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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED: APRIL 30, 2004
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ______________________ to _____________________
Commission File number: 0-028176
Whitehall Jewellers, Inc.
(Exact name of registrant as specified in its charter)
Delaware 36-1433610
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
155 N. Wacker Drive, Suite 500, Chicago, IL 60606
(Address of principal executive offices) (zip code)
312/782-6800
(Registrant's telephone number, including area code)
(Former name, former address and former fiscal
year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [X[ No [ ]
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.
The number of shares of the Registrant's common stock, $.001 par value per
share, outstanding as of June 1, 2004 was 13,937,944 and the number of shares of
the Registrant's Class B common stock, $1.00 par value per share, outstanding as
of June 4, 2004 was 142.
PART I - FINANCIAL INFORMATION
Item 1- Financial Statements
Whitehall Jewellers, Inc.
Statements of Operations
for the three months ended April 30, 2004 and 2003
(unaudited)
(in thousands, except per share data)
Three months ended
-------------------------------
April 30, 2004 April 30, 2003
-------------- --------------
Net sales $ 73,028 $ 69,149
Cost of sales (including buying and occupancy
expenses) 48,752 46,038
-------- --------
Gross profit 24,276 23,111
Selling, general and administrative expenses 27,036 26,135
Professional fees and other charges 2,653 635
-------- --------
Loss from operations (5,413) (3,659)
Interest expense 905 908
-------- --------
Loss before income taxes (6,318) (4,567)
Income tax benefit (2,622) (1,780)
-------- --------
Net loss $ (3,696) $ (2,787)
======== ========
Basic earnings per share:
Net loss $ (0.27) $ (0.20)
======== ========
Weighted average common shares and common
share equivalents 13,930 14,206
======== ========
Diluted earnings per share:
Net loss $ (0.27) $ (0.20)
======== ========
Weighted average common shares and common
share equivalents 13,930 14,206
======== ========
The accompanying notes are an integral part of the financial statements.
2
Whitehall Jewellers, Inc.
Balance Sheets
As of April 30, 2004, January 31, 2004 and April 30, 2003
(unaudited, in thousands, except share data)
April 30, 2004 January 31, 2004 April 30, 2003
-------------- ---------------- --------------
ASSETS
Current Assets:
Cash $ 1,432 $ 1,901 $ 1,302
Accounts receivable, net 1,078 2,544 719
Merchandise inventories 197,990 206,146 205,020
Current income tax benefit 4,591 2,294 2,251
Other current assets 837 875 2,281
Deferred financing costs 278 261 510
Deferred income taxes, net 5,791 5,712 2,638
--------- --------- ---------
Total current assets 211,997 219,733 214,721
Property and equipment, net 60,032 60,948 63,655
Goodwill, net 5,662 5,662 5,662
Deferred financing costs 690 654 161
--------- --------- ---------
Total assets $ 278,381 $ 286,997 $ 284,199
========= ========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Revolver loan $ 104,849 $ 80,340 $ 88,559
Current portion of long-term debt 640 640 3,000
Accounts payable 32,289 60,538 49,088
Customer deposits 3,587 3,601 3,635
Accrued payroll 4,542 4,457 4,583
Other accrued expenses 23,471 24,479 12,581
--------- --------- ---------
Total current liabilities 169,378 174,055 161,446
Subordinated debt -- -- 640
Deferred income taxes, net 3,352 3,639 3,753
Other long-term liabilities 3,534 3,535 3,216
--------- --------- ---------
Total liabilities 176,264 181,229 169,055
Commitments and contingencies
Stockholders' equity:
Common stock 18 18 18
Class B common stock -- -- --
Additional paid-in capital 106,122 106,091 105,755
Retained earnings 35,615 39,311 45,238
Treasury stock, at cost (4,119,010;
4,134,143 and 3,817,742 shares,
respectively) (39,638) (39,652) (35,867)
--------- --------- ---------
Total stockholders' equity, net 102,117 105,768 115,144
--------- --------- ---------
Total liabilities and
stockholders' equity $ 278,381 $ 286,997 $ 284,199
========= ========= =========
The accompanying notes are an integral part of the financial statements.
3
Whitehall Jewellers, Inc.
Statements of Cash Flows
for the three months ended April 30, 2004 and 2003
(unaudited, in thousands)
Three months ended
-------------------------------
April 30, 2004 April 30, 2003
-------------- --------------
Cash flows from operating activities:
Net loss $ (3,696) $ (2,787)
Adjustments to reconcile net loss to net cash
(used in) provided by operating activities:
Depreciation and amortization 3,142 2,919
Loss on disposition of assets 138 18
Deferred compensation expense 25 --
Changes in assets and liabilities:
Decrease in accounts receivable, net 1,466 902
Decrease (increase) in merchandise
inventories 8,156 (8,326)
Decrease (increase) in other current
assets 38 (811)
(Increase) in current income tax benefit (2,297) (2,251)
(Decrease) increase in deferred income (366) 135
taxes, net
(Decrease) increase in accounts payable (28,709) 19,638
(Decrease) in income taxes payable -- (3,303)
(Decrease) increase in customer deposits (14) 181
Increase in accrued payroll 85 1,301
(Decrease) increase in accrued liabilities (1,008) 1,201
(Decrease) increase in other long-term
liabilities (1) 78
--------- ---------
Net cash (used in) provided by operating
activities (23,041) 8,895
Cash flows from investing activities:
Capital expenditures (2,297) (4,831)
--------- ---------
Net cash (used in) investing activities (2,297) (4,831)
Cash flows from financing activities:
Borrowing on revolver loan 275,400 166,804
Repayment of revolver loan (250,891) (172,735)
Outstanding checks increase 460 2,666
Repayment of term loan -- (1,500)
Financing costs (120) (75)
Proceeds from employee stock purchase plan 14 30
Proceeds from exercise of stock options 6 --
--------- ---------
Net cash provided by (used in) financing
activities 24,869 (4,810)
--------- ---------
Net change in cash and cash equivalents (469) (746)
Cash and cash equivalents at beginning of period 1,901 2,048
--------- ---------
Cash and cash equivalents at end of period $ 1,432 $ 1,302
========= =========
The accompanying notes are an integral part of the financial statements.
4
Whitehall Jewellers, Inc.
Notes to Financial Statements
1. DESCRIPTION OF OPERATIONS
The financial statements of Whitehall Jewellers, Inc. (the "Company")
include the results of the Company's chain of specialty retail fine jewelry
stores. The Company operates exclusively in one business segment, specialty
retail jewelry. The Company has a national presence with 385 stores as of April
30, 2004, located in 38 states, operating in regional or superregional shopping
malls. The consolidated financial statements include the accounts and
transactions of the Company and its subsidiaries. Intercompany accounts and
transactions have been eliminated.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis for Presentation
The accompanying unaudited financial statements have been prepared in
accordance with Rule 10-01 of Regulation S-X. Consequently, they do not include
all of the disclosures required under accounting principles generally accepted
in the United States of America for complete financial statements. The interim
financial statements reflect all adjustments (consisting only of normal
recurring accruals) which are, in the opinion of management, necessary for a
fair presentation of financial position, results of operations and cash flows
for the interim periods presented. For further information regarding the
Company's accounting policies, refer to the financial statements and footnotes
thereto included in the Whitehall Jewellers, Inc. Annual Report on Form 10-K for
the fiscal year ended January 31, 2004. References in the following notes to
years and quarters are references to fiscal years and fiscal quarters.
Merchandise Inventories
Merchandise inventories are stated principally at the lower of weighted
average cost or market. Purchase cost is reduced to reflect certain allowances
and discounts received from merchandise vendors. Periodic credits or payments
from merchandise vendors in the form of consignment buydowns, volume or other
purchase discounts and other vendor consideration are reflected in the carrying
value of the inventory and recognized as a component of cost of sales as the
merchandise is sold. Additionally, to the extent it is not addressed by
established vendor return privileges, and if the amount of cash consideration
received from the vendor exceeds the estimated fair value of the goods returned,
that excess amount is reflected as a reduction in the purchase cost of the
inventory acquired. Allowances for inventory shrink, scrap and other provisions
are recorded based upon analysis and estimates by the Company.
To the extent the Company's agreements with merchandise vendors provide
credits for co-op advertising, the Company has historically classified such
credits as a reduction to advertising expense in selling, general and
administrative expenses. Emerging Issues Task Force Issue No. 02-16, "Accounting
by a Customer (Including a Reseller) for Certain Consideration Received from a
Vendor" ("EITF 02-16"), which was effective for all arrangements entered into
after December 31, 2002, requires certain merchandise vendor allowances to be
classified as a reduction to inventory cost unless evidence exists supporting an
alternative classification. The Company has recorded such merchandise vendor
allowances as a reduction of inventory cost. In prior years, certain vendors
reimbursed the Company for certain co-op advertising costs that were incurred.
