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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 quarter ended September 28, 2002
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 0-16126
SPIEGEL, INC.
(Exact name of registrant as specified in its charter)
Delaware 36-2593917
-------- ----------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
3500 Lacey Road, Downers Grove, Illinois 60515-5432
---------------------------------------- ----------
(Address of principal executive offices) (Zip Code)
630-986-8800
- --------------------------------------------------------------------------------
(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 [ ] No [X]
APPLICABLE ONLY TO CORPORATE ISSUERS
The number of shares outstanding of each of the issuer's classes of common
stock, as of February 10, 2003 are as follows:
Class A non-voting common stock, $1.00 par value
14,945,144 shares
Class B voting common stock, $1.00 par value
117,009,869 shares
SPIEGEL, INC. AND SUBSIDIARIES
Index to Quarterly Report on Form 10-Q
Thirteen and Thirty-nine Weeks Ended September 28, 2002
PAGE
PART I - FINANCIAL INFORMATION
Item 1 - Financial Statements
Consolidated Balance Sheets,
September 28, 2002, September 29, 2001 and December 29, 2001 4
Consolidated Statements of Operations,
Thirteen and Thirty-nine Weeks Ended September 28, 2002 and
September 29, 2001 5
Consolidated Statements of Cash Flows,
Thirty-nine Weeks Ended September 28, 2002 and September 29, 2001 6
Notes to Consolidated Financial Statements 7-17
Item 2 - Management's Discussion and Analysis of Financial Condition
and Results of Operations 18-29
Item 3 - Quantitative and Qualitative Disclosures About Market Risk 29
Item 4 - Controls and Procedures 30
PART II - OTHER INFORMATION
Item 1 - Legal Proceedings 30
Item 6 - Exhibits and Reports on Form 8-K 31
Signatures 32
Certifications 33
2
EXPLANATORY NOTE
As reported in the Company's Form 8-K filed on February 5, 2003, the
Company's vice president and chief financial officer, James R. Cannataro,
recently resigned from his position. The Company is actively negotiating with,
and expects to announce shortly the appointment of, a new chief financial
officer. The Company's new chief financial officer, once appointed, will need to
perform the review necessary in order to give the certifications required by the
Sarbanes-Oxley Act of 2002.
Consequently, this Form 10-Q for the quarter ended September 28, 2002
is filed by the Company without the CFO certifications required by Sections 302
and 906 of the Sarbanes-Oxley Act of 2002 or the conclusion required of the
Company's chief financial officer in Item 4(a) of Part I of Form 10-Q.
Accordingly, KPMG LLP is unable to complete its review, under Statement on
Auditing Standards No. 71, of the interim financial statements.
As soon as it is available, the Company will file an amendment to its
Quarterly Report on Form 10-Q for the quarter ended September 28, 2002 which is
expected to include: (1) the certifications required by Section 302 and 906 of
the Sarbanes-Oxley Act of 2002 of a chief financial officer and (2) an
indication of whether KPMG LLP has completed its review in accordance with
Statement on Auditing Standards No. 71.
3
Spiegel, Inc. and Subsidiaries
Consolidated Balance Sheets
($000s omitted, except share and per share amounts)
(unaudited) (unaudited)
------------- ------------- -------------
September 28, September 29, December 29,
2002 2001 2001
------------- ------------- -------------
ASSETS
Current assets:
Cash and cash equivalents $ 26,917 $ 49,584 $ 29,528
Receivables, net 545,633 735,110 638,206
Inventories 539,158 607,729 476,903
Prepaid expenses and other current assets 107,077 112,755 88,434
Refundable income taxes 2,185 - 5,798
Deferred income taxes - 36,953 -
Assets of discontinued operations 332,165 469,951 365,767
----------- ----------- -----------
Total current assets 1,553,135 2,012,082 1,604,636
----------- ----------- -----------
Property and equipment, net 316,901 355,385 351,543
Intangible assets, net 135,357 139,848 135,357
Other assets 268,535 143,381 163,812
----------- ----------- -----------
Total assets $2,273,928 $2,650,696 $2,255,348
=========== =========== ===========
LIABILITIES and STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt $1,140,857 $ 30,214 $1,001,857
Related party debt 245,000 - 50,000
Accounts payable and accrued liabilities 386,128 387,597 476,249
Liabilities of discontinued operations 429,507 171,919 512,639
Income taxes payable - 24,245 -
----------- ----------- -----------
Total current liabilities 2,201,492 613,975 2,040,745
----------- ----------- -----------
Long-term debt, excluding current portion - 1,162,643 -
Deferred income taxes - 86,296 -
----------- ----------- -----------
Total liabilities 2,201,492 1,862,914 2,040,745
----------- ----------- -----------
Stockholders' equity:
Class A non-voting common stock, $1.00 par value; authorized
16,000,000 shares; 14,945,144, 14,864,744, and 14,945,144
shares issued and outstanding at September 28, 2002,
September 29, 2001 and December 29, 2001, respectively 14,945 14,945 14,945
Class B voting common stock, $1.00 par value;
authorized 121,500,000 shares;
117,009,869 shares issued and outstanding 117,010 117,010 117,010
Additional paid-in capital 329,489 329,489 329,489
Accumulated other comprehensive loss (12,419) (10,217) (10,162)
Retained earnings (accumulated deficit) (376,589) 336,555 (236,679)
----------- ----------- -----------
Total stockholders' equity 72,436 787,782 214,603
----------- ----------- -----------
Total liabilities and stockholders' equity $2,273,928 $2,650,696 $2,255,348
=========== =========== ===========
See accompanying notes to consolidated financial statements.
4
Spiegel, Inc. and Subsidiaries
Consolidated Statements of Operations
($000s omitted, except share and per share amounts)
(unaudited)
Thirteen Weeks Ended Thirty-nine Weeks Ended
------------------------------------------------------------------
September 28, September 29, September 28, September 29,
2002 2001 2002 2001
------------- ------------- ------------- -------------
Net sales and other revenues:
Net sales $ 472,319 $ 574,736 $ 1,542,825 $ 1,861,140
Finance revenue 22,580 14,260 40,649 69,182
Other revenue 54,933 64,374 189,033 211,158
------------- ------------- ------------- -------------
549,832 653,370 1,772,507 2,141,480
Cost of sales and operating expenses:
Cost of sales, including buying and
occupancy expenses 305,317 378,342 974,011 1,191,484
Selling, general and administrative
expenses 266,667 309,953 890,139 1,000,974
------------- ------------- ------------- -------------
571,984 688,295 1,864,150 2,192,458
Operating loss (22,152) (34,925) (91,643) (50,978)
Interest expense 18,311 14,392 48,289 43,886
------------- ------------- ------------- -------------
Loss from continuing operations before income taxes
and minority interest (40,463) (49,317) (139,932) (94,864)
------------- ------------- ------------- -------------
Income tax benefit - (18,333) - (36,069)
------------- ------------- ------------- -------------
Minority interest in (income) loss of consolidated subsidiary (4) 152 22 605
------------- ------------- ------------- -------------
Loss from continuing operations (40,467) (30,832) (139,910) (58,190)
------------- ------------- ------------- -------------
Earnings from discontinued operations (net of tax expense of
$11,010 and $24,250, respectively) - 18,527 - 38,672
------------- ------------- ------------- -------------
Net loss $ (40,467) $ (12,305) $ (139,910) $ (19,518)
============= ============= ============= =============
Earnings (loss) per common share:
Net earnings (loss) per common share from:
Continuing operations:
Basic and diluted $ (0.31) $ (0.23) $ (1.06) $ (0.44)
Discontinued operations:
Basic and diluted - 0.14 - 0.29
Net loss per common share:
------------- ------------- ------------- -------------
Basic and diluted $ (0.31) $ (0.09) $ (1.06) $ (0.15)
============= ============= ============= =============
Weighted average number of common shares outstanding:
Basic 131,955,013 131,926,286 131,955,013 131,893,049
============= ============= ============= =============
Diluted 131,955,013 131,926,286 131,955,013 131,893,049
============= ============= ============= =============
See accompanying notes to consolidated financial statements.
5
Spiegel, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
($000s omitted)
(unaudited)
Thirty-nine Weeks Ended
-------------------------------
September 28, September 29,
2002 2001
------------- -------------
Cash flows from operating activities:
Loss from continuing operations $(139,910) $ (58,190)
Adjustments to reconcile loss from continuing operations to net
cash used in operating activities:
Loss on sale of fixed assets 488 -
Depreciation and amortization 53,227 50,688
Net pretax losses (gains) on sale of receivables 9,966 (13,834)
Minority interest in loss of consolidated subsidiary (22) (605)
Change in assets and liabilities:
Decrease in receivables, net 82,647 15,221
Increase in inventories (62,177) (45,687)
Increase in prepaid expenses (18,898) (13,069)
Decrease in accounts payable and other accrued liabilities (92,332) (210,638)
Decrease in refundable and payable income taxes, respectively 3,613 (2,392)
---------- ----------
Net cash used in operating activities (163,398) (278,506)
---------- ----------
Cash flows from investing activities:
Net additions to property and equipment (11,600) (52,375)
Proceeds from sale of fixed assets 4,552 -
Net additions to other assets (113,159) (53,442)
---------- ----------
Net cash used in investing activities (120,207) (105,817)
---------- ----------
Cash flows from financing activities:
Issuance of debt 472,000 494,000
Payment of debt (138,000) (95,714)
Payment of dividends - (15,828)
Contribution from minority interest of
consolidated subsidiary 42 4,661
Increase in deferred financing fees (3,535) (343)
Issuance of Class A common shares - 564
---------- ----------
Net cash provided by financing activities 330,507 387,340
---------- ----------
Net cash provided by (used in) discontinued operations (49,530) 11,068
---------- ----------
Effect of exchange rate changes on cash 17 383
---------- ----------
Net change in cash and cash equivalents (2,611) 14,468
Cash and cash equivalents at beginning of period 29,528 35,116
---------- ----------
Cash and cash equivalents at end of period $ 26,917 $ 49,584
========== ==========
Supplemental cash flow information:
Cash paid during the period for:
Interest $ 57,772 $ 53,271
---------- ----------
Income taxes $ 787 $ 22,822
========== ==========
See accompanying notes to consolidated financial statements.
6
Spiegel, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
($000s omitted, except per share amounts)
(unaudited)
(1) Basis of Presentation
The consolidated financial statements included herein are unaudited and have
been prepared from the books and records of the Company in accordance with
accounting principles generally accepted in the United States of America and the
rules and regulations of the Securities and Exchange Commission. All adjustments
(consisting only of normal recurring accruals) which are, in the opinion of
management, necessary for a fair presentation of financial position and
operating results for the interim periods are reflected.
The consolidated financial statements include the accounts of Spiegel, Inc., and
its wholly owned subsidiaries. All significant intercompany transactions and
accounts have been eliminated in consolidation. The Company's private-label
credit card portfolio is serviced by First Consumers National Bank ("FCNB"), a
wholly owned subsidiary. Costs for servicing the private-label portfolio are
charged to the private-label preferred credit card operation by FCNB. Although
the Company plans to discontinue the bankcard business, it plans to remain in
the private-label credit card business. In the future, the Company plans to
issue its private-label credit cards through its merchant operations, rather
than FCNB, but also may consider seeking a third-party credit provider. The
Company is in the process of establishing an in-house capability to service
these receivables or otherwise it will seek to secure a third-party credit
provider. There can be no guarantees that upon sale or liquidation of the
bankcard segment (as discussed in Note 8) the Company will be able to service
the private-label portfolio under a similar cost structure internally or through
a third party credit provider.
