GADZOOKS INC - 10-Q Quarterly Report

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549

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FORM 10-Q

(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED AUGUST 2, 2003

OR

( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934

COMMISSION FILE NUMBER 0-26732

GADZOOKS, INC.
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(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

TEXAS 74-2261048
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(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER IDENTIFICATION NUMBER)
INCORPORATION OR ORGANIZATION)

4121 INTERNATIONAL PARKWAY
CARROLLTON, TX 75007
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(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)

REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: 972-307-5555
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(FORMER NAME, FORMER ADDRESS AND FISCAL YEAR, IF CHANGED SINCE LAST REPORT.)

Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period
that the registrant was required to file such reports), and (2) has
been subject to such filing requirements for the past 90 days.
Yes (X) No ( )

Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act). Yes ( ) No (X)

As of September 4, 2003, the number of shares outstanding of the
registrant's common stock is 9,159,671.

GADZOOKS, INC.

FORM 10-Q

For the Quarter Ended August 2, 2003

INDEX

2

PART 1 -- FINANCIAL INFORMATION

GADZOOKS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
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(IN THOUSANDS)
(UNAUDITED)

The accompanying notes are an integral part of these condensed
consolidated financial statements.

3

GADZOOKS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
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(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)

The accompanying notes are an integral part of these condensed
consolidated financial statements.

4

GADZOOKS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
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(IN THOUSANDS)
(UNAUDITED)

The accompanying notes are an integral part of these condensed
consolidated financial statements.

5

GADZOOKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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1. BASIS OF PRESENTATION

The accompanying condensed consolidated financial statements contain
all adjustments (consisting of only normal recurring accruals)
necessary to present fairly the financial position of the Company as of
August 2, 2003 and February 1, 2003, and the results of operations and
cash flows for the second quarter and six months ended August 2, 2003
and August 3, 2002. The results of operations for the second quarter
and six months then ended are not necessarily indicative of the results
to be expected for the full fiscal year. The condensed consolidated
balance sheet as of February 1, 2003 is derived from audited financial
statements. The condensed consolidated financial statements should be
read in conjunction with the financial statement disclosures contained
in the Company's Annual Report on Form 10-K for the fiscal year ended
February 1, 2003.

Fiscal year: The Company's fiscal year is the 52- or 53-week period
that ends on the Saturday closest to the end of January. "Fiscal 2003"
is the 52-week period ending January 31, 2004.

Stock Option Plans: The following table shows Gadzooks' net income
(loss) for the quarters and six months ended August 2, 2003 and August
3, 2002, as if compensation expense for Gadzooks' stock option plans
applicable to the Company's employees had been determined based upon
the fair value at the grant date for awards consistent with the
methodology prescribed by SFAS 123 (these pro forma effects may not be
representative of expense in future periods since the estimated fair
value of stock options on the date of grant is amortized to expense
over the vesting period, and additional options may be granted or
cancelled in future years):

6

2. LONG-TERM OBLIGATIONS

On April 11, 2003, the Company and Wells Fargo Retail Finance LLC
("Wells Fargo") entered into a three-year $30 million revolving credit
agreement (the "Facility"), which is secured by an exclusive and first
priority, perfected interest in all assets of the Company. The
Company's borrowings under the agreement are limited to 85% of the net
recovery value of eligible inventory (as defined by the Facility) plus
85% of eligible credit card accounts receivable less certain financial
reserves specified by Wells Fargo. The credit agreement also provides
for the issuance of letters of credit that are generally used in
connection with international merchandise purchases. Outstanding
letters of credit issued by the bank reduce amounts otherwise available
for borrowing under the revolving line of credit. The credit facility
subjects the Company to a minimum maintained excess availability
requirement of $3.0 million (as defined by the Facility). Amounts
borrowed under the revolving line will bear interest ranging from 1.25%
to 2.00% above LIBOR, or 0.25% below to 0.50% above Wells Fargo's prime
rate based on credit line utilization. As of August 2, 2003, amounts
available to borrow under the new credit line, as limited as described
above and by outstanding letters of credit of $5.1 million, totaled
$20.9 million.

3. DEFERRED TAX ASSETS

The Company does not currently have a valuation allowance recorded
against its deferred tax assets of $14.3 million. The Company
anticipates an operating loss during the transition phase in fiscal
2003; however, should the loss exceed projections, the Company may need
to recognize a valuation allowance to significantly reduce its deferred
tax assets.