In 2003, the Company
5
changed the terms of its Vendor Trading Agreements to include a vendor allowance
for advertising calculated as a percentage of net merchandise purchases. The
Company earned $426,000 and $489,000 of vendor allowances for advertising for
the first quarter of fiscal year 2004 and 2003, respectively. The Company
records such allowances as a reduction of inventory cost and as the inventory is
sold, the Company will recognize a lower cost of sales.
The Company also obtains merchandise from vendors under various
consignment agreements. The consigned inventory and related contingent
obligations associated with holding and safekeeping such consigned inventory are
not reflected in the Company's financial statements. At the time of sale of
consigned merchandise to customers, the Company records the purchase liability
and the related consignor cost of such merchandise in cost of sales.
Legal Contingencies
The Company is involved in certain legal matters and other claims
including those discussed in Note 8 to the financial statements. As required by
Financial Accounting Standards Board Statement No. 5, "Accounting for
Contingencies", the Company determines whether an estimated loss from a loss
contingency should be accrued by assessing whether a loss is deemed probable and
can be reasonably estimated. The Company analyzes its legal matters and other
claims based on available information to assess potential liability. The Company
consults with outside counsel involved in our legal matters when analyzing
potential outcomes. The accrual for these matters totaled $9.0 million at April
30, 2004.
Based on the nature of such estimates, it is possible that future results
of operations or net cash flows could be materially affected if actual outcomes
are significantly different than management's estimates related to these
matters.
Advertising and Marketing Expense
The Company expenses the production costs of advertising the first time
the advertising takes place, except for direct-response advertising, which is
capitalized and amortized over the expected period of future benefit.
Advertising expense was $1.8 million and $1.4 million for the first quarter of
fiscal years 2004 and 2003, respectively.
Direct-response advertising consists primarily of special offers, flyers
and catalogs that include value off coupons for merchandise.
Income Taxes
Due to the seasonal nature of the business, the Company tends to generate
a significant portion of its income in the fourth quarter. While the 41.5%
effective tax rate currently estimated for the year is management's best
estimate, to the extent that income is significantly more or less than expected,
the Company's effective income tax rate for the remainder of fiscal year 2004
could vary significantly from that of the first quarter.
Stock-Based Compensation
The Financial Accounting Standards Board issued Statement No. 148 ("SFAS
148"), "Accounting for Stock-Based Compensation-Transition and Disclosure,"
during 2002. SFAS 148 amends Statement No. 123 ("SFAS 123"), "Accounting for
Stock-Based Compensation," to provide alternative methods of transition for a
voluntary change to the fair value based method of accounting for stock-based
employee compensation and amends the disclosure requirements to require
6
prominent disclosures in both annual and interim financial statements about the
method of accounting for stock-based employee compensation and the effect of the
method used on reported results. The Company adopted the disclosure requirements
of SFAS 148 as of January 31, 2003.
The Company accounts for stock-based compensation according to Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees,"
which results in no charge to earnings when options are issued at fair market
value.
The following table illustrates the effect on net income and earnings per
share for the three months ended April 30, 2004 and 2003, if the Company had
applied the fair value recognition provisions of SFAS 123, as amended by SFAS
148, to stock-based employee compensation.
April 30, 2004 April 30, 2003
-------------- --------------
Net loss, as reported $ (3,696) $ (2,787)
Deduct: Total stock-based employee
compensation expense determined
under fair value based method, net
of related tax effects 156 267
-------- --------
Pro forma net loss $ (3,852) $ (3,054)
======== ========
Earnings per share:
Basic-as reported $ (0.27) $ (0.20)
======== ========
Basic-pro forma $ (0.28) $ (0.21)
======== ========
Diluted-as reported $ (0.27) $ (0.20)
======== ========
Diluted-pro forma $ (0.28) $ (0.21)
======== ========
For purposes of the pro forma net income and earnings per share
calculation in accordance with SFAS 123, for each option granted during the
three months ended April 30, 2004 and 2003, the fair value is estimated using
the Black-Scholes option-pricing model. The assumptions used are as follows:
April 30, 2004 April 30, 2003
-------------- --------------
Risk-free interest rate 3.3% 3.0%
Dividend yield 0 0
Option life 5.5 years 5.5 years
Volatility 58% 61%
7
Accounting for Guarantees
In November 2002, the Financial Standards Accounting Board issued FASB
Interpretation No. 45 ("FIN 45"), "Guarantor's Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of
Others," an interpretation of FASB Statements No. 5, 57 and 107 and rescission
of FASB Interpretation No. 34. The Company has adopted the guidance of FIN 45
and has reflected the required disclosures in its financial statements
commencing with the financial statements for the year ended January 31, 2003.
Under its bylaws, the Company has agreed to indemnify its officers and
directors for certain events or occurrences while the officer or director is
serving, or was serving, at its request in such capacity. The maximum potential
amount of future payments the Company could be required to make pursuant to
these indemnification obligations is unlimited; however, the Company has
purchased directors and officers liability insurance that, under certain
circumstances, enables it to recover a portion of any future amounts paid. The
Company has no liabilities recorded for these obligations as of April 30, 2004,
however, reference should be made to Note 8 to the financial statements with
respect to legal contingencies.
3. ACCOUNTS RECEIVABLE, NET
As of April 30, 2004, January 31, 2004 and April 30, 2003, accounts
receivable consisted of (in thousands):
April 30, 2004 January 31, 2004 April 30, 2003
-------------- ---------------- --------------
Accounts receivable $ 1,616 $ 3,082 $ 1,366
Less: allowance for
doubtful accounts (538) (538) (647)
------- ------- -------
Accounts receivable,
net $ 1,078 $ 2,544 $ 719
======= ======= =======
4. MERCHANDISE INVENTORIES
As of April 30, 2004, January 31, 2004 and April 30, 2003, merchandising
inventories consisted of (in thousands):
April 30, 2004 January 31, 2004 April 30, 2003
-------------- ---------------- --------------
Raw Materials $ 9,957 $ 9,827 $ 6,514
Finished Goods 188,033 196,319 198,506
-------- -------- --------
Inventory $197,990 $206,146 $205,020
======== ======== ========
Raw materials consist primarily of diamonds, precious gems, semi-precious
gems and gold. Included within finished goods inventory were allowances for
inventory shrink, scrap, and miscellaneous costs of $4,703,000; $3,731,000 and
$2,507,000 as of April 30, 2004, January 31, 2004 and April 30, 2003,
respectively. As of April 30, 2004, January 31, 2004 and April 30, 2003,
consignment inventories held by the Company that were not included in the
balance sheets totaled $86,185,000; $91,635,000 and $72,991,000, respectively.
8
Certain merchandise procurement, distribution and warehousing costs were
allocated to inventory. As of April 30, 2004, January 31, 2004 and April 30,
2003, the amounts included in inventory were $3,537,000; $3,500,000 and
$3,572,000, respectively.
5. ACCOUNTS PAYABLE
Accounts payable includes outstanding checks, which were $4,625,000;
$4,166,000 and $9,178,000 as of April 30, 2004, January 31, 2004 and April 30,
2003, respectively.
6. FINANCING ARRANGEMENTS
Effective July 29, 2003, the Company entered into a Second Amended and
Restated Revolving Credit and Gold Consignment Agreement (as amended, the
"Credit Agreement"), with certain members of its prior bank group to provide for
a total facility of $125.0 million through July 28, 2007. Interest rates and the
commitment fees charged on the unused portion of the facility float based upon
the Company's financial performance as calculated quarterly.
Under the Credit Agreement, the banks have a collateral security interest
in substantially all of the assets of the Company. The Credit Agreement contains
certain restrictions, including restrictions on investments, payment of
dividends, assumption of additional debt, acquisitions and divestitures. The
Credit Agreement also requires the Company to maintain a specified ratio of the
sum of earnings before interest, taxes, depreciation and amortization plus
minimum store rent to the sum of minimum store rent plus cash interest expense.
As of April 30, 2004, the calculated revolver availability, pursuant to the
Credit Agreement, was $120.8 million. The Company had $104.8 million of
outstanding borrowings under the revolving loan facility as of April 30, 2004.
The Company amended the Credit Agreement effective March 23, 2004 in order
to, among other things, (i) add a reserve for customer deposits to the Borrowing
Base (as defined in the Credit Agreement), (ii) add and amend certain financial
covenants, including amending the Fixed Charge Coverage Ratio (as defined in the
Credit Agreement) and adding a covenant to maintain a Net Worth (as defined in
the Credit Agreement) of at least $90.0 million at January 31, 2005, (iii) cap
the borrowings under the facility to a maximum of $85.0 million for at least
thirty consecutive calendar days during the period December 15, 2004 through and
including February 15, 2005, (iv) increase the interest rate at which LIBOR
based borrowings are available under the Credit Agreement to LIBOR plus 2.5%
through April 30, 2005, (v) set the Commitment Fee Rate (as defined in the
Credit Agreement) at 0.5% through April 30, 2005, and (vi) set the Standby
Letter of Credit Fee Rate (as defined in the Credit Agreement) at 2.0% through
April 30, 2005.
