclosures in its financial statements
commencing with the financial statements for the year ended January 31, 2003.
Item 3 - Quantitative and Qualitative Disclosure About Market Risk
Interest Rate Risk
The Company's exposure to changes in interest rates relates primarily
to its borrowing activities to fund business operations. The Company principally
uses floating rate borrowings under its revolving credit and term loan
facilities. The Company's private label credit card provider charges the Company
varying discount rates for its customer's credit program purchases. These
discount rates are sensitive to significant changes in interest rates. The
Company currently does not use derivative financial instruments to protect
itself from fluctuations in interest rates.
Item 4. Controls and Procedures
As of July 31, 2003, the Company's management, including our Chief
Executive Officer and our Chief Financial Officer, carried out an evaluation of
the effectiveness of the design and operation of the Company's disclosure
controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) promulgated
under the Securities Exchange Act of 1934, as amended). Based upon that
evaluation, the Company's Chief Executive Officer and Chief Financial Officer
concluded that the Company's disclosure controls and procedures are effective in
timely alerting them to material information required to be included in the
Company's periodic SEC filings. There has been no change in the Company's
internal control over financial reporting that occurred during the Company's
fiscal quarter ended July 31, 2003 that has materially affected, or is
reasonably likely to materially affect, the Company's internal control over
financial reporting.
17
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
On July 25, 2002, the Company was named a defendant in a wage hour
class action suit filed in California by three former store managers. The case
is based principally upon the allegation that store managers employed by the
Company in California should have been classified as non-exempt for overtime
purposes. In April 2003, the parties reached a preliminary agreement to settle
the matter resulting in a pre-tax charge of $1,000,000, inclusive of the
plaintiffs' attorneys' fees, interest, penalties, administrative costs and other
Company costs. This settlement covers the period from July 25, 1998 through the
date of final settlement approval by the court. The final settlement agreement
was preliminarily approved on August 1, 2003 and notices have been sent to class
members. Class members have until October 17, 2003 to opt out of the settlement.
The Company was named a defendant in a wage hour suit filed in
California by a former employee on May 6, 2003. The case is based principally
upon the allegation that the amount of overtime paid to certain California
employees was less than the amount actually earned. The suit asserts a claim for
$1,000,000. The Company intends to defend the case vigorously. The Company is
unable to predict the outcome or potential exposure of this case, if any, at
this time.
The Company has been named as one of 14 defendants in a lawsuit filed
August 13, 2003 in the United States District Court for the Southern District of
New York, styled Capital Factors, Inc. v. Cosmopolitan Gem Corp., et al., No. 03
Civ. 6097. The case is brought by Capital Factors, Inc. ("Capital"), which
provided financing to defendant Cosmopolitan Gem Corp. ("Cosmopolitan"), an
entity with which the Company has certain consignment and other commercial
arrangements. The complaint alleges that Cosmopolitan defrauded Capital into
advancing funds to Cosmopolitan by misrepresenting Cosmopolitan's finances and
the profitability of its operations, and that the Company, along with other
persons and entities, including other jewelry retailers, aided and abetted or
participated in the alleged fraud. The complaint asserts against the Company
claims under common law and the Racketeer Influenced and Corrupt Organizations
Act ("RICO"). Capital seeks aggregate damages from the defendants of
$30,000,000, with trebling under RICO, plus unspecified punitive damages. The
Company intends to defend the lawsuit vigorously. The Company is unable to
predict the outcome or potential exposure of this case, if any, at this time.
Subsequent to the filing of the complaint, the Company was informed by the SEC
that it has opened an informal inquiry into the allegations contained in the
lawsuit and is seeking information from a number of parties, including the
Company, relating to this matter. The Company intends to cooperate fully with
any request for information it may receive from the SEC.
The Company is subject to other claims and litigation in the normal
course of business. It is the opinion of management that additional liabilities,
if any, resulting from these other claims and litigation are not expected to
have a material adverse effect on the Company's financial condition or results
of operations.
Item 4. Submission of Matters to a Vote of Security Holders
(a) The Company held its annual meeting of stockholders on June 25,
2003.
(b) No answer required.
18
(c) Proposal 1 involved the election of three directors to serve until
the 2006 annual meeting. Those directors and the voting results were
as follows:
NOMINEE FOR AUTHORITY WITHHELD
- --------------------------------------------------------------------------------
Hugh M. Patinkin 13,307,109 277,210
- --------------------------------------------------------------------------------
Norman J. Patinkin 10,333,243 3,251,076
- --------------------------------------------------------------------------------
Daniel H. Levy 13,206,056 378,263
- --------------------------------------------------------------------------------
There were no votes cast against any nominee, and there were no broker non-votes
with respect to any nominee.