These consolidated financial statements should be read in conjunction with the
consolidated financial statements and notes thereto included in the Company's
most recent Annual Report on Form 10-K, which includes consolidated financial
statements for the fiscal year ended December 29, 2001. Due to the seasonality
of the Company's business, results for interim periods are not necessarily
indicative of the results for the year.
The Company was not in compliance with its financial covenants and certain other
covenants contained in its debt agreements and, accordingly, all of the
Company's debt is currently due and payable. The Company has been unable to
successfully negotiate a new credit facility with its lending institutions, to
obtain an amended settlement agreement with MBIA Insurance Corporation ("MBIA"),
or to prevent early amortization events, or "Pay Out Events," from occurring
under its securitization transactions. These matters raise substantial doubt
about the Company's ability to continue as a going concern for a reasonable
period of time. (See Note 9.)
(2) Reclassifications
Certain prior period amounts have been reclassified from amounts previously
reported to conform with the fiscal 2002 presentation. See Note 8.
(3) Intangible Assets
Statement of Financial Accounting Standards (SFAS) No. 142, "Goodwill and Other
Intangible Assets," which supercedes APB Opinion No 17, "Intangible Assets,"
establishes financial accounting and reporting standards for acquired goodwill
and other intangible assets. Under SFAS No. 142, goodwill and other intangible
assets with indefinite lives are not amortized but rather tested for impairment
annually, or more frequently if impairment indicators arise. SFAS No. 142 is
effective for fiscal years beginning after December 15, 2001. The Company's
intangible assets with indefinite lives represent principally goodwill and
trademarks from businesses acquired. Effective at the beginning of fiscal 2002,
the Company ceased amortization of goodwill and trademarks. Upon adoption of
SFAS No. 142, a transitional goodwill impairment test is required. Effective for
fiscal 2002, the Company adopted SFAS No. 142.
7
In the second quarter of fiscal 2002, the Company completed the transitional
goodwill impairment test. The fair value of the reporting unit was estimated
using both a discounted cash flow model and a market comparable approach (as
prescribed in SFAS No. 142), which resulted in no goodwill impairment. If
estimates of fair value or their related assumptions change in the future, the
Company may be required to write-off the impaired portion of the asset, which
could have a material adverse effect on the operating results in the period in
which the write-off occurs.
The carrying amount for each intangible asset class with an indefinite life is
as follows:
September 28, September 29, December 29,
2002 2001 2001
------------- ------------- ------------
Goodwill $ 76,601 $ 79,142 $ 76,601
Trademarks 58,756 60,706 58,756
------------- ------------- ------------
$135,357 $139,848 $135,357
============= ============= ============
The following table reflects net loss and net loss per share as if goodwill and
trademarks were not subject to amortization for the thirteen and thirty-nine
weeks ended September 28, 2002 and September 29, 2001.
Thirteen Weeks Ended Thirty-nine Weeks Ended
----------------------------- -----------------------------
September 28, September 29, September 28, September 29,
2002 2001 2002 2001
------------- ------------- ------------- -------------
Reported net income (loss) $(40,467) $(12,305) $(139,910) $(19,518)
Add back:
Goodwill amortization (net of tax benefit of
$122 and $237, respectively) - 87 - 203
Trademark amortization (net of tax benefit of
$94 and $182, respectively) - 66 - 156
------------- ------------- ------------- -------------
Adjusted net loss $(40,467) $(12,152) $(139,910) $(19,159)
============= ============= ============= =============
Net loss per share (basic and diluted):
Reported net loss $ (0.31) $ (0.09) $ (1.06) $ (0.15)
Goodwill amortization - - - -
Trademark amortization - - - -
------------- ------------- ------------- -------------
Adjusted net loss per share $ (0.31) $ (0.09) $ (1.06) $ (0.15)
============= ============= ============= =============
(4) Derivatives and Hedging Activities
SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities", as
amended, establishes accounting and reporting standards for derivative
instruments and for hedging activities. All derivative financial instruments,
such as interest rate swap agreements and foreign currency forward contracts,
are required to be recorded on the balance sheet at fair value. If the
derivative is designated as a cash flow hedge, the effective portion of changes
in the fair value of the derivative are recorded in other comprehensive loss
(OCL) and are recognized in the income statement when the hedged item affects
earnings. Ineffective portions of changes in the fair value of cash flow hedges
are recognized in earnings.
The adoption of SFAS No. 133 on December 31, 2000, resulted in a cumulative
increase to OCL of $1,566 (net of income tax benefit of $919). The increase to
OCL was attributable to losses of $1,768 (net of income tax benefit of $1,037)
on interest rate swap agreements offset slightly by a $202 gain (net of taxes of
$118) on foreign currency forward contracts. See Note 5.
8
Use of derivative financial instruments:
The Company uses derivative financial instruments principally to manage the risk
that changes in interest rates will affect the amount of its future interest
payments, and to a lesser extent, to manage risk associated with future cash
flows in foreign currencies. The Company does not enter into derivative
financial instruments for any purpose other than cash flow hedging purposes. The
Company does not use derivative financial instruments for trading or other
speculative purposes.
Derivative financial instruments involve elements of market and credit risk not
recognized in the financial statements. The market risk that results from these
instruments relates to changes in interest rates and foreign currency exchange
rates. Credit risk relates to the risk of nonperformance by a counterparty to
one of the Company's derivative transactions. The Company believes that there is
no significant credit risk associated with the potential failure of any
counterparty to perform under the terms of any derivative financial instrument.
Interest rate risk management:
The Company uses a mix of fixed- and variable-rate debt to finance its
operations. Variable-rate debt obligations expose the Company to variability in
interest payments due to changes in interest rates. To limit the variability of
a portion of these interest payments, the Company may enter into
receive-variable, pay-fixed interest rate swaps. Under these interest rate
swaps, the Company receives variable interest rate payments and makes fixed
interest rate payments; thereby creating fixed-rate debt. The variable-rate of
interest received is based on the same terms, including interest rates, notional
amounts and payment schedules, as the hedged interest payments on the
variable-rate debt. These interest rate swaps were determined to be effective;
therefore, changes in fair value are reflected in OCL and not recognized in
earnings until the related interest payments are made.
As of September 28, 2002, the Company is party to interest rate swap agreements,
which are designated as cash flow hedges under SFAS No. 133 and are accounted
for by recording the net interest paid as interest expense on a current basis.
As of September 28, 2002 and September 29, 2001, the cumulative loss in OCL was
$5,619 (net of tax benefit of $1,610) and $3,971 (net of tax benefit of $2,331),
respectively related to the interest rate swap agreements, which are reflected
at fair value of $7,229 and $6,302 in accrued liabilities, respectively. See
Note 5. The Company estimates that $2,657 will be reclassified into earnings
during the twelve months ended September 27, 2003.
At September 28, 2002, the Company had an interest rate swap agreement to hedge
the underlying interest risks on a term loan agreement with Berliner Bank with
effective and termination dates from March 1996 to December 2004. The notional
amount of the interest swap agreement as of September 28, 2002 and September 29,
2001 was $30,000. The fair value of the swap agreement at September 28, 2002 and
September 29, 2001 was $(3,532) and $(3,324), respectively and was estimated by
a financial institution and represents the estimated amount the Company would
pay to terminate the agreement, taking into consideration current interest rates
and risks of the transactions. The counterparties are expected to fully perform
under the terms of the agreements, thereby mitigating the risk from these
transactions.
At September 28, 2002, the Company also had an interest rate swap agreement with
Bank of America to hedge the underlying interest risks on a portion of the
outstanding balance of the revolving credit agreement with an effective and
termination date of July 2003. The notional amount of the interest rate swap
agreement as of September 28, 2002 and September 29, 2001 was $35,000. The fair
value of this swap agreement at September 28, 2002 and September 29, 2001 was
$(3,697) and $(2,978), respectively and was estimated by a financial institution
and represents the estimated amount the Company would pay to terminate the
agreement, taking into consideration current interest rates and risks of the
transactions. The counterparties are expected to fully perform under the terms
of the agreements, thereby mitigating the risk from these transactions.
The Company assesses interest rate cash flow exposure by continually identifying
and monitoring changes in interest rate exposures that may adversely impact
expected future cash flows and by evaluating hedging opportunities. The Company
maintains risk management control systems to monitor interest rate cash flow
risk attributable to both the Company's outstanding and forecasted debt
obligations as well as the
9
Company's offsetting hedge positions. The risk management control systems
involve the use of analytical techniques, including cash flow sensitivity
analysis, to estimate the expected impact of changes in interest rates on the
Company's future cash flows.
Foreign currency risk management:
The Company is subject to foreign currency exchange rate risk related to its
Canadian operations, as well as its joint venture investments in Germany and
Japan. The Company occasionally enters into foreign currency forward contracts
to minimize the variability caused by foreign currency risk related to certain
forecasted semi-annual transactions with the joint ventures that are denominated
in foreign currencies. The principal currency hedged is the Japanese yen.
During the 39-weeks ended September 29, 2001, derivative gains of $202 (net of
taxes of $118) were reclassified to earnings upon settlement of the hedged
transactions. There were no unrealized gains or losses related to foreign
currency forward contracts included in OCL as of September 28, 2002 and
September 29, 2001, respectively. Hedge ineffectiveness, determined in
accordance with SFAS No. 133, had no impact on earnings for the 39-weeks ended
September 28, 2002 and September 29, 2001.
The Company monitors its foreign currency exposures on a continual basis to
maximize the overall effectiveness of its foreign currency hedge positions.
(5) Comprehensive Income (Loss) and Accumulated Other Comprehensive Income
(Loss)
The components of comprehensive income (loss) are as follows:
Thirteen Weeks Ended Thirty-nine Weeks Ended
Sept. 28, Sept. 29, Sept. 28, Sept. 29,
2002 2001 2002 2001
----------- ----------- ----------- -----------
Net income (loss) $(40,467) $(12,305) $(139,910) $(19,518)
Cumulative effect of a change in
accounting for derivative financial
instruments (net of tax benefit of $919) - - - (1,566)
Unrealized gain (loss) on derivatives
(net of tax expense (benefit) of $0,
$(1,044), $282 and $(1,412), respectively) (1,601) (1,778) (2,398) (2,405)
Foreign currency translation adjustment (843) (816) 141 (947)
----------- ----------- ----------- -----------
Comprehensive income (loss) $(42,911) $(14,899) $(142,167) $(24,436)
=========== =========== =========== ===========
The components of accumulated other comprehensive loss are as follows:
Sept. 28, Sept. 29, December 29,
2002 2001 2001
----------- ----------- ------------
Accumulated loss on derivative
financial instruments (net of tax benefit
of $1,610, $2,331 and $1,892, respectively) $ (5,619) $ (3,971) $ (3,221)
Foreign currency translation adjustment (6,800) (6,246) (6,941)
----------- ----------- ------------
$(12,419) $(10,217) $(10,162)
=========== =========== ============
10
(6) Accounts Payable and Accrued Liabilities
Accounts payable and accrued liabilities consist of the following:
September 28, September 29, December 29,
2002 2001 2001
------------- ------------- ------------
Trade payables $ 143,304 $ 146,849 $ 178,496
Gift certificates and other
customer credits 52,653 46,787 60,085
Salaries, wages and employee
benefits 31,553 50,319 55,475
General taxes 63,512 54,736 78,704
Allowance for future returns 18,447 18,711 30,491
Other liabilities 76,659 70,195 72,998
------------- ------------- ------------
Total accounts payable and
accrued liabilities $ 386,128 $ 387,597 $ 476,249
============= ============= ============
(7) Debt, Commitments and Contingencies
Total debt consists of the following:
September 28, September 29, December 29,
2002 2001 2001
------------- ------------- ------------
Revolving credit agreement $ 700,000 $ 740,000 $ 561,000
Otto Versand (GmbH & Co)* senior unsecured loan 145,000 - -
Otto Versand (GmbH & Co)* revolving credit agreement - - 50,000
Term loan agreements, 6.22% to 8.66%
due October 16, 2002 through July 31, 2007 392,857 392,857 392,857
Otto-Spiegel Finance G.m.b.H. & Co. KG
term loan agreement, 4% due December 31, 2002 100,000 - -
Secured notes, 7.25% to 7.35% due November 15, 2002
through November 15, 2005 48,000 60,000 48,000
------------- ------------- ------------
Total debt $ 1,385,857 $ 1,192,857 $ 1,051,857
============= ============= ============
* Otto Versand (GmbH & Co) ("Otto Versand"), a privately held German
partnership, acquired the Company in 1982. In April 1984, Otto Versand
transferred its interest in the Company to its partners and designees. In
October 2002, the German partnership changed its name from Otto Versand (GmbH &
Co) to Otto (GmbH & Co KG), hereinafter referred to as "Otto Versand (GmbH &
Co)" or "Otto Versand".