As of March 22, 2004, the Company and its lenders entered into a letter
agreement pursuant to which the lenders under the Credit Agreement have agreed
that, as of March 23, 2004, the consolidated Capital Factors actions, the
Securities and Exchange Commission (the "SEC") investigation and the United
States Attorney's investigation have not resulted in a breach of the Credit
Agreement. In addition, the lenders have agreed that none of these matters will
give rise to a default or event of default under the Credit Agreement so long as
the resolution of such matters does not involve the payment by the Company of
Restitution (which is defined below) in an amount in excess of $15.0 million or
does not result in the indictment of the Company or any of its current officers,
directors or employees with principal financial or accounting responsibilities.
The letter agreement also states that any settlement involving the payment of
Restitution in excess of $15.0 million shall constitute a default under the
Credit Agreement or any indictment of the
9
Company or any of the persons described above may constitute a default under the
Credit Agreement.
"Restitution" is defined as any restitution paid by the Company (whether
cash or non-cash or current or deferred consideration) arising from a civil
litigation settlement or award and/or criminal penalties paid or payable in
connection with the Capital Factors litigation, the SEC investigation, and/or
the United States Attorney investigation and any other actions or proceedings
directly related thereto; excluding however, (i) amounts paid by the Company for
consignment inventory held on behalf of the parties involved in the Capital
Factors litigation, (ii) amounts already accrued on the books of the Company for
the purchase of merchandise from the parties involved in the Capital Factors
litigation and (iii) the value of any consigned inventory returned to parties
involved in the Capital Factors litigation.
At this time, the Company does not expect the payment of Restitution to
exceed $15.0 million and, based on the Company's current financial plan, expects
to be in compliance with all financial covenants as set forth in the Credit
Agreement for the remainder of fiscal year 2004.
Subject to the contingencies identified in Note 8 to the financial
statements and other risks, including those identified in Forward-Looking
Statements, management expects that based on our current financial plan the cash
flow from operating activities and funds available under the Company's revolving
loan facility should be sufficient to support the Company's current new store
expansion program, seasonal working capital needs and liabilities that may arise
with respect to the Capital Factors related matters and the investigations of
the United States Attorney's Office and the SEC. Additionally, the Company
intends to vigorously contest the putative class action complaints described in
Note 8 and exercise all of its available rights and remedies. Given that these
class action cases are in their early stages, and no substantive proceedings
have occurred, it is not possible to evaluate the likelihood of an unfavorable
outcome in any of these matters, or to estimate any amount or range of potential
loss, if any. While there are many potential outcomes, an adverse outcome in
these actions could have a material adverse effect on the Company's results of
operations, financial condition or liquidity. It cannot be determined at this
stage whether these claims will be resolved in the fiscal year ending January
31, 2005.
If the Company were to trigger an event of default pursuant to the March
22, 2004 letter agreement, the Company may be required to negotiate relief with
its lenders or to seek new financing. There is no assurance that new financing
arrangements would be available on acceptable terms or at all. If the existing
lenders were to cease funding under the revolving loan facility or require
immediate repayment and if the Company were not able to arrange new financing on
acceptable terms, this would have a material adverse effect on the Company,
which could affect the underlying valuation of its assets and liabilities.
The Company expects professional fees to be higher during the second and
third quarters of fiscal 2004 as compared to the prior year periods primarily
due to the matters discussed in Note 8 to the financial statements. These higher
fees will continue to negatively impact earnings and cash flow.
Revolver Loan
The revolving loan facility under the Credit Agreement is available up to
a maximum of $125.0 million, including amounts consigned under the gold
consignment facility, and is limited by a borrowing base computed based on the
value of the Company's inventory and accounts receivables. Availability under
the revolver is based on amounts outstanding thereunder, including the value
10
of consigned gold, if any, which fluctuates based on gold prices. Interest rates
and commitment fees on the unused facility float based on the Company's
quarterly financial performance.
The interest rates for borrowings under the Credit Agreement are, at the
Company's option, based on LIBOR rates or the United States banks' prime rate.
Interest is payable monthly for prime borrowings and upon maturity for LIBOR
borrowings.
Term Loan
In connection with the Credit Agreement, the Company paid the term loan
outstanding under the prior credit agreement, totaling $4.5 million during
fiscal 2003. Interest rates for these borrowings were, at the Company's option,
based on LIBOR rates or the United States banks' prime rate. Interest was
payable monthly for prime borrowings and upon maturity for LIBOR borrowings.
Interest rates and the commitment fee charged on the unused facility float based
on the Company's quarterly financial performance.
Gold Consignment Facility
The Company has the opportunity to enter into gold consignments with
certain third party financial institutions. At this time the Company has no
obligations under the gold consignment facility. In the event of a consignment
of gold, the Company provides the third party financial institution with title
to a certain number of troy ounces of gold held in the Company's existing
merchandise inventory in exchange for cash at the current market price of gold.
The Company then consigns the gold from the third party financial institution,
pursuant to a gold consignment agreement. This agreement entitles the Company to
use the gold in the ordinary course of its business. The gold consignment
facility is a transfer of title in specified quantities of the gold content of
the Company's inventory (a non-financial asset) to a financial institution in
exchange for cash. The Company continues to bear responsibility for damage to
the inventory, as is the case in all of its consigned inventory arrangements
with its other vendors.
The Company accounts for gold consignment transactions as a reduction in
its inventories, as it transfers title to the gold to the financial institution.
Similar to other consigned inventories in the possession of the Company (for
which the Company bears risk of loss but does not possess title), the value of
the inventory is not included in the assets of the Company. The terms of the
gold consignment agreement require the Company to deliver the specified
quantities of consigned gold back to the third party financial institution at
the end of the facility (which currently expires in 2007). Physical delivery can
be made from the Company's inventory or from gold acquired by the Company in the
open market. As an alternative to physical delivery of these specific troy
ounces of gold, the Company can elect to purchase the consigned quantities at
the current market price for gold on that date. The Company currently has no
gold consignment obligations to the banks under the Credit Agreement.
11
7. DILUTIVE SHARES THAT WERE OUTSTANDING DURING THE PERIOD
The following table summarizes the reconciliation of the numerators and
denominators for the basic and diluted earnings per share ("EPS") computations
at April 30, 2004 and 2003.
Three months ended
April 30, 2004 April 30, 2003
-------------- --------------
(in thousands)
Net loss $ (3,696) $(2,787)
Weighted average shares for basic EPS 13,930 14,206
Incremental shares upon conversions:
Stock options --- ---
Weighted average shares for diluted EPS 13,930 14,206
Stock options excluded from the calculation of diluted earnings per share
for the three months ended April 30, 2004 and 2003, were 2,285,767 and 2,433,660
respectively, due to their antidilutive effect on the calculations.
8. COMMITMENTS AND CONTINGENCIES
The Company has been named as one of 14 defendants in a lawsuit originally
filed in the United States District Court for the Southern District of New York,
now pending in New York State Supreme Court, Commercial Division. The case is
brought by Capital Factors, Inc. ("Capital Factors"), which provided financing
to defendant Cosmopolitan Gem Corp. ("Cosmopolitan"), an entity with which the
Company has certain consignment and other commercial arrangements. The complaint
alleges that Cosmopolitan defrauded Capital Factors into advancing funds to
Cosmopolitan by misrepresenting Cosmopolitan's finances and the profitability of
its operations, and that the Company, along with other persons and entities,
including other jewelry retailers, aided and abetted or participated in the
alleged fraud. The complaint asserts against the defendants, including the
Company, claims under common law and the Racketeer Influenced and Corrupt
Organizations Act ("RICO"). Capital Factors seeks aggregate damages from all of
the defendants, including the Company, of $30,000,000, plus unspecified punitive
damages, interest and fees. Damages, excluding punitive damages, awarded
pursuant to claims asserted under RICO as well as interest on such damages are
subject to trebling, within the discretion of the court.
The Company has also been named as one of 13 defendants in an amended
complaint filed on December 2, 2003 by International Diamonds, L.L.C.
("International") and its affiliate, Astra Diamonds Manufacturers, Ltd.
("Astra"). Astra is an Israeli diamond wholesaler that supplied diamonds to
Cosmopolitan; International is a joint venture formed by Cosmopolitan and Astra
to sell high quality finished diamond jewelry in the United States. The amended
complaint, consolidated with the Capital Factors action described above (the
"consolidated Capital Factors actions"), alleges that the Company, along with
other jewelry retailers and business affiliates of Cosmopolitan, participated in
Cosmopolitan's fraudulent scheme to defraud Capital Factors, and thus injured
International and Astra. The complaint asserts claims under common law and RICO,
seeking aggregate damages from all of the defendants, including the Company, of
$6,800,000 plus interest and fees. Damages awarded pursuant to claims asserted
under RICO as well as interest on such damages are subject to trebling, within
the discretion of the court. In addition, the complaint alleges claims against
the Company for breach of contract for
12
approximately $2,520,000 in goods delivered and invoiced to the Company, for
which International has not received payment.