(d) Not applicable.
19
Item 5 - Other Information
Forward-Looking Statements
This report contains certain forward-looking statements (as such term
is defined in Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934) and information relating to the Company that
are based on the current beliefs of management of the Company as well as
assumptions made by and information currently available to management including
statements related to the markets for our products, general trends and trends in
our operations or financial results, plans, expectations, estimates and beliefs.
In addition, when used in this report, the words "anticipate," "believe,"
"estimate," "expect," "intend," "plan," "predict" and similar expressions and
their variants, as they relate to the Company or our management, may identify
forward-looking statements. Such statements reflect our judgment as of the date
of this report with respect to future events, the outcome of which is subject to
certain risks, including the factors described below, which may have a
significant impact on our business, operating results or financial condition.
Investors are cautioned that these forward-looking statements are inherently
uncertain. Should one or more of these risks or uncertainties materialize, or
should underlying assumptions prove incorrect, actual results or outcomes may
vary materially from those described herein. The Company undertakes no
obligation to update forward-looking statements. The following factors, among
others, may impact forward-looking statements contained in this report: (1) a
change in economic conditions or the financial markets, acts of terrorism, armed
conflict, or other factors which negatively impacts the retail sales environment
and/or reduce discretionary spending on goods such as jewelry; (2) reduced
levels of mall traffic caused by economic conditions, a change in the financial
markets, acts of terrorism, armed conflict or other factors; (3) our ability to
execute our business strategy and the related effects on comparable store sales
and other results; (4) the extent and results of our store expansion strategy
and associated occupancy costs, and access to funds for new store openings; (5)
the high degree of fourth quarter seasonality of our business; (6) the extent
and success of our marketing and promotional programs; (7) personnel costs and
the extent to which we are able to retain and attract key personnel; (8) the
effects of competition; (9) the availability and cost of consumer credit; (10)
relationships with suppliers; (11) our ability to maintain adequate information
systems capacity and infrastructure; (12) our leverage and cost of funds and
changes in interest rates that may increase such costs; (13) our ability to
maintain adequate loss prevention measures; (14) fluctuations in raw material
prices, including diamond, gem and gold prices; (15) the extent and results of
our E-commerce strategies and those of others; (16) the potential effect of
power crises on the Company's operations including blackouts affecting our
stores and the malls in which they are located and the ability of our suppliers
to produce and deliver inventory; (17) the potential adverse impact of new virus
and other computer security programs; (18) regulation affecting the industry
generally, including regulation of marketing practices; (19) the successful
integration of acquired locations and assets into our existing operations; (20)
business interruption or a negative impact on the business as a result of events
beyond the control of the Company, including natural disaster, acts of God,
actions or decrees of governmental bodies and acts of war or terrorism; and (21)
the risk factors identified from time to time in our filings with the SEC.
20
Item 6 - Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit Number Description
-------------- -----------
10.1 Second Amended and Restated Revolving Credit and Gold Consignment Agreement, dated as of July 29,
2003, among the Company, the Banks listed therein, LaSalle Bank National Association, ABN AMRO Bank
N.V., and JP Morgan Chase Bank
31.1 Certification of the Chief Executive Officer pursuant to Rule 13a-14(a) of the Securities Exchange
Act of 1934
31.2 Certification of the Chief Financial Officer pursuant to Rule 13a-14(a) of the Securities Exchange
Act of 1934
32.1 Certification of Chief Executive Officer pursuant to 18 United States Code Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2 Certification of Chief Financial Officer pursuant to 18 United States Code Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
(b) Reports on Form 8-K
On May 8, 2003, the Company filed a Current Report on
Form 8-K with the SEC, to furnish, under Item 12 of that form,
a press release announcing sales for the first quarter ended
April 30, 2003.
On May 28, 2003, the Company filed a Current Report
on Form 8-K with the SEC, to furnish, under Item 12 of that
form, a press release reporting financial results for the
first quarter ended April 30, 2003.
21
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
WHITEHALL JEWELLERS, INC.
(Registrant)
Date: September 12, 2003 By: /s/ Jon H. Browne
-------------------------------------
Jon H. Browne
Executive Vice President -
Chief Financial Officer and
Treasurer
(duly authorized officer and
principal financial officer)
22