4. EARNINGS PER SHARE

The following table outlines the Company's calculation of weighted
average shares outstanding (in thousands):

The treasury stock method is used to determine dilutive potential
common shares outstanding related to stock options. Options, that are
antidilutive, are not considered in the treasury stock method
calculation. Options excluded from the earnings per share calculation
due to their antidilutive nature totaled 1,590,028 and 588,825 for the
quarters ended August 2, 2003 and August 3, 2002, and 1,590,028 and
536,174 for the six months ended August 2, 2003 and August 3, 2002,
respectively.

5. STORE CLOSING COSTS

During the second quarter of fiscal 2003, the Company closed four
stores that had been identified as under-performing, for a total of 13
stores closed during the six months ended August 2, 2003. Additionally,
the Company has entered into agreements to close 12 more stores. The
total costs incurred as a result of the store closings and termination
agreements, totaled $1.4 million and $2.7 million for the quarter and
six months ended August 2, 2003, respectively. These costs, primarily
composed of lease termination costs, are included in selling, general
and administrative expenses.

7

6. INVENTORY LIQUIDATION COSTS

The Company entered into an agreement with a consulting firm to help
with the complete liquidation of its men's inventory. Under the terms
of the agreement, the Company reimbursed the firm for certain operating
costs and paid the firm a portion of the sales proceeds based on
certain specified levels of sales performance as defined in the
contract. All amounts paid to the firm or accrued under the contract
were contingent upon the firm's ability to meet certain minimum levels
of sales performance. A total of $2.6 million and $3.0 million has been
recorded as selling, general and administrative expenses during the
quarter and six months ended August 2, 2003, respectively, pursuant to
this agreement. As of August 2, 2003, the men's inventory liquidation
has been completed; therefore, no additional costs will be incurred
pursuant to the agreement.

8

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS

GENERAL

Gadzooks is a mall-based specialty retailer of clothing, accessories, shoes,
fragrances and cosmetics for young women, principally between the ages of 16 and
22. Historically, the Company has catered to the clothing needs of both young
men and women. The conversion of the Gadzooks stores to an all-female
merchandise assortment took place in July 2003. In the second half of fiscal
2001, the Company began testing a new retail concept with the opening of four
Orchid stores. The Orchid concept caters to the unique innerwear and sleepwear
needs of females between the ages of 14 and 22. As of August 2, 2003, the
Company had closed 13 Gadzooks stores since the beginning of the fiscal year and
operated 423 Gadzooks stores and four Orchid stores for a total of 427 stores in
41 states.

The Company's business is subject to seasonal influences with higher sales
during the Christmas holiday, back-to-school and spring break seasons.
Management's discussion and analysis should be read in conjunction with the
Company's financial statements and the notes related thereto.

CRITICAL ACCOUNTING POLICIES

The preparation of Gadzooks' consolidated financial statements in conformity
with accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the balance sheet date, as well as the reported amounts of
revenues and expenses during the reporting period. On an ongoing basis,
management evaluates such estimates including sales return rates, inventory
reserves, impairment of long-lived assets, income taxes and accrued expenses.
Actual results may differ from estimates.

Gadzooks' accounting policies are generally straightforward; however, the
following issues require more significant management judgments and estimates.

REVENUE RECOGNITION. Retail merchandise sales are recognized at the point of
sale less sales returns and employee discounts. Management records a provision
for estimated sales returns based on historical return rates. If sales return
rates change, an additional allowance may be required.

INVENTORY VALUATION. Inventories are valued at the lower of average cost or
market. Cost is determined using the weighted-average method. Markdown
allowances received from vendors are recorded as a reduction of inventory cost
and therefore as a reduction of cost of goods sold in the period in which the
related merchandise is sold. In addition, inventories include an allocation of
buying and distribution costs to prepare product for the stores. This inventory
valuation method requires certain management estimates and judgments, including
estimates of merchandise markdowns, which could significantly affect gross
margin. Management estimates the markdown reserve based on several factors,
including but not limited to, merchandise quantities, historical markdown
percentages, aged seasonal merchandise and future merchandise plans. If future
demand or merchandise markdowns are less favorable than those projected by
management, additional inventory adjustments may be required. On a monthly
basis, management estimates shrink based on historical shrink rates. These
estimates are compared to actual results as inventory counts are taken and
reconciled to the general ledger. Gadzooks has not experienced significant
fluctuations in historical shrink rates.