For the reporting period December 29, 2001 and September 28, 2002, the Company
was not in compliance with its financial and certain other covenants contained
in its debt agreements and, accordingly, all of the Company's debt is currently
due and payable.
The Company has a $750,000 revolving credit agreement with a group of banks. The
commitment is comprised of two components, including a $600,000 long-term
agreement maturing in July 2003 and a $150,000 364-day agreement that matured in
June 2002. Borrowings under the Company's $600,000 long-term revolving credit
agreement were $600,000 at September 28, 2002. Borrowings under the $150,000
364-day agreement were $100,000 at September 28, 2002. The revolving credit
agreement provides for restrictions on the availability of additional financing
if a "material adverse change" in the Company's business has occurred. In
February 2002, the Company determined, with its lending institutions, that a
material adverse change had occurred due to the operating performance
experienced in the fourth quarter of fiscal 2001 and due to the estimated loss
recorded on the sale of the bankcard segment. Accordingly, on
11
February 18, 2002, the borrowing capacity under the revolving credit facility
was capped at $700,000, which represented the Company's borrowings outstanding
on this date.
The Company's revolving and non-affiliate loan agreements provide for
restrictive covenants, including restrictions on the payment of dividends.
Financial covenants contained in these agreements establish minimum levels of
tangible net worth and require the maintenance of certain ratios, including
fixed charge coverage ("Coverage"), total debt to equity ("Leverage"), and
adjusted debt to earnings before interest, taxes, depreciation and amortization,
and rents ("Debt to EBITDAR"). Additionally, these and certain other debt
agreements contain cross default provisions. For the reporting period September
28, 2002, the Company was in violation of its financial covenants and certain of
its other covenants. Accordingly, the financial statements reflect all of the
Company's debt obligations under "current portion of long-term debt." (See Note
9.) The Company is working with its lending group to restructure the existing
credit facilities and to enter into new credit facilities. However, there can be
no assurances that either a new credit facility or alternative sources of
financing will be available to the Company.
In September 2001, the Company entered into a revolving credit agreement with
Otto Versand (GmbH & Co), a related party. The initial availability under this
credit agreement was $75,000. The credit agreement bears interest at a variable
rate based on LIBOR plus a margin, comparable to the Company's other revolving
credit agreements. The initial agreement extended through December 15, 2001. In
November 2001, this revolving credit agreement with Otto Versand (GmbH & Co) was
increased from $75,000 to $100,000 and the maturity date was extended from
December 15, 2001 to June 15, 2002. As of February 2002, the balance outstanding
under the revolving credit agreement with Otto Versand (GmbH & Co) was $100,000.
This obligation was extinguished with the proceeds of new term loans in the
aggregate amount of $100,000 from Otto-Spiegel Finance G.m.b.H. & Co. KG. These
term loans had a maturity date of December 31, 2002, bear interest at a rate of
4% per annum and may be subordinate to the borrowings under any new credit
facility. As of September 28, 2002, related party borrowings consisted of senior
unsecured loans from Otto Versand (GmbH & Co) in the amount of $145,000 and
$100,000 in term loans from Otto-Spiegel Finance G.m.b.H & Co. KG. Interest
expense attributable to the borrowings from Otto Versand (GmbH & Co) and
Otto-Spiegel Finance G.m.b.H & Co. KG during the 13- and 39- weeks ended
September 28, 2002 was $1,879 and $4,422, respectively. As of February 2003, the
related party borrowings outstanding consisted of the $100,000 term loans from
Otto-Spiegel Finance G.m.b.H. & Co. KG and the $60,000 senior unsecured loan
from Otto Versand (GmbH & Co).
The Company maintains a $150,000 letter of credit facility in addition to
off-balance sheet stand-by letters of credit, which are used for the purchase of
inventories. The total letter of credit facility commitments outstanding at
September 28, 2002 and September 29, 2001 were approximately $6,000 and
$119,000, respectively. However, the letter of credit facilities provide
restrictions on the availability of additional financing if a "material adverse
change" in the Company's business has occurred. In February 2002, the Company
determined, with our lending institutions, that a material adverse change had
occurred due to the operating performance experienced in the fourth quarter of
fiscal 2001 and due to the estimated loss recorded on the sale of the bankcard
segment. Accordingly, on February 18, 2002, no additional letter of credit
facilities were available to the Company. In March 2002, the Company entered
into a Vendor Payment Services Agreement with Otto International Hong Kong
(OIHK), a related party. Under the terms of the agreement, the Company has open
account terms with various vendors in certain countries in Asia. The duration of
the agreement is for one year, automatically continuing unless terminated by
either party with three months' written notice. OIHK will pay the vendors the
purchase order value less a fee within seven days of the purchase order receipt.
The Company will repay OIHK for 100% of the purchase order value for goods
purchased by Spiegel and Newport News sixty days from the date of sea shipments
and thirty days from the date of air shipments. Due to the larger volume of
purchases made by Eddie Bauer in comparison to Spiegel and Newport News, the
Company will make weekly advance payments to OIHK for 100% of the purchase order
value of goods purchased by Eddie Bauer prior to shipment. Finally, under the
provisions of the Vendor Payment Services Agreement, OIHK has a lien over each
shipment of goods supplied by vendors on behalf of the Company's merchant
operations. The lien shall arise at the time OIHK makes the vendor payments
relevant to the shipment in question and shall not be satisfied until receipt by
OIHK of the repayment by the Company of the Vendor Payments in question. Such
right provides that, upon the receipt of a notice from the Payment Servicer, the
Merchant or the vendor would be required to tender any goods, for which the
Merchant has not reimbursed OIHK, to OIHK.
Substantially all of the Company's credit card receivables are sold to trusts
that, in turn, sell certificates and notes representing undivided interests in
the trusts to investors. The receivables are sold without recourse. At present,
these trusts have issued six series (each a "Series") of asset backed securities
("ABS"), three of which are backed, on a revolving basis, by private-label
receivables and three of which are backed, also on
12
a revolving basis, by bankcard receivables. MBIA Insurance Corporation ("MBIA")
insures the investors in two of the private-label Series. Certain minimum
performance requirements must be achieved for each of the ABS Series. In the
event that the financial performance of the receivables falls below the required
minimum threshold, an early amortization event ("Pay out Event") will occur. A
"Pay Out Event" would divert monthly excess cash flow remaining after the
payment of debt service and other expenses to repay principal to noteholders on
an accelerated basis, rather than to pay the cash to the Company upon deposit of
new receivables. This excess cash flow would otherwise have been utilized by the
Company to fund its existing operations.
The Company forecasts that, for the reporting period ending on February 28,
2003, it will fail to meet these minimum performance requirements on two of the
Series that are backed by bankcard receivables and potentially on one of the
insured Series backed by private-label receivables. If the two bankcard Series
fail to meet these minimum performance requirements, there would be an automatic
Pay Out Event applicable to these two Series, as well as to the remaining
bankcard Series as a result of cross-default provisions, in early March 2003. In
addition, failure to meet the minimum performance requirements by the one
insured private-label Series would result in an automatic Pay Out Event
applicable to that Series as well as to the uninsured private-label Series in
early March 2003, which would entitle MBIA to declare a Pay Out Event on the
remaining insured private-label Series.
If these Pay Out Events were to occur, the Company may be required, for at least
a period of time, to transfer newly generated receivables from existing
customers to the securitization vehicles for the benefit of the investors,
without receiving payment in cash for these receivables. The Company would not
have sufficient cash or cash flow from operations to make up this shortfall.
Accordingly, the Company would need to obtain a new credit facility or some
other source of financing. Given the Company's current financial condition, it
may be unable to obtain this alternative financing.
On April 4, 2002, MBIA Insurance Corporation ("MBIA") issued a notice asserting
the occurrence of one "Pay Out Event" as a result of a dispute regarding the
proper calculation of the minimum performance requirements and the existence of
circumstances which, if not cured within 45 days following the date of such
notice, would result in the occurrence of a second "Pay Out Event," under the
two insured Series issued by the Spiegel Credit Card Master Note Trust (the
"Trust") and known as Series 2000-A and Series 2001-A. Those Series are
supported by private label credit card receivables originated by FCNB and for
which MBIA insures the payments to noteholders and The Bank of New York acts as
indenture trustee.
The Company and FCNB filed suit and obtained a temporary restraining order
against MBIA and The Bank of New York on April 11, 2002, in the Supreme Court of
the State of New York, County of New York. On May 16, 2002, the Company and MBIA
entered into a settlement agreement pursuant to which, among other things, MBIA
agreed to withdraw its April 4, 2002 letter. In addition, the Company and FCNB
agreed to dismiss the litigation and obtain a backup servicer no later than
December 1, 2002. Finally, the Company agreed to increase the amounts required
to be on deposit in a reserve account established for the benefit of MBIA as
insurer of the notes. Amounts in that reserve account are available to cover the
shortfall in any period, if any, between available collections on the
receivables and the amounts owing in respect of principal and interest on the
notes, prior to a claim being made against the insurer for such amounts.
Pursuant to the agreement, increases in the reserve account will be funded by
diverting excess receivables collections that would otherwise be available to
the Company; provided that during the first seven months following the date of
the settlement agreement such diversions were limited to a maximum of $9,000 per
month and an incremental $60,000 in the aggregate for the seven-month period.
This diversion of excess cash is measured based upon certain receivable
portfolio performance criteria. Accordingly, the actual reserve requirements may
differ from the dollar amounts disclosed above based upon actual receivable
portfolio performance. The agreement with MBIA contains other requirements,
including the requirement to file the Company's and FCNB's 2001 financial
statements by December 6, 2002. In addition, the Company agreed to appoint a
backup servicer for the servicing of its receivable portfolio and to execute a
backup servicing agreement by December 1, 2002. The Company is not presently in
compliance with the requirements of the MBIA agreement and is currently
negotiating an amendment to the MBIA agreement to extend the date of these
requirements. There can be no guarantees that MBIA will
13
not exercise its remedies under the settlement agreement, which would include
declaring the occurrence of a "Pay Out Event", as described above. See Note 9.