In connection with the consolidated Capital Factors actions in New York
state court, the Company has filed an interpleader action for declaratory
relief, asking the Court to determine the proper parties to whom the Company
must pay amounts and deliver goods that are not in dispute related to goods
received from Cosmopolitan and certain other entities. In its answer to the
interpleader, Capital Factors has asserted that the Company owes Cosmopolitan
$8,600,000 in accounts receivable on invoices assigned to Capital Factors. This
amount is included in the $30,000,000 of losses that Capital Factors seeks in
its RICO claims. In addition, Ultimo, Inc. ("Ultimo"), a jewelry supplier, is a
defendant in the International action and in the interpleader action. Ultimo
provided certain items of jewelry to the Company on a consignment basis and
asserts that: (1) the Company has sold approximately $450,000 worth of such
items, the proceeds of which it claims remain in the Company's possession; and
(2) the Company continues to possess approximately $1,780,000 worth of its
consignment goods. Ultimo asserts that it should receive these consignment
proceeds and goods. Capital Factors and International also have asserted claims
to these proceeds and goods. The Company plans to place the remaining
consignment goods into escrow, and the New York State Supreme Court has
announced that it will hold a hearing as early as June 2004 to determine the
proper distribution of these consignment goods. The consignment proceeds and the
amount of accounts payable due already have been placed in the Company's outside
counsel's escrow account pending court determination of the proper recipient.
The Company is not currently aware of any accounts payable due and owing to any
of the claimants in this action that are not already reflected in the Company's
accounts payable and accrued liabilities or that have been placed in the
Company's outside counsel's escrow account.
In these consolidated Capital Factors actions, document discovery has
begun and certain depositions have been taken. In addition, the Company has
filed motions to dismiss both the Capital Factors and International/Astra
complaints. The motions are currently pending before the court.
As previously disclosed, the United States Attorney for the Eastern
District of New York is conducting a criminal investigation regarding matters
that include those alleged in the consolidated Capital Factors actions. The
Company, among others, is a subject of this criminal investigation and is
cooperating fully with the United States Attorney.
In addition, subsequent to the filing of the complaint by Capital Factors
and as previously disclosed, the SEC initiated an informal inquiry into matters
that are the subject of the consolidated Capital Factors actions. On November 3,
2003, the Company received a subpoena issued by the SEC as a part of a formal
investigation by the SEC with respect to the matters that are the subject of the
consolidated Capital Factors actions. The Company produced documents to the SEC
in response to the SEC's subpoena and information requests. The Company is
cooperating fully with the SEC in connection with this formal investigation.
In accordance with Financial Accounting Standards Board Statement No. 5,
"Accounting for Contingencies," the Company determines whether an estimated loss
from a loss contingency should be accrued by assessing whether a loss is deemed
probable and can be reasonably estimated. For the fourth quarter of the fiscal
year ended January 31, 2004, the Company recorded a litigation accrual of $8.6
million for the consolidated Capital Factors actions and the United States
Attorney and SEC investigations. As previously disclosed in a press release
furnished to the SEC under cover of a Current Report on Form 8-K dated May 27,
2004, for the first quarter of fiscal year 2004, the Company
13
recorded an additional accrual in the amount of $350,000 with respect to these
matters in light of ongoing settlement discussions. There are no assurances that
the Company will be able to reach a settlement with any of the parties to the
consolidated Capital Factors actions or that such a settlement or settlements,
as the case may be, will be for the amount recorded as a reserve. However, the
Company currently believes that it is more likely than not that it will reach a
settlement or settlements, as the case may be, pertaining to the consolidated
Capital Factors actions in the near term. Given the amounts sought in the
consolidated Capital Factors actions, and the inherent unpredictability of
litigation, it is possible that an adverse outcome in excess of the amount
recorded could occur and these actions could have a material adverse effect on
the Company's results of operations, financial condition or liquidity. The
Company is unable at this time to predict the ultimate outcome of the
consolidated Capital Factors actions or the United States Attorney and SEC
investigations.
As of March 22, 2004, the Company and its lenders entered into a letter
agreement pursuant to which the lenders under the Credit Agreement have agreed
that, as of March 23, 2004, the consolidated Capital Factors actions, the SEC
investigation and the United States Attorney's investigation have not resulted
in a breach of the Credit Agreement. In addition, the lenders have agreed that
none of these matters will give rise to a default or event of default under the
Credit Agreement so long as the resolution of such matters does not involve the
payment by the Company of Restitution (which is defined below) in an amount in
excess of $15.0 million, or does not result in the indictment of the Company or
any of its current officers, directors or employees with principal financial or
accounting responsibilities. The letter agreement also states that any
settlement involving the payment of Restitution in excess of $15.0 million shall
constitute a default under the Credit Agreement or any indictment of the Company
or any of the persons described above may constitute a default under the Credit
Agreement.
"Restitution" is defined as any restitution paid by the Company (whether
cash or non-cash or current or deferred consideration) arising from a civil
settlement or award and/or criminal penalties paid or payable in connection with
the Capital Factors litigation, the SEC investigation and/or the United States
Attorney investigation and any other actions or proceedings directly related
thereto; excluding, however, (i) amounts paid by the Company for consignment
inventory held on behalf of the parties involved in the Capital Factors
litigation and (ii) amounts already accrued on the books of the Company for the
purchase of merchandise from the parties involved in the Capital Factors
litigation and (iii) the value of any consigned inventory returned to parties
involved in the Capital Factors litigation.
At this time the Company does not expect the payment of Restitution to
exceed $15.0 million and, based on the Company's current financial plan, expects
to be in compliance with all financial covenants as set forth in the Credit
Agreement for the remainder of fiscal year 2004.
On February 12, 2004, a putative class action complaint captioned Greater
Pennsylvania Carpenters Pension Fund, et al. v. Whitehall Jewellers, Inc. et
al., Case No. 04 C 1007, was filed in the U.S. District Court for the Northern
District of Illinois against the Company and certain of the Company's current
and former officers. The complaint makes reference to the litigation filed by
Capital Factors, Inc. above and to the Company's November 21, 2003 announcement
that it had discovered violations of Company policy by the Company's Executive
Vice President, Merchandising, with respect to Company documentation regarding
the age of certain store inventory. The complaint further makes reference to the
Company's December 22, 2003 announcement that it would restate results for
certain prior periods. The complaint purports to allege that the Company and its
officers made false and misleading statements
14
and falsely accounted for revenue and inventory during the putative class period
of November 19, 2001 to December 10, 2003. The complaint purports to allege
violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934
("1934 Act") and Rule 10b-5 promulgated thereunder.
On February 18, 2004, a putative class action complaint captioned Michael
Radigan, et al., v. Whitehall Jewellers, Inc. et al., Case No. 04 C 1196, was
filed in the U.S. District Court for the Northern District of Illinois against
the Company and certain of the Company's current and former officers, charging
violations of Sections 10(b) and 20(a) of the 1934 Act and Rule 10b-5
promulgated thereunder, and alleging that the Company and its officers made
false and misleading statements and falsely accounted for revenue and inventory
during the putative class period of November 19, 2001 to December 10, 2003. The
factual allegations of this complaint are similar to those made in the Greater
Pennsylvania Carpenters Pension Fund complaint discussed above.
On February 20, 2004, a putative class action complaint captioned Milton
Pfeiffer, et al., v. Whitehall Jewellers, Inc. et al., Case No. 04 C 1285, was
filed in the U.S. District Court for the Northern District of Illinois against
the Company and certain of the Company's current and former officers, charging
violations of Sections 10(b) and 20(a) of the 1934 Act and Rule 10b-5
promulgated thereunder, and alleging that the Company and its officers made
false and misleading statements and falsely accounted for revenue, accounts
payable, inventory, and vendor allowances during the putative class period of
November 19, 2001 to December 10, 2003. The factual allegations of this
complaint are similar to those made in the Greater Pennsylvania Carpenters
Pension Fund complaint discussed above.
On April 6, 2004, the District Court in the Greater Pennsylvania
Carpenters case, No. 04 C 1107 consolidated the Pfeiffer and Radigan complaints
with the Greater Pennsylvania Carpenters action, and dismissed the Radigan and
Pfeiffer actions as separate actions. On April 14, 2004, the court granted the
plaintiffs up to 60 days to file an amended consolidated complaint. The Court
also designated the Greater Pennsylvania Carpenters Pension Fund as the lead
plaintiff in the action and designated Greater Pennsylvania's counsel as lead
counsel.