LONG-TERM ASSET IMPAIRMENT. Management periodically reviews its long-lived
assets for impairment and records a provision whenever events or circumstances
indicate that the net book value of the asset may not be recoverable. Impairment
is determined based on several factors, including but not limited to, current
year operating loss or cash flow loss combined with a history and forecast of
operating or cash flow losses, significant negative industry or economic trends
and a current expectation, that more likely than not, the asset will be disposed
of significantly before the end of its previously estimated useful life. If
management determines that impairment exists, an impairment loss is recognized
if the sum of the expected future cash flows (undiscounted and before interest)
from the use of the assets is less than the net book value of the assets. The
amount of the impairment loss is measured as the difference between the net book
value of the assets and the estimated fair market value of the related assets.

9

DEFERRED TAX ASSETS. The Company does not currently have a valuation allowance
recorded against its deferred tax assets of $14.3 million. If management
determines it is more likely than not that its deferred tax assets would not be
realizable in the future, a valuation allowance would be recorded to reduce the
deferred tax asset to its net realizable value. The Company anticipates an
operating loss during the transition phase in fiscal 2003 and expects to return
to profitability in fiscal 2004; however, should the loss for fiscal 2003 exceed
projections, the Company may need to recognize a valuation allowance to
significantly reduce its deferred tax assets. The Company will perform a review
of its financial performance at the end of each quarter during 2003 to evaluate
the likelihood of realizing its deferred tax assets.

ACCRUED EXPENSES. On a monthly basis, certain expenses are estimated in an
effort to reflect these expenses in the proper period. Gadzooks' most material
estimates relate to self-insurance reserves, store level operating expenses and
bonuses. The self-insurance reserves for medical and worker's compensation
claims are recorded based on historical claim levels adjusted for growth in the
employee base. If the historical claims used to calculate these estimates are
not reflective of actual results, additional expenses may be incurred up to the
point that the Company's stop loss insurance begins. The Company is self-insured
for property and casualty claims at the store level. Property and casualty
claims at a store level are estimated and recognized as incurred. Accrued store
level operating expenses are estimated based on current activity and historical
results. Bonuses are based on performance and projected performance for the
remainder of the bonus period. If actual results are significantly different
from Gadzooks' expectations, an adjustment to expenses may be required.

CONVERSION TO ALL-FEMALE MERCHANDISE ASSORTMENT

The conversion of all Gadzooks stores to an all-female merchandise assortment
took place in July 2003. The Company anticipates an operating loss during the
transition phase in fiscal 2003 and expects to return to profitability in fiscal
2004. Although it is not possible to predict all of the costs associated with
the transition, the Company does plan to spend at least $1.5 million to $2.5
million in fiscal 2003 to market the new concept, of which $906,000 has been
spent through August 2, 2003. The Company hired a consulting firm to help with
the liquidation of its men's inventory. Under the terms of the agreement, the
Company reimbursed the firm for certain operating costs and paid the firm a
portion of the sales proceeds based on certain specified levels of sales
performance as defined in the contract. A total of $3.0 million has been
recorded as selling, general and administrative expenses during the six months
ended August 2, 2003 pursuant to this agreement. No assurance can be given that
the conversion will be successful, or that the Company will return to
profitability.

STORE CLOSINGS

The Company has closed 13 Gadzooks stores and contracted to close 12 additional
stores in fiscal 2003. The Company is also pursuing the closure of up to 10 more
under-performing stores during the remainder of fiscal 2003. The costs
associated with closing these stores, including, but not limited to, lease
termination costs and employee severance, is expected to be between $2.7 million
and $3.5 million in the aggregate, of which $2.7 million has been spent through
August 2, 2003. Costs and expenses associated with store closures will be
recognized at the time the liability is incurred. In addition to the Gadzooks'
closings, the Company intends to close one Orchid store during the third quarter
and replace it with a more suitably sized location in another mall. No assurance
can be given, however, that these stores will be closed during fiscal 2003, that
additional stores will not be closed during fiscal 2003 or that the costs
related to closing stores will not exceed the range provided.