On May 15, 2002, FCNB entered into an agreement with the Office of the
Comptroller of the Currency ("OCC"), the primary federal regulator of FCNB. The
agreement calls for FCNB to comply with certain requirements. The agreement,
among other things, (i) contains restrictions on transactions between the bank
and its affiliates and requires the bank to complete a review of all existing
agreements with affiliated companies, and to make necessary and appropriate
changes; (ii) requires the bank to obtain an aggregate of $198,000 in
guarantees, which guarantees have been provided through the Company's majority
shareholder; (iii) restricts the bank's ability to accept, renew or rollover
deposits; (iv) places restrictions on its ability to issue new credit cards and
make credit line increases; (v) requires the bank within 30 days of the
agreement to file with the OCC a disposition plan to either sell, merge or
liquidate the bank; (vi) requires the bank to maintain sufficient assets to meet
daily liquidity requirements; (vii) requires the bank to complete a
comprehensive risk management assessment; (viii) establishes minimum capital
levels for the bank; (ix) provides for increased oversight by and reporting to
the OCC; and (x) provides for the maintenance of certain asset growth
restrictions.
In October 2002, the Company submitted a revised disposition plan to the OCC.
The disposition plan generally provides for the sale or liquidation of the
bankcard portfolio by April 30, 2003 and a liquidation of FCNB thereafter. On
November 27, 2002, the OCC approved the disposition plan. Under the terms of
this plan, if FCNB did not receive an acceptable offer to buy the bankcard
portfolio in January 2003, it was required to implement plans to liquidate its
bankcard portfolio. FCNB, in addition to its own bankcard operations, issues
substantially all of the Company's private-label credit cards and services the
related receivables, including securitized receivables.
On February 14, 2003, the Company received a letter from the OCC requiring FCNB
to immediately begin the process of liquidating the bankcard portfolio and
indicating the steps it must take to do so. The OCC letter requires FCNB to: 1)
notify the trustee for each of the Company's bankcard Series that FCNB will
either amend the relevant securitization documents to replace FCNB with a
successor servicer and administrator or resign as servicer and administrator at
the earliest date permissible under the agreements, 2) cease all credit card
solicitations for its bankcards, 3) cease accepting new bankcard applications
and credit lines and offering credit line increases to any existing bankcard
account, 4) notify cardholders that FCNB will no longer honor bankcard charges
on or before March 31, 2003, and 5) cease accepting new charges on existing
bankcard accounts on or before April 1, 2003.
The Company has complied and continues to comply with the OCC requirements set
forth in its letter of February 14, 2003. The Company also continues to have
discussions with potential acquirers for the sale of the bankcard business. If
the Company is not able to sell the bankcard business before Apri1 1, 2003, a
Pay Out Event will occur with respect to each bankcard Series as a result of the
OCC's requirements that FCNB cease accepting new charges on existing bankcard
accounts.
In the third quarter of fiscal 2002, the Company was informed by one of the
rating agencies that it may downgrade the rating of the First Consumers Credit
Card Master Note Trust Series 2001-VFN Class A Notes and the Spiegel Credit Card
Master Note Trust Series 2001-VFN Class A Notes. Under the provisions of the
existing securitization agreements, a rating agency downgrade would result in a
"Pay Out Event" of the receivable securitizations. In order to avoid such a "Pay
Out Event", the Company agreed to increase its percentage of required collateral
accordingly. This had the impact of increasing the receivables retained by the
Company. The financing of these additional receivables will be generated from
existing cash flows from operations and through the Company's existing credit
facilities, if available.
In December 2002 and January 2003, four lawsuits were filed in the United States
District Court for the Northern District of Illinois, Eastern Division, against
the Company and certain current and former officers alleging violations of
Section 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5
promulgated thereunder. The plaintiffs purport to represent shareholders who
purchased the Company's common stock between April 24, 2001 and April 19, 2002.
The Company believes these claims lack merit and intends to defend against them
vigorously.
14
The staff of the Securities and Exchange Commission has commenced an informal
investigation into the conduct of the Company and its officers and directors,
which focuses on the Company's compliance with its disclosure obligations under
the federal securities laws. For further information, see Item 1 of Part II of
this Report.
The Company is routinely involved in a number of other legal proceedings and
claims, which cover a wide range of matters. In the opinion of management, these
other legal matters are not expected to have any material adverse effect on the
consolidated financial position or results of operations of the Company.
(8) Discontinued Operations
Historically, the operating results of the Company were reported for two
segments: merchandising and bankcard. The merchandising segment included an
aggregation of the Company's three merchant divisions and the private-label
preferred credit operation. The bankcard segment included the bankcard
operations of FCNB, the Company's special-purpose bank, and Financial Services
Acceptance Corporation (FSAC). In the fourth quarter of fiscal 2001, the Company
formalized a plan to sell the bankcard segment. The Company continues to have
discussions with potential acquirers for the sale of the bankcard business.
However, there can be no guarantees that the outcome of these discussions will
result in the sale of the bankcard business in the time permitted by the OCC. To
the extent that the Company is unable to sell the bankcard segment, this segment
will be liquidated as part of the liquidation of FCNB in its entirety, as
required under an agreement with the OCC.
The disposition of the bankcard segment was accounted for in fiscal 2001 in
accordance with APB No. 30, "Reporting the Results of Operations-Reporting the
Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and
Infrequently Occurring Events and Transactions." Accordingly, results of this
business have been classified as discontinued operations for all periods
presented. Interest expense was allocated to discontinued operations based upon
debt that could be specifically attributed to the bankcard segment. Effective at
the beginning of fiscal 2002, the Company adopted SFAS No. 144, "Accounting for
the Impairment and Disposal of Long-Lived Assets." Upon adoption, the Company
changed the presentation of net assets of discontinued operations for all
periods presented.
As a result of the Company's plan to sell the bankcard segment, the remaining
business segment is the merchandising segment, which includes the private-label
preferred credit card operations related to the sale of the Company's
merchandise. The merchandising segment is reflected in the Company's
Consolidated Financial Statements as continuing operations.
Discontinued operations include management's best estimates of the amounts to be
realized on the sale of the bankcard segment. In the fourth quarter of fiscal
2001, the Company recorded an estimated loss on disposal of the bankcard segment
of $319,297. This charge includes an estimate of severance and fees of $8,000
and estimated losses from the bankcard segment of $40,000 from the measurement
date to the disposal date. If the Company were to sell the bankcard business for
less than these estimates or were required to liquidate the bankcard portfolio,
the Company will likely have to increase its estimated loss on the disposal of
the bankcard segment. Earnings (losses) for the bankcard segment for the 13 and
39-weeks ending September 28, 2002 totaled $4,762 and $(6,979), which were
recorded against the Company's loss on disposal accrual.
15
Assets and liabilities of the discontinued operations are as follows:
September 28, September 29, December 29,
2002 2001 2001
------------- ------------- ------------
Current assets of discontinued operations $267,305 $419,805 $ 314,160
Long-term assets 64,860 50,146 51,607
--------- -------- ----------
Assets of discontinued operations 332,165 469,951 365,767
--------- -------- ----------
Current liabilities (including estimated loss
on disposal) 429,507 139,690 512,639
Long-term liabilities - 32,229 -
--------- -------- ----------
Liabilities of discontinued operations 429,507 171,919 512,639
--------- -------- ----------
Total net assets (liabilities) of discontinued
operations $(97,342) $298,032 $(146,872)
========= ======== ==========
(9) Going Concern
The Company's revolving and non-affiliate loan agreements contain covenants,
including restrictions on the payment of dividends and financial covenants that
require the Company to maintain minimum levels of tangible net worth and certain
ratios, including fixed charge coverage ("Coverage"), total debt to equity
("Leverage"), and adjusted debt to earnings before interest, taxes, depreciation
and amortization, and rents ("Debt to EBITDAR"). For the reporting periods
December 29, 2001, and September 28, 2002, the Company was in violation of its
financial covenants and certain other covenants contained in the Company's debt
agreements and, accordingly, all of the Company's debt is currently due and
payable. The Company is working with its lending group to restructure the
existing credit facilities and to enter into new credit facilities. However,
there can be no assurances that either a new credit facility or alternative
sources of financing will be available to the Company.
In addition, the Company has not complied with the provisions of the MBIA
settlement agreement as of February 2003. The Company is working with MBIA to
obtain amended settlement agreements. However, there can be no guarantees that
MBIA will not exercise its remedies under the settlement agreement, which would
include a "Pay Out Event".
Finally, the Company has forecasted that, for the reporting period ending
February 28, 2003, it will not meet certain minimum performance requirements on
two of its six Series of ABS securities which relate to bankcard receivables
sold, and potentially on one of the insured Series, which relate to
private-label receivables sold. If these three Series fail to meet these minimum
performance requirements, there would be an automatic Pay Out Event, either
directly or as a result of cross-default provisions, on five of the six Series
and MBIA would be entitled to declare a Pay Out Event on the sixth Series.
The Company was not in compliance with its financial and certain other covenants
contained in its debt agreements and, accordingly, all of the Company's debt is
currently due and payable. The Company has been unable to successfully negotiate
a new credit facility with its lending institutions, to obtain an amended
settlement agreement with MBIA Insurance Corporation ("MBIA"), or to prevent Pay
Out Events from occurring under its securitization transactions. These matters,
among others, raise substantial doubt about the Company's ability to continue as
a going concern for a reasonable period of time. The consolidated financial
statements do not include any adjustments that might result from the outcome of
this uncertainty. In addition, the Company is currently assessing the effect on
its financial statements of a Pay Out Event with respect to one or more of its
private-label Series. While it is likely that any such Pay Out Event would have
a material adverse effect on the Company's financial condition and results of
operations, the Company is unable, at this time, to quantify the effect on the
Company's financial statements.
The Company has taken actions to improve its cash flow through effective working
capital management, most notably the management of inventory levels across each
business unit. In addition, the Company is
16
developing strategies to enhance its marketing and merchandising initiatives
while at the same time lowering its cost structure. Finally, the Company
continues to have discussions with its lending institutions and its majority
shareholder regarding additional financing. There can be no assurances that any
or all of these matters will be resolved satisfactorily, or if resolved
satisfactorily, will provide resources sufficient to sustain the Company's
operations. As a result, the Company may not have sufficient funds to finance
its operations beginning in the near future and thereafter. In light of the
Company's existing operating and financing challenges, the Company is exploring
a range of strategic options, in conjunction with its ongoing discussions with
lenders and other parties, to restructure its debt obligations and
securitization arrangements and provide for the Company's continued operations.
17
Item 2 - Management's Discussion and Analysis of Financial Condition and Results
of Operations ($000s omitted, except per share amounts)
RESULTS OF OPERATIONS
The Company, like other retailers, experiences seasonal fluctuations in its
revenues and net earnings. Historically, a significant amount of the Company's
net sales and a majority of its net earnings have been realized during the
fourth quarter. Accordingly, the results for the thirteen and thirty-nine week
periods ended September 28, 2002 are not necessarily indicative of the results
to be expected for the entire year.
The following table sets forth the statement of operations data for the thirteen
and thirty-nine weeks ended September 28, 2002 and September 29, 2001. Certain
prior year amounts have been reclassified to conform with the fiscal 2002
presentation.