On June 10, 2004, a putative class action complaint captioned Joshua
Kaplan, et al., v. Whitehall Jewellers, Inc. et al., Case No. 04 C 3971, was
filed in the U.S. District Court for the Northern District of Illinois against
the Company and certain of the Company's current and former officers, charging
violations of Sections 10(b) and 20(a) of the 1934 Act and Rule 10b-5
promulgated thereunder, and alleging that the Company and its officers made
false and misleading statements and falsely accounted for revenue, accounts
payable, inventory, and vendor allowances during the putative class period of
November 19, 2001 to December 10, 2003. The factual allegations of this
complaint are similar to those made in the Greater Pennsylvania Carpenters
Pension Fund complaint discussed above.
The Company intends to vigorously contest these putative class action
complaints and exercise all of its available rights and remedies. Given that
these cases are in their early stages, and no substantive proceedings have
occurred, it is not possible to evaluate the likelihood of an unfavorable
outcome in any of these matters, or to estimate any amount or range of potential
loss, if any. While there are many potential outcomes, an adverse outcome in any
of these actions could have a material adverse effect on the Company's results
of operations, financial condition or liquidity. It cannot be determined at this
stage whether these claims will be resolved in the fiscal year ending January
31, 2005.
On January 16, 2004, the Company was named as a defendant in a copyright
infringement lawsuit filed in the United States District Court for the District
of Minnesota by Janel Russell Designs, Inc. ("Janel Russell Designs"). Janel
Russell Designs asserts that the Company is infringing its copyright in a
jewelry design by selling infringing merchandise. Janel Russell Designs seeks
unquantified damages. Two of the allegedly infringing pieces are supplied to the
Company by Samuel Aaron Inc. and one is supplied by Princess Pride Creations.
Each of the suppliers has also been sued by Janel Russell Designs in separate
lawsuits. Pursuant to language in certain Vendor Trading Agreements the Company
entered into with each supplier, the Company tendered the defense of the cases
to Samuel Aaron and Princess Pride and
15
demanded indemnification. Both vendors have agreed to defend and indemnify the
Company. The Company filed its answer on March 3, 2004.
The Company is also involved from time to time in certain other legal
actions and regulatory investigations arising in the ordinary course of
business. Although there can be no certainty, it is the opinion of management
that none of these other actions or investigations will have a material adverse
effect on our results of operations or financial condition.
The Company leases the premises for its office facilities and all of its
retail stores, and certain office and computer equipment generally under
non-cancelable agreements for periods up to 13 years. Most leases require the
payment of taxes, insurance and maintenance costs. Future minimum rentals under
non-cancelable operating leases as of April 30, 2004 are as follows:
Years ending April 30 (in thousands) Amount
- ------------------------------------ ---------
2005 $ 29,797
2006 28,704
2007 27,128
2008 25,103
2009 21,723
Thereafter 49,749
---------
Total future minimum rent obligations $ 182,204
---------
The future minimum rentals under non-cancelable operating leases
information presented at January 31, 2004 has been revised as follows:
Years ending January 31 (in thousands) Amount
- -------------------------------------- ---------
2005 $ 29,934
2006 29,114
2007 27,518
2008 25,918
2009 22,672
Thereafter 54,468
---------
Total future minimum rent obligations $ 189,624
---------
9. RELATED PARTY TRANSACTIONS
In the past, the Company provided certain office services to Double P
Corporation, PDP Limited Liability Company and CBN Limited Liability Company or
other companies, from time to time, which own and operate primarily mall-based
snack food stores, and in which Messrs. Hugh Patinkin, John Desjardins and
Matthew Patinkin own a 52% equity interest. A substantial portion of the
remaining equity interest is owned by the adult children and other family
members of Norman Patinkin, a member of the Company's Board of Directors. For
these services, Double P Corporation paid the Company $700 per month. Effective
February 1, 2004, the Company no longer provides these services. Matthew
Patinkin previously served as a director of Double P Corporation and one of
Norman Patinkin's adult children is a director and chief executive officer of
Double P Corporation. Messrs. Hugh Patinkin, John Desjardins and Matthew
Patinkin spend a limited amount of time providing services to Double P
Corporation, PDP Limited Liability Company and CBN Limited Liability Company.
Such services are provided in accordance with the Company's Code of Conduct. In
the case of Hugh Patinkin and John Desjardins, these services are performed
solely in their capacities as shareholders of Double P Corporation. In the case
of Matthew Patinkin, these services are performed in his capacity as a
shareholder of Double P Corporation and were previously performed in his
capacities as a director and a shareholder of Double P Corporation. Messrs. Hugh
Patinkin and John Desjardins receive no remuneration for these services other
than reimbursement of expenses incurred. Matthew Patinkin receives no
remuneration for these services other than the fee he previously received for
his services as a director of Double P Corporation. In several cases, the
Company and Double P Corporation agreed to divide and separately lease
contiguous mall space. The Company and Double P Corporation concurrently
negotiated separately with each landlord ("Simultaneous Negotiations") to reach
agreements for their separate locations. Since the Company's initial public
offering, its policy had required that the terms of any such leases must be
approved by a majority of the Company's outside directors. The Company had
conducted such negotiations in less than ten situations since the Company's
initial public offering in 1996. The Company's current policy is that it will no
longer enter into such Simultaneous Negotiations.
16
The Company offers health insurance coverage to the members of its Board
of Directors. The health insurance policy options and related policy cost
available to the Directors are the same as those available to the Company's
senior level employees.
The Company operates a program under which executive officers and
directors, and parties introduced to the Company by its executive officers and
directors, are permitted to purchase most Company merchandise at approximately
ten percent above the Company's cost. During the first quarter of fiscal 2004,
no such purchases were made under this program as compared to $26,000 of such
purchases in the first quarter of fiscal 2003.
10. RECLASSIFICATIONS
Certain Balance Sheet amounts from prior periods were reclassified to
conform to the current year presentation. These reclassifications had no impact
on earnings or equity.
17
PART I - FINANCIAL INFORMATION
Item 2 - Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following discussion and analysis of the Company's financial condition and
results of operations should be read in conjunction with the Company's unaudited
financial statements, including the notes thereto. This section contains
statements that constitute "forward-looking statements" within the meaning of
the Private Securities Litigation Reform Act of 1995. See Forward-Looking
Statements disclosure at the end of this section.
Results of Operations
Overview
The Company is a leading national retailer of fine jewelry (based on
number of stores) operating 385 stores in 38 states as of April 30, 2004. The
Company offers a selection of merchandise in the following categories: diamond,
gold, precious and semi-precious jewelry and watches, an approach oriented
toward the Company's target customer base, middle to upper-middle income men and
women over 25 years of age. Jewelry purchases are discretionary for consumers
and may be particularly affected by adverse trends in the general economy and
perceptions of such conditions affecting disposable consumer income. During the
first quarter of fiscal 2004, increased sales from certain sales focused
programs, a strong Valentine's holiday performance, and an improvement in
general economic conditions and consumer confidence resulted in higher
comparable store sales than in the year-ago period.
The Company reported a net loss of $3.7 million for the first quarter of
fiscal 2004, as compared to a net loss of $2.8 million for first quarter of
fiscal 2003. The increase in the Company's first quarter net loss is due in part
to an increase in professional fees and other charges incurred primarily in
connection with the consolidated Capital Factors actions and the related
investigations by the United States Attorney and the Securities and Exchange
Commission (the "SEC"), as described in Note 8 to the financial statements. For
the fourth quarter of the fiscal year ended January 31, 2004, the Company
accrued a litigation reserve of $8.6 million for the consolidated Capital
Factors actions and the United States Attorney and SEC investigations. Since
that time, the Company has engaged in additional settlement negotiations
relating to these matters. In light of developments in these discussions, the
Company has recorded an additional accrual in the quarter ended April 30, 2004
in the amount of $350,000. There are no assurances that the Company will be able
to reach a settlement with any of the parties to the consolidated Capital
Factors actions, or that such a settlement or settlements, as the case may be,
will be for the amount recorded as a reserve. However, the Company currently
believes that it is more likely than not that it will reach a settlement or
settlements, as the case may be, pertaining to the consolidated Capital Factors
actions in the near term. The Company is unable at this time to predict the
ultimate outcome of the consolidated Capital Factors actions or the United
States Attorney and SEC investigations.
The Company's business is highly seasonal. Historically, income generated
in the fourth fiscal quarter ending each January 31 represents all or a majority
of the income generated during the fiscal year. The Company has historically
experienced lower net sales in each of its first three fiscal quarters and
expects this trend to continue. The Company's quarterly and annual results of
operations may fluctuate significantly as a result of factors including, among
others: increases or decreases in comparable store sales; the timing of new
store openings; net sales contributed by new stores; timing of certain holidays
and Company-initiated special events; changes in
18
the Company's merchandise; marketing or credit programs; general economic,
industry, weather conditions and disastrous national events that affect consumer
spending as well as pricing, merchandising, marketing, credit and other programs
of competitors.