RESULTS OF OPERATIONS

The second quarter ended August 2, 2003 compared to the second quarter ended
August 3, 2002

Net Sales

Net sales decreased approximately $8.2 million, or 10.7 percent, to $68.5
million during the second quarter of fiscal 2003 from $76.7 million during the
comparable quarter of fiscal 2002. The total Company sales decrease was due to a
comparable store sales decrease of $7.4 million and a sales decrease of $1.4
million due to closed stores, partially offset by $600,000 of sales from the 11
new stores not yet included in the comparable store sales base. Comparable store
sales decreased 9.9 percent for the second quarter of fiscal 2003. Sales by
category in the average store changed as follows versus the prior year quarter:
junior shoes - increased by 28 percent; junior accessories - increased by 24
percent; junior apparel - increased by 10 percent; and men's merchandise -

10

decreased by 35 percent. The decrease in comparable store sales is attributed to
the conversion to an all-female merchandise assortment and a difficult retail
environment. The Company's average transaction size decreased 9.1 percent, and
the number of transactions per average store increased by 0.2 percent.

Comparable store sales for fiscal August 2003 decreased by 33.6 percent from the
prior year. The Company is currently making inventory level and mix adjustments
that management believes will positively impact the business for the holiday
season as well as the next couple of months. No assurance can be given that
these inventory level and mix adjustments will positively impact future
business.

Gross profit

Gross profit decreased approximately $9.6 million to $9.7 million during the
second quarter of fiscal 2003 from $19.3 million during the comparable quarter
of fiscal 2002. As a percentage of net sales, gross profit decreased 11.1
percentage points to 14.1 percent from 25.2 percent for the comparable quarter
of last year. Merchandise margins as a percentage of sales declined 9.2 percent
from the prior year. This decrease is primarily attributable to the completion
of the men's inventory liquidation and increased markdown activity in the junior
category during the period. Occupancy costs as a percentage of sales increased
by 1.5 percent, and buying and distribution costs as a percentage of sales
increased by 0.3 percent. The increase in occupancy costs (which are relatively
fixed in nature) as a percentage of sales was due to the negative leverage
effect of the comparable store sales decrease, which was slightly offset by
operating leverage achieved as a result of the closing of under performing
stores and reduced depreciation expense resulting from the prior year impairment
of certain under-performing stores. The increase in buying and distribution
costs as a percentage of sales was due primarily to the negative leverage effect
of the comparable store sales decrease.

Selling, general and administrative expenses

Selling, general and administrative expenses ("SG&A") increased approximately
$3.2 million to $22.4 million during the second quarter of 2003 from $19.2
million during the comparable quarter of fiscal 2002. The aggregate increase in
SG&A is primarily attributable to costs of $2.6 million associated with the
liquidation of the men's merchandise, lease termination costs of $1.4 million
and additional advertising and marketing expenses of $302,000 related to the
transition. These costs were offset in part by a reduction in payroll, employee
benefits and inventory service costs as well as a gain on fixtures disposed of
in the second quarter of fiscal 2003 versus a loss recognized in the prior
year's quarter on an abandoned information systems project. As a percentage of
net sales, SG&A increased by 7.7 percentage points to 32.7 percent during the
second quarter of fiscal 2003 from 25.0 percent during the second quarter of
last year. The increase in the SG&A percentage was due to negative leverage from
the comparable store sales decrease, costs associated with the liquidation of
the men's merchandise, lease termination costs and the increase in advertising
and marketing costs related to the transition.

Interest

The Company recorded $35,000 in net interest expense during the second quarter
of fiscal 2003 compared to $21,000 in net interest income in the comparable
period of last year. The change is due primarily to higher fees associated with
the larger credit facility and, to a lesser extent, increased letter of credit
activity, lower average cash balances and lower market interest rates.

Income tax benefit

The Company's income tax status changed to an income tax benefit of $4.9 million
during the second quarter of fiscal 2003 from an income tax provision of $72,000
in the comparable period of last year as a result of the operating loss recorded
in the second quarter of fiscal 2003. The Company anticipates an operating loss
during the transition phase in fiscal 2003 and expects to return to
profitability in fiscal 2004; however, should the loss for fiscal 2003 exceed
projections, the Company may need to recognize a valuation allowance to
significantly reduce its existing deferred tax asset balance and possibly reduce
or eliminate any future tax benefits associated with the generation of net
operating losses. The Company will perform a review of its financial performance
at the end of each quarter during 2003 to evaluate the likelihood of realizing
its deferred tax assets.