Thirteen Weeks Thirty-nine Weeks
Ended Ended
Sept. 28, Sept. 29, Sept. 28, Sept. 29,
($000's omitted) 2002 2001 2002 2001
- -------------------------------------------------------- --------- ---------- ----------
Net sales $472,319 $574,736 $1,542,825 $1,861,140
Finance revenue 22,580 14,260 40,649 69,182
Other revenue 54,933 64,374 189,033 211,158
Cost of sales
(including buying and occupancy expenses) 305,317 378,342 974,011 1,191,484
Selling, general and administrative expenses 266,667 309,953 890,139 1,000,974
Operating loss (22,152) (34,925) (91,643) (50,978)
Interest expense 18,311 14,392 48,289 43,886
Income tax benefit - (18,333) - (36,069)
Minority interest in (income) loss
of consolidated subsidiary (4) 152 22 605
Loss from continuing operations (40,467) (30,832) (139,910) (58,190)
Earnings from discontinued operations
(net of tax expense of $6,353 and $24,250,
respectively) - 18,527 - 38,672
Net loss $(40,467) $(12,305) $ (139,910) $ (19,518)
Other information:
Gross profit margin (% of total net sales) 35.4% 34.2% 36.9% 36.0%
SG&A expenses (% of total revenue) 48.5% 47.4% 50.2% 46.7%
Comparison of the 13 Weeks Ended September 28, 2002 and September 29, 2001
- --------------------------------------------------------------------------
Net sales: Net sales decreased by $102,417 or 17.8% to $472,319 for the 13 weeks
ended September 28, 2002 from net sales of $574,736 for the 13 weeks ended
September 29, 2001. The decrease in net sales was driven by lower catalog and
retail net sales, partially offset by a two percent increase in e-commerce net
sales. Weak customer demand for the product offer, as well as, lower catalog
circulation and less promotional activity, were primary reasons for the sales
decrease in the current year period. Eddie Bauer's comparable store sales
decreased 13% for the 13-week period ended September 28, 2002. In addition,
third quarter sales results for the merchants were negatively impacted by more
stringent credit-granting measures taken in the Company's private-label
preferred credit card operation. Approximately 31% of the Company's net sales
for the 13 weeks ended September 28, 2002 were made with the Company's
private-label credit cards. If one or more Pay Out Events occur under the
Company's private-label securitization arrangements, the Company's net sales may
decline substantially if the Company were required to significantly reduce its
use of private-label credit cards.
Finance revenue: Finance revenue increased by $8,320 or 58.4% to $22,580 for the
13 weeks ended September 28, 2002 from $14,260 for the 13 weeks ended September
29, 2001. This was driven by increased excess cash flow generated from the trust
due to increased credit fee revenue and lower net
18
charge-offs versus the comparable period last year. If one or more Payout Events
occur under the Company's securitization arrangements, the Company's finance
revenues would decline sharply.
Other revenue: Other revenue decreased by $9,441 or 14.7% to $54,933 for the 13
weeks ended September 28, 2002 from $64,374 for the 13 weeks ended September 29,
2001. This decrease resulted from lower delivery income at each of the merchants
driven by lower order volume.
Cost of sales: Cost of sales decreased by $73,025 or 19.3% to $305,317 for the
13 weeks ended September 28, 2002, from $378,342 for the 13 weeks ended
September 29, 2001. The dollar decrease in cost of sales was primarily due to
the decline in net sales. In addition, product sourcing initiatives and lower
markdowns resulted in a gross profit margin improvement of 120 basis points in
comparison to the prior year period.
Selling, general and administrative expenses ("SG&A"): SG&A expenses decreased
by $43,286 or 14.0%, to $266,667 for the 13 weeks ended September 28, 2002 from
$309,953 for the 13 weeks ended September 29, 2001. As a percentage of total
revenue, SG&A expenses increased to 48.5% for the 13 weeks ended September 28,
2002 from 47.4% in the comparable period of the prior year. This increase was
driven by lower advertising productivity at the merchant companies, which
resulted in higher advertising costs as a percentage of net sales. Lower
operating expenses, including payroll and benefit costs, partially offset the
unfavorable advertising productivity.
Operating loss: The Company recorded an operating loss of $22,152 for the 13
weeks ended September 28, 2002 compared to an operating loss of $34,925 for the
comparable period of the prior year. The improvement in the current year was
driven by gross margin improvements at the retail stores and lower operating
expenses.
Interest expense: Interest expense totaled $18,311 and $14,392 for the 13 weeks
ended September 28, 2002 and September 29, 2001, respectively. Increased average
debt levels resulted in higher interest expense in comparison to the prior year
period, despite lower borrowing rates on the Company's debt obligations.
Income tax benefit: The Company has recorded no tax benefits associated with its
pretax losses incurred for the 13-week period ending September 28, 2002 due to
substantial doubt about the Company's ability to continue as a going concern
(See Note 9 to the consolidated financial statements). The consolidated
effective tax rate for the 13-week period ended September 29, 2001 was 37.2%.
The Company assesses its effective tax rate on a continuous basis.
Comparison of the 39 Weeks Ended September 28, 2002 and September 29, 2001
- --------------------------------------------------------------------------
Net sales: Net sales decreased by $318,315 or 17.1% to $1,542,825 for the 39
weeks ended September 28, 2002 from net sales of $1,861,140 for the 39-weeks
ended September 29, 2001. The decrease in net sales was driven by lower catalog
and retail net sales, partially offset by an increase in e-commerce net sales.
The decrease in net sales for the 39 weeks ended September 28, 2002 reflects
weak customer demand, as well as a planned decline in catalog circulation for
each of the merchants and reduced promotional activity at Eddie Bauer. Eddie
Bauer's comparable store sales figures decreased 14% for the 39-week period
ended September 28, 2002. Finally, net sales declined due to more stringent
credit-granting measures taken in the Company's private-label preferred credit
card operation. Approximately 34% of the Company's net sales for the 39 weeks
ended September 28, 2002 were made with the Company's private-label credit
cards. If one or more Pay Out Events occur under the Company's private-label
securitization arrangements, the Company's net sales may decline substantially
if the Company were required to significantly reduce its use of private-label
credit cards.
Finance revenue: Finance revenue decreased $28,533 or 41.2% to $40,649 for the
39 weeks ended September 28, 2002 from $69,182 for the 39 weeks ended September
29, 2001. This was driven by a decrease in net pretax gains (losses) on the
securitization of private-label preferred credit card receivables. Net pretax
gains decreased $23,388 and totaled $(9,554) and $13,834 for the 39-weeks ended
September
19
28, 2002 and September 29, 2001, respectively. The decline in net pretax gains
resulted primarily from higher discounts recorded on additional cash reserve
requirements due to weak portfolio performance as well as an increase in charge
offs compared to the prior year. If one or more Payout Events occur under the
Company's securitization arrangements, the Company's finance revenues would
decline sharply.
Other revenue: Other revenue decreased by $22,125 or 10.5% to $189,033 for the
39 weeks ended September 28, 2002 from $211,158 for the 39 weeks ended September
29, 2001. This decrease resulted from lower delivery income at the merchant
companies driven by lower order volume, which was partially offset by an
increase in royalty revenue at Eddie Bauer relating to licensing agreements
entered into with third-party licensees.
Cost of sales: Cost of sales decreased by $217,473 or 18.3% to $974,011 for the
39 weeks ended September 28, 2002 from $1,191,484 for the 39 weeks ended
September 29, 2001. As a percentage of net sales, cost of sales decreased to
63.1% for the 39 weeks ended September 28, 2002 from 64.0% in the comparable
period of the prior year. The dollar decrease in cost of sales was primarily due
to the decline in net sales. Product sourcing initiatives and lower markdowns
resulted in a gross profit margin improvement of 90 basis points versus the
comparable period of the prior year.
Selling, general and administrative expenses ("SG&A"): SG&A expenses decreased
$110,835 or 11.1%, to $890,139 for the 39 weeks ended September 28, 2002 from
$1,000,974 for the 39 weeks ended September 29, 2001. Although SG&A expenses
decreased in comparison to the prior year period, as a percentage of total
revenue, SG&A expenses increased to 50.2% for the 39-weeks ended September 29,
2002 from 46.7% in the comparable period of the prior year. This increase is
partially due to lower advertising productivity at the merchant companies, which
resulted in higher advertising costs as a percentage of net sales. Higher fixed
operating costs on a lower net sales level also contributed to the higher SG&A
rate in comparison to the prior year period. Additionally, operating expenses
associated with the private-label preferred credit operation declined at a
slower rate than the decline in finance revenues.
Operating loss: The Company recorded an operating loss of $91,643 for the 39
weeks ended September 28, 2002 compared to an operating loss of $50,978 for the
comparable period of the prior year. This decrease was driven by lower net sales
at each of the merchant companies and lower net finance revenue from the
private-label preferred credit card operation.
Interest expense: Interest expense totaled $48,289 and $43,886 for the 39 weeks
ended September 28, 2002 and September 29, 2001, respectively. Increased average
debt levels resulted in higher interest expense in comparison to the prior year
period despite lower borrowing rates on the Company's debt obligations.
Income tax benefit: The Company has recorded no tax benefits associated with its
pretax losses incurred for the 39-week period ended September 28, 2002 due to
substantial doubt about the Company's ability to continue as a going concern
(See Note 9 to the consolidated financial statements). The Company's
consolidated effective tax rate was 38.0% for the 39-week period ended September
29, 2001. The Company assesses its effective tax rate on a continuous basis.
LIQUIDITY AND CAPITAL RESOURCES
The Company has historically met its operating and cash requirements through
funds generated from operations, the securitization of credit card receivables
and the issuance of debt and common stock. However, the Company has been unable
to successfully negotiate a new credit facility with its lending institutions,
to obtain an amended settlement agreement with MBIA Insurance Corporation
("MBIA"), and to assure the future achievement of minimum performance
requirements under its securitization transactions. These matters raise
substantial doubt about the Company's ability to continue as a going concern for
a reasonable period of time.
Net cash used in operating activities totaled $163,398 for the 39-week period
ended September 28, 2002 compared to $278,506 for the 39-week period ended
September 29, 2001. Net cash used in operations improved by $115,108 compared to
the prior year period. The improvement in the current year period
20
resulted from lower cash utilized for accounts payable and accrued liabilities.
This reflects lower beginning inventory levels in the current year period
relative to the prior year period as a result of the Company's commitment to
tightly manage inventory in response to the decline in net sales. Inventory
levels were 11% lower at September 28, 2002 as compared to September 29, 2001. A
decrease in bonus and long-term incentive payments in comparison to the prior
year period also contributed to the decline in net cash used in operating
activities.
Net cash used in investing activities totaled $120,207 for the 39-week period
ended September 28, 2002 compared to $105,817 in the same period last year. This
increase in cash used in investing activities was primarily due to an increase
of $105,677 in cash reserve requirements to support the receivable
securitization transactions due to unfavorable credit card portfolio
performance. The Company maintains cash reserve accounts as necessary,
representing reserve funds used as credit enhancement for specific classes of
investor certificates. Partially offsetting this increase in net cash used in
investing activities was a reduction in net additions to property and equipment
in the current year period of approximately $40 million. Net additions in the
current year were comprised primarily of Eddie Bauer retail store remodeling and
expansion, the purchase of an administrative building for Newport News and
information technology purchases for equipment and development.