Results of Operations
The following table sets forth for the periods indicated certain
information derived from the unaudited statements of operations of the Company
expressed as a percentage of net sales for such periods.
Three months ended
-------------------------------
April 30, 2004 April 30, 2003
-------------- --------------
Percentage of net sales
Net sales 100.0% 100.0%
Cost of sales (including buying and
occupancy expenses) 66.8 66.6
----- -----
Gross profit 33.2 33.4
Selling, general and administrative expenses 37.0 37.8
Professional fees and other charges 3.6 0.9
----- -----
Loss from operations (7.4) (5.3)
Interest expense 1.2 1.3
----- -----
Loss before income taxes (8.6) (6.6)
Income tax benefit (3.6) (2.6)
----- -----
Net loss (5.0%) (4.0%)
----- -----
Net Sales
Net sales for the first quarter of fiscal 2004 increased $3.9 million, or
5.6%, to $73.0 million from $69.1 million in the first quarter of fiscal 2003.
New store sales accounted for an increase in sales of $2.6 million. Comparable
store sales increased $2.2 million, or 3.3%, in the first quarter of fiscal 2004
from the first quarter of fiscal 2003. Additionally, sales were $0.3 million
higher due to changes in sales returns and allowances. These increases were
partially offset by a sales decrease of $1.2 million related to closed stores.
The improvement in comparable store sales was due in part to increased sales
generated from certain sales focused initiatives, a strong 2004 Valentine's
holiday sales performance, and an improvement in general economic conditions and
consumer confidence as compared to the prior year period. The total number of
merchandise units sold increased by approximately 4.1% in the first quarter of
fiscal 2004 from the first quarter of fiscal 2003, while the average price per
merchandise sale increased to $278 in the first quarter of fiscal 2004 from $277
in the first quarter of fiscal 2003. Credit sales as a percentage of net sales
decreased to 39.6% in the first quarter of fiscal 2004 compared to 40.5% in the
first quarter of fiscal 2003. The Company opened 5 new stores in the first
quarter of fiscal 2004, and on April 30, 2004 operated 385 stores, the same
number of stores as on April 30, 2003.
Gross Profit
Gross profit increased $1.2 million, or 5.0%, to $24.3 million from $23.1
million in the first quarter of fiscal 2004 compared to the same period in
fiscal 2003. Gross profit as a percentage of sales decreased to 33.2% in the
first quarter of fiscal 2004 compared to 33.4% in the first quarter of fiscal
2003. Merchandise gross margins improved by approximately 110 basis points as a
result of tighter control over discounting, particularly in the diamond
category; price increases on numerous items implemented during March, motivated
by higher raw material prices; and margin improvements on certain
19
promotional items. These margin improvements were more than offset by an
increase in inventory reserves for damaged inventory, lower vendor discounts and
allowances recognized and higher amount of procurement costs included in cost of
sales compared to the same period in the prior year. Total procurement costs
have remained consistent with prior periods, however, the level of procurement
activity has decreased.
Expenses
Selling, general and administrative expenses, excluding professional fees
and other charges, increased $0.9 million, or 3.4%, to $27.0 million from $26.1
million in the first quarter of fiscal 2004 compared to the same period in
fiscal 2003. Selling, general and administrative expense as a percent of sales
decreased to 37.0% versus 37.8% in first quarter 2003. The dollar increase
primarily related to higher personnel expense ($0.6 million), higher advertising
expense ($0.4 million) and higher other expense ($0.1 million) which were
partially offset by lower credit expense ($0.1 million). The increase in
personnel expense is attributable to higher salary and wage rates and the
addition of support office positions. The increase in other expense is primarily
due to an increase in insurance expense. Advertising expense increased due to
timing of certain promotional expenses.
Professional fees and other charges increased by $2.1 million to a total
of $2.7 million in the first quarter of fiscal 2004 from $0.6 million in the
prior year period, primarily associated with the consolidated Capital Factors
actions and the related United States Attorney and SEC investigations as
described in Note 8 of the financial statements. In light of developments in the
ongoing settlement discussions, the Company has accrued an additional reserve of
$350,000 during the first quarter of fiscal 2004.
Loss from Operations
As a result of the factors discussed above, loss from operations was $5.4
million in the first quarter of fiscal 2004 compared to a loss of $3.7 million
in the first quarter of fiscal 2003. As a percentage of net sales, loss from
operations was 7.4% in the first quarter of fiscal 2004 as compared to 5.3% in
the prior year period.
Interest Expense
Interest expense remained relatively unchanged at $0.9 million in both the
first quarter of fiscal 2004 and 2003. In fiscal 2004, higher average loan
revolver borrowings and higher interest rates were offset by a reduction in the
amortization of deferred financing costs and the elimination of the term loan
interest in connection with the new loan facility.
Income Tax Benefit
Income tax benefit of $2.6 million in the first quarter of 2004 compared
to an income tax benefit of $1.8 million in the first quarter of 2003, reflects
an expected annual effective tax rate of 41.5% for fiscal 2004. While the 41.5%
effective tax rate currently estimated for the year is management's best
estimate, to the extent that income is significantly more or less than expected,
the Company's effective income tax rate for the remainder of fiscal year 2004
could vary significantly from that of the first quarter. The Company's annual
effective tax rate was 35.8% for fiscal 2003.
20
Liquidity and Capital Resources
The Company's cash requirements consist principally of funding inventory
at existing stores, capital expenditures and working capital (primarily
inventory) associated with the Company's new stores. The Company's primary
sources of liquidity have historically been cash flow from operations and bank
borrowings under the Company's Second Amended and Restated Revolving Credit and
Gold Consignment Agreement dated July 29, 2003 (the "Credit Agreement"), as
amended effective March 23, 2004. The Company had $104.8 million of outstanding
borrowings under the revolving loan facility as of April 30, 2004.
The Company's inventory levels and working capital requirements have
historically been highest in advance of the Christmas season. The Company has
funded these seasonal working capital needs through borrowings under the
Company's revolver and increases in trade payables and accrued expenses. As of
April 30, 2004, the maximum availability under the credit facility was $120.8
million based on the borrowing base formula. The credit facility covenants also
require the Company to attain certain operating results.
The Company's cash flow used in operating activities was $23.0 million in
the first quarter of 2004 compared to $8.9 million provided by operating
activities in the first quarter of fiscal 2003. Depreciation and amortization
($3.1 million) and decreases in merchandise inventories ($8.2 million) and
accounts receivables ($1.5 million), were partially offset by decreases in
accounts payable ($28.7 million) and accrued liabilities ($1.0 million) and an
increase in current income taxes benefit ($2.3 million) and loss from operations
($3.7 million). The decrease in merchandise inventories is due in part to the
introduction of a number of programs implemented by the Company during the first
quarter of fiscal 2004 focused on reducing less productive inventory. The
decrease in accounts payable is primarily attributable to the payment of
merchandise inventory invoices from the fourth quarter of fiscal 2003 and the
first quarter of fiscal 2004.
Cash generated by financing activities included revolver borrowings ($24.5
million) and an increase in outstanding checks ($0.5 million). The Company
utilized cash in the first quarter of 2004 to fund capital expenditures of $2.3
million, primarily related to the opening of 5 new stores in the first quarter
of 2004.
The Company amended the Credit Agreement effective March 23, 2004 in order
to, among other things, (i) add a reserve for customer deposits to the Borrowing
Base (as defined in the Credit Agreement), (ii) add and amend certain financial
covenants, including amending the Fixed Charge Coverage Ratio (as defined in the
Credit Agreement) and adding a covenant to maintain a Net Worth (as defined in
the Credit Agreement) of at least $90.0 million at January 31, 2005, (iii) cap
the borrowings under the facility to a maximum of $85.0 million for at least
thirty consecutive calendar days during the period December 15, 2004 through and
including February 15, 2005, (iv) increase the interest rate at which LIBOR
based borrowings are available under the Credit Agreement to LIBOR plus 2.5%
through April 30, 2005, (v) set the Commitment Fee Rate (as defined in the
Credit Agreement) at 0.5% through April 30, 2005, and (vi) set the Standby
Letter of Credit Fee Rate (as defined in the Credit Agreement) at 2.0% through
April 30, 2005.
As of March 22, 2004, the Company and its lenders entered into a letter
agreement pursuant to which the lenders under the Credit Agreement have agreed
that, as of March 23, 2004, the consolidated Capital Factors actions, the SEC
investigation and the United States Attorney's investigation have not resulted
in a breach of the Credit Agreement. In addition, the lenders have agreed that
none of these matters will give rise to a default or event of default under the
Credit Agreement so long as the resolution of such matters does not
21
involve the payment by the Company of Restitution (which is defined below) in an
amount in excess of $15.0 million, or does not result in the indictment of the
Company or any of its current officers, directors or employees with principal
financial or accounting responsibilities. The letter agreement also states that
any settlement involving the payment of Restitution in excess of $15.0 million
shall constitute a default under the Credit Agreement or any indictment of the
Company or any of the persons described above may constitute a default under the
Credit Agreement.