11

The six months ended August 2, 2003 compared to the six months ended August 3,
2002.

Net sales

Net sales decreased approximately $15.8 million, or 10.2 percent, to $139.2
million during the first six months of fiscal 2003 from $155.0 million during
fiscal 2002. The total Company sales decrease for the first six months of fiscal
2003 was attributable to a comparable store sales decrease of $15.5 million, or
10.3 percent, and a sales decrease of $1.9 million due to closed stores,
partially offset by $1.6 million of sales for the new stores not yet included in
the comparable store sales base. The Company experienced comparable store sales
increases in all its major categories except men's merchandise, which has now
been completely liquidated as a result of the Company's transition to an
all-female merchandise assortment. The Company's average transaction size
decreased by 6.9 percent, and the number of transactions per average store
decreased by 2.8 percent.

Gross profit

Gross profit decreased approximately $18.0 million to $22.9 million during the
first six months of fiscal 2003 from $40.9 million during the comparable six
months of fiscal 2002. As a percentage of net sales, gross profit decreased 9.9
percentage points to 16.5 percent from 26.4 percent for the comparable six
months of last year. Merchandise margins as a percentage of sales were 7.5
percent lower than the prior year. This decrease is primarily attributable to
the liquidation of the men's inventory and increased markdown activity in the
junior category during the period. Additionally, there was a 2.0 percent
increase in occupancy costs as a percentage of sales and a 0.5 percent increase
in buying and distribution costs as a percentage of sales. The increase in
occupancy, buying and distribution costs as a percentage of sales was due
primarily to the negative leverage effect of the comparable store sales
decrease.

Selling, general and administrative expenses

Selling, general and administrative expenses increased approximately $4.4
million to $42.4 million during the first six months of 2003 from $38.0 million
during the comparable six months of fiscal 2002. The aggregate increase in SG&A
is primarily attributable to costs of $3.0 million associated with the
liquidation of the men's merchandise, lease termination costs of $2.7 million
and additional advertising and marketing expenses of $906,000 related to the
transition. As a percentage of net sales, SG&A increased 6.0 percent to 30.5
percent during the first six months of fiscal 2003 from 24.5 percent during the
comparable six months of last year. The increase in the SG&A percentage is a
result of the negative leverage effect of the comparable store sales decrease,
costs associated with the liquidation of the men's merchandise, lease
termination costs and the increase in advertising and marketing costs related to
the transition.

Interest

The Company recorded $17,000 in net interest expense during the first six months
of fiscal 2003 compared to $65,000 in net interest income in the comparable
period of last year. The change is due primarily to higher fees associated with
the larger credit facility, and to a lesser extent, increased letter of credit
activity, lower average cash balances and lower market interest rates.

Income tax benefit

The Company's income tax status changed to an income tax benefit of $7.5 million
during the first six months of fiscal 2003 from an income tax provision of $1.2
million in the comparable period of last year as a result of the operating loss
recorded in the first six months of fiscal 2003. The Company anticipates an
operating loss for fiscal 2003 and expects to return to profitability in fiscal
2004; however, should the loss for fiscal 2003 exceed projections, the Company
may need to recognize a valuation allowance to significantly reduce its existing
deferred tax asset balance and possibly reduce or eliminate any future tax
benefits associated with the generation of net operating losses. The Company
will perform a review of its financial performance at the end of each quarter
during 2003 to evaluate the likelihood of realizing its deferred tax assets.

12

LIQUIDITY AND CAPITAL RESOURCES

General

The Company is currently meeting its cash requirements through cash and cash
equivalents on-hand and its line of credit. The Company is also seeking
alternative methods for raising additional capital, which may not be available
on favorable terms, if at all.

Cash Flows

At August 2, 2003, cash and cash equivalents were $5.0 million, a decrease of
$15.8 million since February 1, 2003. The primary uses of cash were a net loss
before depreciation of $7.1 million, capital expenditures of $2.8 million and
net working capital changes of $5.9 million.