Net cash used in discontinued operations totaled $49,530 for the 39-week period
ending September 28, 2002, an increase of $60,598 compared to net cash provided
by discontinued operations of $11,068 in the same period last year. The primary
reason for the decrease in net cash provided by discontinued operations was due
to a decrease in operating results in comparison to the prior year period and
increases in other assets including credit card accounts receivable.
As of September 28, 2002, total debt was $1,385,857 compared to $1,192,857 as of
September 29, 2001. The increase in total debt from September 29, 2001 was
primarily driven by declining operating results for the Company and increased
funding requirements for the private-label preferred credit card operation to
support collateral requirements due to weak portfolio performance. The Company
has a $750,000 revolving credit agreement with a group of banks. Borrowings
under the agreement are comprised of a $600,000 long-term component maturing
July 2003 and a $150,000 364-day component that matured in June 2002. Borrowings
under the Company's $600,000 long-term revolving credit agreement were $600,000
at September 28, 2002. Borrowings under the $150,000, 364-day agreement were
$100,000 at September 28, 2002. However, the revolving credit agreement provides
for restrictions on the availability of additional financing if a "material
adverse change" in the Company's business has occurred. In February 2002, the
Company determined, with its lending institutions, that a material adverse
change had occurred due to the operating performance experienced in the fourth
quarter of fiscal 2001 and due to the estimated loss recorded on the sale of the
bankcard segment. Accordingly, on February 18, 2002, the borrowing capacity
under the revolving credit facility was capped at $700,000, which represented
the Company's borrowings outstanding on this date.
The Company's revolving and non-affiliated loan agreements provide for
restrictive covenants, including restrictions on the payment of dividends.
Financial covenants of the revolving and term loan agreements establish minimum
levels of tangible net worth and require the maintenance of certain ratios,
including fixed charge coverage ("Coverage"), total debt to equity ("Leverage"),
and adjusted debt to earnings before interest, taxes, depreciation and
amortization, and rents ("Debt to EBITDAR"). Additionally, these and certain
other debt agreements contain cross default provisions. For the reporting period
September 28, 2002, the Company was in violation of its financial covenants and
certain other covenants. Accordingly, the financial statements reflect all of
the Company's debt obligations under "current portion of long-term debt". (See
Note 9). The Company is working with its lending group to restructure the
existing credit facilities and to enter into new credit facilities. However,
there can be no assurances that a new credit facility will be available to the
Company.
If the Company is not able to enter into a new credit facility, alternative
sources of financing will be required to obtain the necessary liquidity to
continue to operate the business. While the Company is
21
presently considering its alternatives, given its current financial condition,
it may be unable to obtain this alternative financing. These matters raise
substantial doubt about the Company's ability to continue as a going concern for
a reasonable period of time. See Note 9 to the consolidated financial
statements.
Otto Versand (GmbH & Co) ("Otto Versand"), a privately held German partnership,
acquired the Company in 1982. In April 1984, Otto Versand transferred its
interest in the Company to its partners and designees. In October 2002, the
German partnership changed its name from Otto Versand (GmbH & Co) to Otto (GmbH
& Co KG), hereinafter referred to as "Otto Versand (GmbH & Co)" or "Otto
Versand".
In September 2001, the Company entered into a revolving credit agreement with
Otto Versand (GmbH & Co), a related party. The initial availability under this
credit agreement was $75,000. The credit agreement bears interest at a variable
rate based on LIBOR plus a margin, comparable to the Company's other revolving
credit agreements. The initial agreement extended through December 15, 2001. In
November 2001, this revolving credit agreement with Otto Versand (GmbH & Co) was
increased from $75,000 to $100,000 and the maturity date was extended from
December 15, 2001 to June 15, 2002. At December 29, 2001, borrowings under this
agreement totaled $50,000. As of February 2002, the balance outstanding under
the revolving credit agreement with Otto Versand (GmbH & Co) was $100,000. This
obligation was extinguished with the proceeds of new term loans in the aggregate
amount of $100,000 from Otto-Spiegel Finance G.m.b.H. & Co. KG, a related party.
These term loans had a maturity date of December 31, 2002, bear interest at a
rate of 4% per annum and may be subordinate to borrowings under any new credit
facility. As of September 28, 2002, related party borrowings consisted of senior
unsecured loans from Otto Versand (GmbH & Co) in the amount of $145,000 and
$100,000 in term loans from Otto-Spiegel Finance G.m.b.H & Co. KG. Interest
expense attributable to the borrowings from Otto Versand (GmbH & Co) and
Otto-Spiegel Finance G.m.b.H & Co. KG during the 13- and 39-weeks ended
September 28, 2002 was $1,879 and $4,422, respectively. As of February 2003, the
related party borrowings outstanding consisted of the $100,000 term loans from
Otto-Spiegel Finance G.m.b.H. & Co. KG and the $60,000 senior unsecured loan
from Otto Versand (GmbH & Co).
A principal source of liquidity for the Company has been its ability to
securitize substantially all of the credit card receivables that it generates.
Many of the customers at the Company's merchant companies have received credit
through private-label credit cards issued by FCNB, the Company's special-purpose
bank. Approximately 41% of the Company's total net sales in fiscal 2001 were
made with the Company's private-label credit cards. FCNB also has issued
MasterCard and VISA bankcards to the general public.
The Company securitizes the receivables generated by the use of its
private-label cards and bankcards by selling them to securitization vehicles,
which, in turn, sell asset backed securities ("ABS") to investors. The
receivables are sold without recourse. At present, these vehicles have issued
six series (each a "Series") of ABS securities. The Spiegel Credit Card Master
Note Trust Series 2000-A notes, the Spiegel Credit Card Master Note Trust Series
2001-A notes and the Spiegel Credit Card Master Note Trust Series 2001-VFN notes
are backed, on a revolving basis, by private-label receivables. The First
Consumers Master Trust Series 1999-A certificates, the First Consumers Credit
Card Master Note Trust Series 2001-A notes and the First Consumers Credit Card
Master Note Trust Series 2001-VFN notes are backed, also on a revolving basis,
by bankcard receivables. MBIA Insurance Corporation ("MBIA") insures the
investors in the Spiegel 2000-A Series and the Spiegel 2001-A Series. Under
these arrangements, the securitization vehicles had outstanding an aggregate of
approximately $2.2 billion of notes and certificates at the end of December
2002.
Each Series requires that the revolving pool of receivables supporting the
Series achieve certain minimum performance requirements. If the receivables pool
cannot achieve these minimum performance requirements, a "Pay Out Event" will
occur. A Pay Out Event, which is also known as an early amortization event,
would divert monthly excess cash flow remaining after the payment of debt
service and other expenses to repay principal to investors on an accelerated
basis, rather than to pay the cash to the Company upon deposit of new
receivables. These cash payments would have been utilized by the Company to fund
its operations.
22
The following table reflects the facility amounts and the maturity dates of the
Company's off-balance sheet facilities:
($000's omitted) 2002 2003 2004 2005 2006 Thereafter
- --------------------- ------ ------ -------- ---------- -------- ----------
First Consumers
Master Trust Series
1999-A $ - $ - $250,000 $ - $ - $ -
First Consumers
Credit Card Master
Note Trust Series
2001-A - - - - 600,000 -
Spiegel Credit Card
Master Note Trust
& First Consumers
Credit Card
Master Note Trust
Series 2001-VFN - - - 1,500,000 - -
Spiegel Credit Card
Master Note Trust
Series 2000-A - - - 600,000 - -
Spiegel Credit Card
Master Note Trust
Series 2001-A - - - 600,000 - -
------ ------ -------- ---------- -------- ----------
Total Securitizations $ - $ - $250,000 $2,700,000 $600,000 $ -
====== ====== ======== ========== ======== ==========
As previously reported, the Company had forecasted that, in the next several
months, receivable pools would not meet the minimum performance requirements. As
a result of a new forecast, the Company presently expects that, for the
reporting period ending on February 28, 2003, it will fail to meet these minimum
performance requirements on the First Consumers 1999-A Series and the First
Consumers 2001-A Series that are backed by bankcard receivables and potentially
on the Spiegel 2000-A Series backed by private-label receivables. If the two
bankcard Series fail to meet these minimum performance requirements, there would
be an automatic Pay Out Event applicable to these two Series, as well as to the
First Consumers 2001-VFN Series as a result of cross-default provisions, in
early March 2003. In addition, failure to meet the minimum performance
requirements by the Spiegel 2000-A Series would result in an automatic Pay Out
Event applicable to that Series as well as to the Spiegel 2001-VFN Series in
early March 2003, which would entitle MBIA to declare a Pay Out Event on the
Spiegel 2001-A Series. If the Company is not able to restructure its existing
credit facilities or enter into new credit facilities with its lending
institutions, an insolvency event under the three private-label Series of ABS
securities would be deemed to have occurred which would constitute a Pay Out
Event applicable to the three Series.
If these Pay Out Events were to occur, the Company may be required, for at least
a period of time, to transfer newly generated receivables from existing
customers to the securitization vehicles for the benefit of the investors,
without receiving payment in cash for these receivables. The Company would not
have sufficient cash or cash flow from operations to make up this shortfall.
Accordingly, the Company would need to obtain a new credit facility or some
other source of financing. The Company has been in default on its existing
revolving credit facility since fiscal 2001 and, accordingly, the Company is not
permitted to
23
borrow additional amounts under this facility and all existing borrowings
thereunder are currently due and payable. As a result, the Company may be unable
to obtain this alternative financing.
In the third quarter of fiscal 2002, the Company was informed by one of the
rating agencies that it may downgrade the rating of the First Consumers Credit
Card Master Note Trust Series 2001-VFN Class A Notes and the Spiegel Credit Card
Master Note Trust Series 2001-VFN Class A Notes. Under the provisions of the
existing securitization agreements, a rating agency downgrade would result in a
"Pay Out Event" of the receivable securitizations. In order to avoid such a "Pay
Out Event", the Company agreed to increase its percentage of required collateral
accordingly. This had the impact of increasing the receivables retained by the
Company. The financing of these additional receivables will be generated from
existing cash flows from operations and through the Company's existing credit
facilities, if available.
On April 4, 2002, MBIA issued a notice asserting the occurrence of one "Pay Out
Event" as a result of a dispute regarding the proper calculation of the minimum
performance requirements and the existence of circumstances which, if not cured
within 45 days following the date of such notice, would result in the occurrence
of a second "Pay Out Event," under Spiegel Series 2000-A and Series 2001-A.
Those Series are supported by private label credit card receivables originated
by FCNB and for which MBIA insures the payments to noteholders and The Bank of
New York acts as indenture trustee.
The Company and FCNB filed suit and obtained a temporary restraining order
against MBIA and The Bank of New York on April 11, 2002, in the Supreme Court of
the State of New York, County of New York. On May 16, 2002, the Company and MBIA
entered into a settlement agreement pursuant to which, among other things, MBIA
agreed to withdraw its April 4, 2002 letter. In addition, the Company and FCNB
agreed to dismiss the litigation, and to obtain a backup servicer no later than
December 1, 2002. Finally, the Company agreed to increase the amounts required
to be on deposit in a reserve account established for the benefit of MBIA as
insurer of the notes. Amounts in that reserve account are available to cover the
shortfall in any period, if any, between available collections on the
receivables and the amounts owing in respect of principal and interest on the
notes, prior to a claim being made against the insurer for such amounts.