"Restitution" is defined as any restitution paid by the Company (whether
cash or non-cash or current or deferred consideration) arising from a civil
settlement or award and/or criminal penalties paid or payable in connection with
the Capital Factors litigation, the SEC investigation and/or the United States
Attorney investigation and any other actions or proceedings directly related
thereto; excluding, however, (i) amounts paid by the Company for consignment
inventory held on behalf of the parties involved in the Capital Factors
litigation, (ii) amounts already accrued on the books of the Company for the
purchase of merchandise from the parties involved in the Capital Factors
litigation and (iii) the value of any consigned inventory returned to parties
involved in the Capital Factors litigation.
At this time the Company does not expect the payment of Restitution to
exceed $15.0 million and, based on the Company's current financial plan, expects
to be in compliance with all financial covenants as set forth in the Credit
Agreement for the remainder of fiscal year 2004.
Subject to the contingencies identified in Note 8 to the financial
statements and other risks, including those identified in Forward-Looking
Statements, management expects that based on our current financial plan the cash
flow from operating activities and funds available under the Company's revolving
loan facility should be sufficient to support the Company's current new store
expansion program, seasonal working capital needs and liabilities that may arise
with respect to the Capital Factors related matters and the investigations of
the United States Attorney's Office and the SEC. Additionally, the Company
intends to vigorously contest the putative class action complaints and exercise
all of its available rights and remedies. Given that these class action cases
are in their early stages, and no substantive proceedings have occurred, it is
not possible to evaluate the likelihood of an unfavorable outcome in any of
these matters, or to estimate any amount or range of potential loss, if any.
While there are many potential outcomes, an adverse outcome in these actions
could have a material adverse effect on the Company's results of operations,
financial condition or liquidity. It cannot be determined at this stage whether
these claims will be resolved in the fiscal year ending January 31, 2005.
If the Company were to trigger an event of default pursuant to the March
22, 2004 letter agreement, the Company may be required to negotiate relief with
its lenders or to seek new financing. There is no assurance that new financing
arrangements would be available on acceptable terms or at all. If the existing
lenders were to cease funding under the revolving loan facility or require
immediate repayment and if the Company were not able to arrange new financing on
acceptable terms, this would have a material adverse effect on the Company,
which could affect the underlying valuation of its assets and liabilities.
Management expects that cash flow from operating activities and funds
available under its revolving credit facility should be sufficient to support
the Company's current new store expansion program and seasonal working capital
needs for the foreseeable future.
22
Contractual Obligations
The following summarizes the Company's contractual obligations at April
30, 2004:
PAYMENTS DUE BY PERIOD
-------------------------------------------------------
Less than 1 - 3 4 - 5 More than
(in thousands) Total 1 year Years Years 5 years
- -------------- ----- ------ ----- ----- -------
Revolver $104,849 $ -- $ -- $104,849 $ --
Accrued interest 144 144 -- -- --
Subordinated debt 640 640 -- -- --
Operating leases 182,204 29,797 80,935 39,557 31,915
-------- -------- -------- -------- ---------
Total contractual
obligations $287,837 $ 30,581 $ 80,935 $144,406 $ 31,915
-------- -------- -------- -------- ---------
In the normal course of business, the Company issues purchase orders to
vendors for purchase of merchandise inventories. The outstanding amount of these
purchase orders is not included in the above table, as the purchase orders may
be cancelled at the option of the Company without penalty.
Gold Price Risk
The Company does not hedge gold price changes. Current increases in gold
prices have had and may have a future negative impact on gross margin to the
extent sales prices for such items do not increase commensurately.
Diamond Price Risk
Recent increases in diamond prices may have a future negative impact on
gross margin to the extent that sales prices for such items do not increase
commensurately.
Inflation
The Company believes that inflation generally has not had a material
effect on the results of its operations. There is no assurance, however, that
inflation will not materially affect the Company in the future.
Critical Accounting Policies and Estimates
The Company's critical accounting policies and estimates, including the
assumptions and judgments underlying them, are disclosed in the notes to the
Financial Statements and Management's Discussion and Analysis of Financial
Condition and Results of Operations in the Form 10-K filing for the year ended
January 31, 2004. These policies have been consistently applied in all material
respects and address such matters as revenue recognition, inventory valuation,
depreciation methods and asset impairment recognition. While the estimates and
judgments associated with the application of these policies may be affected by
different assumptions or conditions, the Company believes the estimates and
judgments associated with the reported amounts are appropriate in the
circumstances. Management has discussed the development and selection of these
critical accounting estimates with the audit committee of our Board of
Directors.
Due to the seasonal nature of the business, the Company tends to generate
nearly all of its income in the fourth quarter. While the 41.5% effective tax
rate currently estimated for the year is management's best estimate, to the
extent that income is significantly more or less than
23
expected, the Company's effective income tax rate for the fourth quarter and the
full year could vary significantly from that of the previous quarters.
Merchandise inventories are stated principally at the lower of weighted
average cost or market. Purchase cost is reduced to reflect certain allowances
and discounts received from vendors. Periodic credits or payments from
merchandise vendors in the form of consignment buydowns, volume or other
purchase discounts and other vendor considerations are reflected in the carrying
value of the inventory and recognized as a component of cost of sales as the
merchandise is sold. Additionally, to the extent it is not addressed by
established vendor return privileges, and if the amount of cash consideration
received from the vendor exceeds the estimated fair value of the goods returned,
that excess amount is reflected as a reduction in the purchase cost of the
inventory acquired. Allowances for inventory shrink, scrap and other provisions
are recorded based upon analysis and estimates by the Company.
To the extent the Company's agreements with merchandise vendors provide
credits for co-op advertising, the Company has historically classified such
credits as a reduction to advertising expense in selling, general and
administrative expenses. Emerging Issues Task Force ("EITF") Issue No. 02-16,
"Accounting by a Customer (Including a Reseller) for Certain Consideration
Received from a Vendor" ("EITF 02-16"), which was effective for all arrangements
entered into after December 31, 2002, requires certain merchandise vendor
allowances to be classified as a reduction to cost of sales unless evidence
exists supporting an alternative classification. In prior years, certain vendors
reimbursed the Company for certain co-op advertising costs that were incurred.
In 2003, the Company changed the terms of its Vendor Trading Agreements to
include a vendor allowance for advertising calculated as a percentage of net
merchandise purchases. During the first quarter the Company earned $426,000 and
$489,000 of vendor allowances for advertising for the first quarter of fiscal
year 2004 and 2003, respectively. The Company records such allowances as a
reduction of inventory cost and as the inventory is sold, the Company will
recognize a lower cost of sales.
The Company also obtains merchandise from vendors under various
consignment agreements. The consigned inventory and related contingent
obligations associated with holding and safekeeping such consigned inventory are
not reflected in the Company's financial statements. At the time of sale of
consigned merchandise to customers, the Company records the purchase liability
and the related consignor cost of such merchandise in cost of sales.
Transactions with Affiliates and Related Parties
In the past, the Company provided certain office services to Double P
Corporation, PDP Limited Liability Company and CBN Limited Liability Company or
other companies, from time to time, which own and operate primarily mall-based
snack food stores, and in which Messrs. Hugh Patinkin, John Desjardins and
Matthew Patinkin own a 52% equity interest. A substantial portion of the
remaining equity interest is owned by the adult children and other family
members of Norman Patinkin, a member of the Company's Board of Directors. For
these services, Double P Corporation paid the Company $700 per month. Effective
February 1, 2004, the Company no longer provides these services. Matthew
Patinkin previously served as a director of Double P Corporation and one of
Norman Patinkin's adult children is a director and chief executive officer of
Double P Corporation. Messrs. Hugh Patinkin, John Desjardins and Matthew
Patinkin spend a limited amount of time providing services to Double P
Corporation, PDP Limited Liability Company and CBN Limited Liability Company.
Such services are provided in accordance with the Company's Code of Conduct. In
the case of Hugh Patinkin and John Desjardins, these services are performed
solely in their capacities as shareholders of Double P Corporation. In the case
of Matthew Patinkin, these services are performed in his capacity as a
24
shareholder of Double P Corporation and were previously performed in his
capacities as a director and a shareholder of Double P Corporation. Messrs. Hugh
Patinkin and John Desjardins receive no remuneration for these services other
than reimbursement of expenses incurred. Matthew Patinkin receives no
remuneration for these services other than the fee he previously received for
his services as a director of Double P Corporation. In several cases, the
Company and Double P Corporation agreed to divide and separately lease
contiguous mall space. The Company and Double P Corporation concurrently
negotiated separately with each landlord ("Simultaneous Negotiations") to reach
agreements for their separate locations. Since the Company's initial public
offering, its policy had required that the terms of any such leases must be
approved by a majority of the Company's outside directors. The Company had
conducted such negotiations in less than ten situations since the Company's
initial public offering in 1996. The Company's current policy is that it will no
longer enter into such Simultaneous Negotiations.