Credit Facility

On April 11, 2003, the Company and Wells Fargo Retail Finance LLC ("Wells
Fargo") entered into a three-year $30 million revolving credit agreement (the
"Facility"), which is secured by an exclusive and first priority, perfected
interest in all assets of the Company. The Company's borrowings under the
agreement are limited to 85% of the net recovery value of eligible inventory (as
defined by the Facility) plus 85% of eligible credit card accounts receivable
less certain financial reserves specified by Wells Fargo. The credit agreement
also provides for the issuance of letters of credit that are generally used in
connection with international merchandise purchases. Outstanding letters of
credit issued by the bank reduce amounts otherwise available for borrowing under
the revolving line of credit. The credit facility subjects the Company to a
minimum maintained excess availability requirement of $3.0 million (as defined
by the Facility). Amounts borrowed under the revolving line will bear interest
ranging from 1.25% to 2.00% above LIBOR, or 0.25% below to 0.50% above Wells
Fargo's prime rate based on credit line utilization. As of August 2, 2003,
amounts available to borrow under the new credit line, as limited as described
above and by outstanding letters of credit of $5.1 million, totaled $20.9
million.

Conversion to All-Female Merchandise Assortment

The conversion of all Gadzooks stores to an all-female merchandise assortment
took place in July 2003. The Company anticipates an operating loss during the
transition phase in fiscal 2003 and expects to return to profitability in fiscal
2004. Although it is not possible to predict all of the costs associated with
the transition, the Company plans to spend at least $1.5 million to $2.5 million
in fiscal 2003 to market the new concept, of which $906,000 has been spent
through August 2, 2003. The Company hired a consulting firm to help with the
liquidation of its men's inventory. Under the terms of the agreement, the
Company reimbursed the firm for certain operating costs and paid the firm a
portion of the sales proceeds based on certain specified levels of sales
performance as defined in the contract. A total of $3.0 million has been
recorded as selling, general and administrative expenses during the six months
ended August 2, 2003 pursuant to this agreement. No assurance can be given that
the conversion will be successful, or that the Company will return to
profitability.

Store Closings

The Company has already closed 13 stores and contracted to close 12 additional
stores in fiscal 2003. The Company is also pursuing the closure of up to 10 more
under-performing stores in fiscal 2003. The costs associated with closing these
stores, including, but not limited to, lease termination costs and employee
severance, is expected to be between $2.7 million and $3.5 million in the
aggregate, of which $2.7 million has been spent through August 2, 2003. Costs
and expenses associated with store closures will be recognized at the time the
liability is incurred. In addition to the Gadzooks' closings, the Company
intends to close one Orchid store during the third quarter and replace it with a
more suitably sized location in another mall. No assurance can be given,
however, that these stores will be closed during fiscal 2003, that additional
stores will not be closed during fiscal 2003 or that the costs related to the
closing of the stores will not exceed the range provided.

Factoring

Currently, 55 percent to 65 percent of the Company's vendors generate liquidity
by entering into factoring arrangements whereby factors purchase the vendor's
invoices. This financing mechanism allows Gadzooks' vendors to receive payment
in a shorter period of time. Any material changes in the terms extended by these
factors could adversely affect the Company's ability to meet its cash
requirements and maintain necessary liquidity going forward.

13

Capital Expenditures

The Company anticipates capital expenditures of $4.3 million to $4.8 million for
the remainder of fiscal 2003 to pay for fixtures related to the conversion to an
all-female concept, purchase and/or upgrade information systems and reconfigure
its distribution center. The Company believes it can satisfy its cash
requirements for fiscal 2003 using its existing cash balances, cash generated
from operations, and funds available under its revolving credit agreement. The
Company is currently seeking alternative methods for raising additional capital,
which may not be available on favorable terms, if at all. Future cash flows are
subject to a number of variables and there can be no assurance that Gadzooks
will have access to sufficient capital to meet its capital requirements. Any
significant changes, such as changes in the Company's current vendor or factor
payment terms or substantial declines in sales, could materially and adversely
impact Gadzooks' liquidity going forward.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Company does not engage in trading market risk sensitive instruments and
does not purchase as investments, as hedges, or for purposes "other than
trading" instruments that are likely to expose the Company to market risk,
whether it be from interest rate, foreign currency exchange, commodity price or
equity price risk. The Company has issued no debt instruments, entered into no
forward or futures contracts, purchased no options and entered into no swaps.