Pursuant to the agreement, increases in the reserve account will be funded by
diverting excess receivables collections that would otherwise be available to
the Company; provided that during the first seven months following the date of
the settlement agreement such diversions were limited to a maximum of $9,000 per
month and an incremental $60,000 in the aggregate for the seven-month period.
This diversion of excess cash is measured based upon certain receivable
portfolio performance criteria. Accordingly, the actual reserve requirements may
differ from the dollar amounts disclosed above based upon actual receivable
portfolio performance. The agreement with MBIA contains other requirements,
including the requirement to file the Company's and FCNB's 2001 financial
statements by December 6, 2002. In addition, the Company agreed to appoint a
backup servicer for the servicing of its receivable portfolio and to execute a
backup servicing agreement by December 1, 2002. The Company is not presently in
compliance with the requirements of the MBIA agreement and is currently
negotiating an amendment to the MBIA agreement to extend the date of these
requirements. There can be no guarantees that MBIA will not exercise its
remedies under the settlement agreement, which would include declaring the
occurrence of a "Pay Out Event", as described above. See Note 9 to the
consolidated financial statements.
On May 15, 2002, FCNB entered into an agreement with the Office of the
Comptroller of the Currency ("OCC"), the primary federal regulator of FCNB. The
agreement calls for FCNB to comply with certain requirements. The agreement,
among other things, (i) contains restrictions on transactions between the bank
and its affiliates and requires the bank to complete a review of all existing
agreements with affiliated companies, and to make necessary and appropriate
changes; (ii) requires the bank to obtain an aggregate of $198,000 in
guarantees, which, guarantees have been provided through the Company's majority
shareholder; (iii) restricts the banks ability to accept, renew or rollover
deposits; (iv) places restrictions on the bank's ability to issue new credit
cards and make credit line increases; (v) requires the bank within 30 days of
the agreement to file with the OCC a disposition plan to either sell, merge or
liquidate the bank; (vi) requires the bank to maintain sufficient assets to meet
daily liquidity requirements; (vii) requires the bank to complete a
comprehensive risk management assessment; (viii) establishes minimum capital
levels for the bank; (ix) provides for increased oversight by and reporting to
the OCC; and (x) provides for the maintenance of certain asset growth
restrictions.
24
In October 2002, the Company submitted a revised disposition plan to the OCC.
The disposition plan generally provides for the sale or liquidation of the
bankcard portfolio by April 30, 2003 and a liquidation of FCNB thereafter. On
November 27, 2002, the OCC approved the disposition plan. Under the terms of
this plan, if FCNB did not receive an acceptable offer to buy the bankcard
portfolio in January 2003, it was required to implement plans to liquidate its
bankcard portfolio. FCNB, in addition to its own bankcard operations, issues
substantially all of the Company's private-label credit cards and services the
related receivables, including securitized receivables.
On February 14, 2003, the Company received a letter from the OCC requiring FCNB
to immediately begin the process of liquidating the bankcard portfolio and
indicating the steps it must take to do so. The OCC letter requires FCNB to: 1)
notify the trustee for each of the Company's bankcard Series that FCNB will
either amend the relevant securitization documents to replace FCNB with a
successor servicer and administrator or resign as servicer and administrator at
the earliest date permissible under the agreements, 2) cease all credit card
solicitations for its bankcards, 3) cease accepting new bankcard applications
and credit lines and offering credit line increases to any existing bankcard
account, 4) notify cardholders that FCNB will no longer honor bankcard charges
on or before March 31, 2003, and 5) cease accepting new charges on existing
bankcard accounts on or before April 1, 2003.
The Company has complied and continues to comply with the OCC requirements set
forth in its letter of February 14, 2003. The Company also continues to have
discussions with potential acquirers for the sale of the bankcard business. If
the Company is not able to sell the bankcard business before Apri1 1, 2003, a
Pay Out Event will occur with respect to each bankcard Series as a result of the
OCC's requirements that FCNB cease accepting new charges on existing bankcard
accounts.
Although the Company plans to discontinue the bankcard business, it plans to
remain in the private-label credit card business. In the future, it plans to
issue its private-label credit cards through its merchant operations, rather
than FCNB, but also may consider seeking a third-party credit provider. The
Company is in the process of establishing an in-house capability to service
these receivables or otherwise it will seek to secure a third-party credit
provider.
25
Overall, aggregate maturities under the Company's cash obligations as of
September 28, 2002 are as follows:
($000's omitted) 2002 2003 2004 2005 2006 Thereafter
- --------------------- --------- ------------ ---------- --------- --------- ----------
Revolving credit
agreement $ - $ 700,000 $ - $ - $ - $ -
Otto Versand
(GmbH & Co)
Senior
unsecured loans - 145,000 - - - -
Term loan
agreements - 392,857 - - - -
Otto-Spiegel
Finance G.m.b.H
& Co KG
Term loan
agreements - 100,000 - - - -
Secured notes - 48,000 - - - -
Operating leases 31,788 124,265 112,185 99,103 84,103 283,633
--------- ------------ ---------- --------- --------- -----------
Total cash
obligations $31,788 $1,510,122 $112,185 $99,103 $84,103 $283,633
========= ============ ========== ========= ========= ===========
The Company was not in compliance with its financial covenants and certain other
covenants contained in its debt agreements and, accordingly, all of the
Company's debt is currently due and payable. The above table has reflected the
Company's credit obligations with its lending institutions as payable in 2003.
See Note 9 to the consolidated financial statements
In addition, the Company has other commercial commitments as of September 28,
2002 as follows:
($000's omitted) 2002 2003 2004 2005 2006 Thereafter
- --------------------- -------- -------- -------- -------- -------- ------------
Standby letters of
credit 2,500 3,500 - - - -
-------- -------- -------- -------- -------- ------------
Total commercial
commitments $2,500 $3,500 $ - $ - $ - $ -
======== ======== ======== ======== ======== ============
The Company maintains a $150,000 letter of credit facility in addition to
off-balance sheet stand-by letters of credit, which are used for the purchase of
inventories. The total letter of credit facility commitments outstanding at
September 28, 2002 and September 29, 2001 were approximately $6,000 and
$119,000, respectively. However, the letter of credit facilities provide
restrictions on the availability of additional financing if a "material adverse
change" in the Company's business has occurred. In February 2002, the Company
determined, with its lending institutions, that a material adverse change had
occurred due to the operating performance experienced in the fourth quarter of
fiscal 2001 and due to the estimated loss recorded on the sale of the bankcard
segment. Accordingly, on February 18, 2002, no additional letter of credit
facilities were available to the Company. In March 2002, the Company entered
into a Vendor Payment Services Agreement with Otto International Hong Kong
(OIHK), a related party. Under the terms of the agreement, the Company has open
account terms with various vendors in certain countries in Asia. The duration of
the agreement is for one year, automatically continuing unless terminated by
either party with three months' written notice. OIHK will pay the vendors the
purchase order value less a fee within seven days of the purchase order receipt.
The Company will repay OIHK for 100% of the purchase order
26
value for goods purchased by Spiegel and Newport News sixty days from the date
of sea shipments and thirty days from the date of air shipments. Due to the
larger volume of purchases made by Eddie Bauer in comparison to Spiegel and
Newport News, the Company will make weekly advance payments to OIHK for 100% of
the purchase order value of goods purchased by Eddie Bauer prior to shipment.
Finally, under the provisions of the Vendor Payment Services Agreement, OIHK has
a lien over each shipment of goods supplied by vendors on behalf of the
Company's merchant operations. The lien shall arise at the time OIHK makes the
vendor payments relevant to the shipment in question and shall not be satisfied
until receipt by OIHK of the repayment by the Company of the Vendor Payments in
question. Such right provides that, upon the receipt of a notice from the
Payment Servicer, the Merchant or the vendor would be required to tender any
goods, for which the Merchant has not reimbursed OIHK, to OIHK.
The Company was not in compliance with its financial covenants and certain other
covenants contained in its debt agreements and, accordingly, all of the
Company's debt is currently due and payable. The Company's ability to satisfy
debt obligations and to pay principal and interest on debt, fund working capital
and make anticipated capital expenditures will depend on the occurrence and
effect of Pay Out Events applicable to its private-label securitizations, the
outcome of its negotiations with its lenders, resolution of the uncertainty
relating to the sale or liquidation of the bankcard segment, the Company's
ability to service private-label preferred credit programs and any other changes
in market conditions that are beyond the Company's control, as well as the
Company's future performance. There can be no assurances that any or all of
these matters will be resolved satisfactorily, or if resolved satisfactorily,
will provide resources sufficient to sustain the Company's operations. These
matters raise substantial doubt about the Company's ability to continue as a
going concern for a reasonable period of time.
As a result of these matters, the Company may not have sufficient funds to
finance its operations beginning in the near future and thereafter. In light of
the Company's existing operating and financing challenges, the Company is
exploring a range of strategic options, in conjunction with its ongoing
discussions with lenders and other parties, to restructure its debt obligations
and securitization arrangements and provide for the Company's continued
operations. As part of these efforts, the Company is taking steps to engage the
services of restructuring advisors.
RELATED PARTY TRANSACTIONS
Otto Versand (GmbH & Co) ("Otto Versand"), a privately held German partnership,
acquired the Company in 1982. In April 1984, Otto Versand transferred its
interest in the Company to its partners and designees. Otto Versand and the
Company have entered into certain agreements seeking to benefit both parties by
providing for the sharing of expertise. In October 2002, the German partnership
changed its name from Otto Versand (GmbH & Co) to Otto (GmbH & Co KG),
hereinafter referred to as "Otto Versand (GmbH & Co)" or "Otto Versand". The
following is a summary of such agreements and certain other transactions:
The Company utilizes the services of Otto Versand International (GmbH) as a
buying agent for the Company in Hong Kong, Taiwan, Korea, India, Italy,
Indonesia, Singapore, Thailand, Poland, Brazil and Turkey. Otto Versand
International (GmbH) is a wholly owned subsidiary of Otto Versand. Buying agents
locate suppliers, inspect goods to maintain quality control, arrange for
appropriate documentation and, in general, expedite the process of procuring
merchandise in these areas. Under the terms of its arrangements, the Company
paid $2,787 and $6,293 for the 13 and 39-weeks ended September 28, 2002,
respectively, and $2,388 and $7,504 for the 13 and 39-weeks ended September 29,
2001, respectively. The arrangements are indefinite in term but may generally be
canceled by either party upon one year written notice.
In March 2002, the Company entered into a Vendor Payment Services Agreement with
Otto International Hong Kong (OIHK), a related party. Under the terms of the
agreement, the Company has open account terms with various vendors in certain
countries in Asia. The duration of the agreement is for one year, automatically
continuing unless terminated by either party with three months written notice.
OIHK will pay the vendors the purchase order value less a fee within seven days
of the purchase order receipt. The Company will repay OIHK for 100% of the
purchase order value for goods purchased by Spiegel and Newport News sixty days
from the date of sea shipments and thirty days from the date of air shipments.
Due to the larger volume of purchases made by Eddie Bauer in comparison to
Spiegel and Newport News, the Company will make weekly advance payments to OIHK
for 100% of the purchase order value for goods purchased by Eddie Bauer prior to
shipment. Finally, under the provisions of the Vendor Payment Services
Agreement, OIHK has a lien over each shipment of goods supplied by vendors on
behalf of the Company's merchant operations. The lien shall arise at the time
OIHK makes the vendor payments relevant to the shipment in question and shall
not be satisfied until receipt by OIHK of the repayment by the Company of the
Vendor Payments in question. Such right provides that, upon the receipt of a
notice from the Payment Servicer, the Merchant or the vendor would be required
to tender any goods, for which the Merchant has not reimbursed OIHK, to OIHK.
In September 2001, the Company entered into a revolving credit agreement with
Otto Versand. The initial availability under this credit agreement was $75,000.
The credit agreement bears interest at a variable rate based on LIBOR plus a
margin, comparable to the Company's other revolving credit agreements. The
initial agreement extended through December 15, 2001. In November 2001, this
revolving credit
27
agreement with Otto Versand was increased from $75,000 to $100,000 and the
maturity date was extended from December 15, 2001 to June 15, 2002. As of
February 2002, the balance outstanding under the revolving credit agreement with
Otto Versand was $100,000. This obligation was extinguished with the proceeds of
new term loans in the aggregate amount of $100,000 from Otto-Spiegel Finance
G.m.b.H. & Co. KG. These term loans had a maturity date of December 31, 2002,
bear interest at a rate of 4% per annum and may be subordinate to borrowings
under any new credit facility. As of September 28, 2002, related party
borrowings consisted of senior unsecured loans from Otto Versand (GmbH & Co) in
the amount of $145,000 and $100,000 in subordinated term loans from Otto-Spiegel
Finance G.m.b.H & Co. KG. Interest expense attributable to the borrowings from
Otto Versand (GmbH & Co) and Otto-Spiegel Finance G.m.b.H & Co. KG during the
13- and 39- weeks ended September 28, 2002 was $1,879 and $4,422, respectively.
As of February 2003, the related party borrowings outstanding consisted of the
$100,000 term loans from Otto-Spiegel Finance G.m.b.H. & Co. KG and the $60,000
senior unsecured loan from Otto Versand (GmbH & Co).
ACCOUNTING STANDARDS
In June 2002, the Financial Accounting Standards Board (FASB) issued SFAS No.
146, "Accounting for Costs Associated with Exit or Disposal Activities". SFAS
No. 146 addresses financial accounting and reporting for costs associated with
exit or disposal activities and nullifies Emerging Issues Task Force (EITF)
Issue No. 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 is effective for exit or disposal activities that
are initiated after December 31, 2002, with early application encouraged.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation-Transition and Disclosure - an amendment of FASB Statement No. 123.
This Statement amends FASB 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. In addition, this Statement amends the disclosure requirements of
Statement No. 123 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. This
Statement is effective for fiscal years ending after December 15, 2002. Earlier
application of the transition provisions is permitted for entities with a fiscal
year ending prior to December 15, 2002, provided that financial statements for
the 2002 fiscal year have not been issued as of the date this Statement is
issued. Early application of the disclosure provisions is encouraged. The
Company does not expect the adoption of SFAS No. 148 to have a material effect
on its consolidated results of operations or financial position.
OTHER As previously disclosed, the Company's executive vice president and chief
financial officer, James R. Cannataro, resigned from his position in early
February 2003. The Company is actively negotiating with, and expects to announce
shortly the appointment of, a new chief financial officer. The Company cannot
predict whether there will be further changes in the composition of its board of
directors or management.
FORWARD-LOOKING STATEMENTS
This report contains statements that are forward-looking within the meaning of
applicable federal securities laws and are based upon the Company's current
expectations and assumptions. You should not place undue reliance on those
statements because they speak only as of the date of this report.
Forward-looking statements include information concerning the Company's possible
or assumed future results of operations. These statements often include words
such as "expect," "plan," "believe," "anticipate", "intend," "estimate," or
similar expressions. As you read and consider this report, you should understand
that these statements are not guarantees of performance or results. They involve
risks, uncertainties and assumptions. Although the Company believes that these
forward-looking statements are based on reasonable assumptions, you should be
aware that many factors could affect our actual financial results and actual
results could differ materially from the forward-looking statements. These
factors include, but are not limited to, the uncertainty regarding the Company's
ability to enter into new credit facilities with its
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lending institutions, uncertainty regarding the Company's ability to amend its
existing agreement with MBIA, the occurrence of events that may result in an
early amortization ("Pay Out Event") of the Company's asset-backed securities,
the uncertainty relating to the sale or liquidation of the bankcard segment;
increased oversight or restrictions by the OCC on the bankcard segment which
could reduce the market value of the bankcard segment; the risk associated with
fulfilling the obligations set forth in the Bank's disposition plan; the
availability of future liquidity support from the Company's majority
stockholder; reduction in cash available from the Company's securitization
transactions; the financial strength and performance of the retail and direct
marketing industry; changes in consumer spending patterns; dependence on the
securitization of credit card receivables to fund operations; state and federal
laws and regulations related to offering and extending credit; risks associated
with collections on the Company's credit card portfolio; interest rate
fluctuations; postal rate increases; paper or printing costs; the success of
planned merchandising, advertising, marketing and promotional campaigns; and
various other factors beyond the Company's control.
All future written and oral forward-looking statements made by the Company or
persons acting on the Company's behalf are expressly qualified in their entirety
by the cautionary statements contained or referred to above. Except for the
Company's ongoing obligations to disclose material information as required by
the federal securities laws, we do not have any obligation or intention to
release publicly any revisions to any forward-looking statements to reflect
events or circumstances in the future or to reflect the occurrence of
unanticipated events.
Item 3 - Quantitative and Qualitative Disclosures About Market Risk
($000s omitted)
The Company is exposed to market risk from changes in interest rates, the
securitization of credit card receivables and, to a lesser extent, foreign
currency exchange rate fluctuations. In seeking to minimize risk, the Company
manages exposure through its regular operating and financing activities and,
when deemed appropriate, through the use of derivative financial instruments.
The Company does not use financial instruments for trading or other speculative
purposes and is not party to any leveraged financial instruments.
Interest rates:
The Company manages interest rate exposure through a mix of fixed- and
variable-rate financings. The Company is generally able to meet certain targeted
objectives through its direct borrowings. Substantially all of the Company's
variable-rate exposure relates to changes in the one-month LIBOR rate. If the
one-month LIBOR rate had changed by 50 basis points, the Company's third quarter
2002 interest expense would have changed by approximately $1,042. Interest rate
swaps may be used to minimize interest rate exposure when appropriate based on
market conditions. The notional amounts of the Company's interest rate swap
agreements totaled $65,000 at September 28, 2002.
The Company believes that its interest rate exposure management policies,
including the use of derivative financial instruments, are adequate to manage
material market risk exposure.
Securitizations:
In conjunction with its asset-backed securitizations, the Company recognizes
gains representing the present value of estimated future cash flows that the
Company expects to receive over the estimated outstanding securitization period.
These future cash flows consist of an estimate of the excess of finance charges
and fees over the sum of the interest paid to certificate holders, contractual
servicing fees and charge-offs along with the future finance charges and
principal collections related to retained interests in securitized receivables.
Changes in interest rates and certain estimates inherent in determining the
present value of these estimated future cash flows are influenced by factors
outside the Company's control, and as a result, could materially change in the
near term.
Foreign currency exchange rates:
The Company is subject to foreign currency exchange risk related to its Canadian
operations, as well as its
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joint venture investments in Germany and Japan. The Company is party to certain
transactions with the above joint ventures that are denominated in foreign
currencies. The Company monitors the exchange rates related to these currencies
on a continual basis and will enter into forward derivative contracts for
foreign currency when deemed advantageous based on current pricing and
historical information. The Company believes that its foreign exchange risk and
the effect of this hedging activity are not material due to the size and nature
of the above operations. There were no foreign currency hedging contracts
outstanding at September 28, 2002.
Item 4. Controls And Procedures
(a) Evaluation of disclosure controls and procedures. The Company's
principal executive officer, after evaluating the effectiveness of
the Company's disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14(c) and 15d-14(c)) on February 25, 2003,
has concluded that, as of such date, the Company's disclosure
controls and procedures were adequate and effective to ensure that
material information relating to the Company and its consolidated
subsidiaries would be made known to him by others within those
entities. Please see the Explanatory Note at the beginning of this
Report.
(b) Changes in internal controls. There were no significant changes in
the Company's internal controls or in other factors that could
significantly affect the Company's disclosure controls and
procedures subsequent to the date of their evaluation nor were
there any significant deficiencies or material weaknesses in the
Company's internal controls, except as noted below.
The Company's independent auditors have informed the audit
committee of certain internal control deficiencies which
constitute reportable conditions. These control deficiencies
relate to the Company's wholly owned subsidiary, FCNB.
Specifically, the deficiencies relate to routine transactions and
accounting estimates, policies and procedures, and account balance
classifications in the financial statements. The Company has
assigned the highest priority to the correction of these
deficiencies and is committed to addressing them as soon as
possible. The Company believes that other controls are in place to
mitigate the risk that these deficiencies could lead to material
misstatements in the Company's financial statements. In addition,
as disclosed herein, the Company has formalized a plan to sell the
bankcard segment and FCNB will be sold or liquidated as part of
the disposition of the bankcard segment.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
In January 2003, the staff of the Securities and Exchange Commission (the "SEC")
commenced an informal investigation into the conduct of the Company and its
officers and directors, which focuses on the Company's compliance with its
disclosure obligations, including (i) the Company's failure to file when due
required reports with the SEC under the Securities Exchange Act of 1934,
beginning with its Form 10-K for fiscal year 2001, (ii) allegedly inaccurate
statements made by the Company in its notices that these reports would be filed
late, and (iii) the Company's alleged failure to publicly disclose material
information in violation of Rule 10b-5, including that its auditors believed
that the audit report on the Company's 2001 financial statements would have to
contain a "going concern" qualification absent the Company addressing certain
financial issues. The SEC staff has advised the Company that it will promptly
recommend to the SEC that an action be brought against the Company seeking
preliminary injunctive relief to prevent future violations and to impose other
procedures to ascertain whether there have been other violations of the
securities laws. Moreover, the SEC may also seek monetary remedies against the
Company, as well as pursue a formal investigation into the conduct of directors,
officers and certain other individuals involved in the Company's affairs.
The Company has established a special committee of its Board of Directors
including Dr. Winfried Zimmermann, Hans-Otto Schrader and Dr. Rainer Hillebrand
that are overseeing the Company's response to the investigation. The Company has
advised the SEC staff that it intends to cooperate with the investigation.
The Company cannot predict when or on what terms the SEC investigation or
possible enforcement actions will be concluded, nor can the Company predict what
effect the investigation or its conclusion will have on the Company's financial
condition or results of operations.
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Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit Number Description of Exhibit
99 Section 906 Certification
(b) The were no reports filed on Form 8-K during the thirteen week period ended
September 28, 2002.
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SIGNATURE
- ---------
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.
February 25, 2003
SPIEGEL, INC.
/s/ Martin Zaepfel
- -------------------------------------------
Martin Zaepfel
Vice Chairman, President and Chief Executive Officer
(Principal Operating Executive Officer and
duly authorized officer of Registrant)
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CERTIFICATIONS
- --------------
I, Martin Zaepfel, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Spiegel, Inc;
2. Based on my knowledge, this quarterly 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 quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly 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 quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and we 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
quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's 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 registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in
this quarterly report whether or not 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.
No other officers of the Company have certified this Report.
See Explanatory Note.
See Item 4 of this Report.
Date: February 25, 2003
-----------------
/s/ Martin Zaepfel
-----------------------------
Martin Zaepfel
Chief Executive Officer
33