The Company's primary market risk exposure is that of interest rate risk. A
change in LIBOR, or the Prime Rate as set by Wells Fargo, would affect the rate
at which the Company could borrow funds under its credit Facility.

STATEMENT REGARDING FORWARD-LOOKING DISCLOSURE

Certain sections of this Quarterly Report on Form 10-Q, including the preceding
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," contain various forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended. When used in this report, words
such an "anticipate," "believe," "estimate," "expect," "intend," "plan,"
"predict," "project," "will" and similar expressions, as they relate to us or
our management, identify forward-looking statements. These forward-looking
statements are based on information currently available to our management.
Actual results could differ materially from those contemplated by the
forward-looking statements as a result of certain factors, including, but not
limited to, fluctuations in store sales results, changes in economic conditions,
changes in vendor or factor payment terms, fluctuations in quarterly results and
other factors discussed in this report, as well as in the "Risk Factors" section
of the Company's Annual Report on Form 10-K for the fiscal year ended February
1, 2003. Such statements reflect the current views of our management with
respect to future events and are subject to these and other risks, uncertainties
and assumptions relating to our operations, results of operations, growth
strategy and liquidity. All subsequent written and oral forward-looking
statements attributable to us, or persons acting on our behalf, are expressly
qualified in their entirety by this paragraph.

CONTROLS AND PROCEDURES

Our management, with the participation of our Chairman of the Board and Chief
Executive Officer (our principal executive officer) and our Chief Financial
Officer (our principal financial officer) have concluded, based on their
evaluation as of the end of the period covered by this report, that our
disclosure controls and procedures are effective to ensure that information
required to be disclosed by us in the reports filed or submitted by us in under
the Securities Exchange Act of 1934, as amended, is recorded, processed,
summarized and reported within the time periods specified in the SEC's rules and
forms, and include controls and procedures designed to ensure that information
required to be disclosed by us in such reports is accumulated and communicated
to our management, including our principal executive officer and financial
officer, as appropriate to allow timely decisions regarding required disclosure.

There were no changes in our internal controls during the period covered by this
report that have materially affected or are reasonably likely to materially
affect our internal controls over financial reporting going forward.

14

PART II - OTHER INFORMATION

Items 1-3 - None

Item 4 - Submission of Matters to a Vote of Security Holders

(a) The Annual Meeting of Shareholders of the Company was held on
June 17, 2003.

(b) Information regarding the Company's directors is contained in
the Company's Definitive Proxy Statement, which was filed with
the Commission on May 13, 2003.

(c) Election of Directors: Carolyn Greer Gigli, Ron G. Stegall and
Gerald R. Szczepanski were elected to serve as directors until
the Company's 2006 annual meeting of shareholders according to
the following vote:

Amendment to 1995 Stock Option Plan: The 1995 Non-Employee
Director Stock Option Plan (the "Director Plan") was amended
to (i) increase the number of shares for which options will be
granted to newly-elected or appointed non-employee directors
from 5,000 shares to 15,000 shares, (ii) provide for a
one-time grant of an option to purchase 10,000 shares to each
non-employee director on the day of the Annual Meeting and
(iii) increase the number of shares available for issuance
under the Director Plan from 100,000 to 200,000.

For: 8,341,483
Against or Withheld: 396,314
Abstention: 55,408

Amendment to Employee Stock Purchase Plan: The Employee Stock
Purchase Plan was amended to increase the maximum aggregate
number of shares reserved for issuance from 110,000 to
160,000.

For: 8,610,924
Against or Withheld: 139,198
Abstention: 43,083

Ratification of Accountants: The selection of
PricewaterhouseCoopers LLP as the Company's independent
accountants for the fiscal year ending January 31, 2004 was
ratified by the shareholders according to the following vote:

For: 8,651,786
Against or Withheld: 137,864
Abstention: 3,555

(d) None

Item 5 - None

Item 6 - Exhibits and Reports on Form 8-K.

(a) See Index of Exhibits.

(b) None.

15

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.

GADZOOKS, INC.
(Registrant)

DATE: September 4, 2003 By: /s/ JAMES A. MOTLEY
-------------------------------------------
James A. Motley
Vice President / Chief Financial Officer
(Chief Accounting Officer and
Duly Authorized Officer of the Registrant)

16

INDEX TO EXHIBITS

- ----------

* Filed herewith.

17