The Company offers health insurance coverage to the members of its Board
of Directors. The health insurance policy options and related policy cost
available to the Directors are the same as those available to the Company's
senior level employees.
The Company operates a program under which executive officers and
directors, and parties introduced to the Company by its executive officers and
directors, are permitted to purchase most Company merchandise at approximately
ten percent above the Company's cost. During the first quarter of fiscal 2004,
no such purchases were made under this program as compared to $26,000 of such
purchases in the first quarter of fiscal 2003.
Accounting for Guarantees
In November 2002, the Financial Standards Accounting Board issued FASB
Interpretation No. 45 ("FIN 45"), "Guarantor's Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of
Others," an interpretation of FASB Statements No. 5, 57 and 107 and rescission
of FASB Interpretation No. 34. The Company has adopted the guidance of FIN 45
and has reflected the required disclosures in its financial statements
commencing with the financial statements for the year ended January 31, 2004.
Under its bylaws, the Company has agreed to indemnify its officers and
directors for certain events or occurrences while the officer or director is, or
was serving, at its request in such capacity. The maximum potential amount of
future payments the Company could be required to make pursuant to these
indemnification obligations is unlimited; however, the Company has a directors
and officers liability insurance policy that, under certain circumstances,
enables it to recover a portion of any future amounts paid. The Company has no
liabilities recorded for these obligations as of April 30, 2004, however,
reference should be made to Note 8 to the financial statements with respect to
legal contingencies.
Item 3. Quantitative and Qualitative Disclosure About Market Risk
Interest Rate Risk
The Company's exposure to changes in interest rates relates primarily to
its borrowing activities to fund business operations. The Company principally
uses floating rate borrowings under its revolving credit facility. The Company's
private label credit card provider charges the Company varying discount rates
for its customers' credit program purchases. These discount rates are sensitive
to changes in interest rates. The Company currently does
25
not use derivative financial instruments to protect itself from fluctuations in
interest rates.
Gold Price Risk
The Company does not hedge gold price changes. Current increases in gold
prices have had and may have a future negative impact on gross margin to the
extent sales prices do not increase commensurately.
Item 4. - Controls and Procedures
The Company's management, with the participation of our Chief Executive
Officer and our Chief Financial Officer, have carried out an evaluation of the
effectiveness of the design and operation of the Company's disclosure controls
and procedures (as defined in Rule 13a-15(e) promulgated under the Securities
Exchange Act of 1934, as amended). Based upon this evaluation, the Company's
Chief Executive Officer and Chief Financial Officer concluded that the Company's
disclosure controls and procedures were effective as of April 30, 2004 to
provide reasonable assurance that information required to be disclosed by the
Company in reports filed or submitted 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. There were no changes in the
Company's internal control over financial reporting that occurred during the
Company's fiscal quarter ended April 30, 2004 that have materially affected, or
are reasonably likely to materially affect, the Company's internal control over
financial reporting.
26
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
The Company has been named as one of 14 defendants in a lawsuit originally
filed in the United States District Court for the Southern District of New York,
now pending in New York State Supreme Court, Commercial Division. The case is
brought by Capital Factors, Inc. ("Capital Factors"), which provided financing
to defendant Cosmopolitan Gem Corp. ("Cosmopolitan"), an entity with which the
Company has certain consignment and other commercial arrangements. The complaint
alleges that Cosmopolitan defrauded Capital Factors into advancing funds to
Cosmopolitan by misrepresenting Cosmopolitan's finances and the profitability of
its operations, and that the Company, along with other persons and entities,
including other jewelry retailers, aided and abetted or participated in the
alleged fraud. The complaint asserts against the defendants, including the
Company, claims under common law and the Racketeer Influenced and Corrupt
Organizations Act ("RICO"). Capital Factors seeks aggregate damages from all of
the defendants, including the Company, of $30,000,000, plus unspecified punitive
damages, interest and fees. Damages, excluding punitive damages, awarded
pursuant to claims asserted under RICO as well as interest on such damages are
subject to trebling, within the discretion of the court.
The Company has also been named as one of 13 defendants in an amended
complaint filed on December 2, 2003 by International Diamonds, L.L.C.
("International") and its affiliate, Astra Diamonds Manufacturers, Ltd.
("Astra"). Astra is an Israeli diamond wholesaler that supplied diamonds to
Cosmopolitan; International is a joint venture formed by Cosmopolitan and Astra
to sell high quality finished diamond jewelry in the United States. The amended
complaint, consolidated with the Capital Factors action described above (the
"consolidated Capital Factors actions"), alleges that the Company, along with
other jewelry retailers and business affiliates of Cosmopolitan, participated in
Cosmopolitan's fraudulent scheme to defraud Capital Factors, and thus injured
International and Astra. The complaint asserts claims under common law and RICO,
seeking aggregate damages from all of the defendants, including the Company, of
$6,800,000 plus interest and fees. Damages awarded pursuant to claims asserted
under RICO as well as interest on such damages are subject to trebling, within
the discretion of the court. In addition, the complaint alleges claims against
the Company for breach of contract for approximately $2,520,000 in goods
delivered and invoiced to the Company, for which International has not received
payment.
In connection with the consolidated Capital Factors actions in New York
state court, the Company has filed an interpleader action for declaratory
relief, asking the Court to determine the proper parties to whom the Company
must pay amounts and deliver goods that are not in dispute related to goods
received from Cosmopolitan and certain other entities. In its answer to the
interpleader, Capital Factors has asserted that the Company owes Cosmopolitan
$8,600,000 in accounts receivable on invoices assigned to Capital Factors. This
amount is included in the $30,000,000 of losses that Capital Factors seeks in
its RICO claims. In addition, Ultimo, Inc. ("Ultimo"), a jewelry supplier, is a
defendant in the International action and in the interpleader action. Ultimo
provided certain items of jewelry to the Company on a consignment basis and
asserts that: (1) the Company has sold approximately $450,000 worth of such
items, the proceeds of which it claims remain in the Company's possession; and
(2) the Company continues to possess approximately $1,780,000 worth of its
consignment goods. Ultimo asserts that it should receive these consignment
proceeds and goods. Capital Factors and International also have asserted claims
to these proceeds and goods. The Company plans to place the remaining
consignment goods into escrow, and the New York State Supreme Court has
announced that it will hold a hearing as
27
early as June 2004 to determine the proper distribution of these consignment
goods. The consignment proceeds and the amount of the accounts payable due
already have been placed in the Company's outside counsel's escrow account
pending court determination of the proper recipient. The Company is not
currently aware of any accounts payable due and owing to any of the claimants in
this action that are not already reflected in the Company's accounts payable and
accrued liabilities or have been placed in the Company's outside counsel's
escrow account.
In these consolidated Capital Factors actions, document discovery has
begun and certain depositions have been taken. In addition, the Company has
filed motions to dismiss both the Capital Factors and International/Astra
complaints. The motions are currently pending before the court.
As previously disclosed, the United States Attorney for the Eastern
District of New York is conducting a criminal investigation regarding matters
that include those alleged in the consolidated Capital Factors actions. The
Company, among others, is a subject of this criminal investigation and is
cooperating fully with the United States Attorney.
In addition, subsequent to the filing of the complaint by Capital Factors
and as previously disclosed, the Securities and Exchange Commission (the "SEC")
initiated an informal inquiry into matters that are the subject of the
consolidated Capital Factors actions. On November 3, 2003, the Company received
a subpoena issued by the SEC as a part of a formal investigation by the SEC with
respect to the matters that are the subject of the consolidated Capital Factors
actions. The Company produced documents to the SEC in response to the SEC's
subpoena and information requests. The Company is cooperating fully with the SEC
in connection with this formal investigation.
In accordance with Financial Accounting Standards Board Statement No. 5,
"Accounting for Contingencies," the Company determines whether an estimated loss
from a loss contingency should be accrued by assessing whether a loss is deemed
probable and can be reasonably estimated. For the fourth quarter of the fiscal
year ended January 31, 2004, the Company recorded a litigation accrual of $8.6
million for the consolidated Capital Factors actions and the United States
Attorney and SEC investigations. As previously disclosed in a press release
furnished to the SEC under cover of a Current Report on Form 8-K dated May 27,
2004, for the first quarter of fiscal year 2004, the Company recorded an
additional accrual in the amount of $350,000 with respect to these matters in
light of ongoing settlement discussions. There are no assurances that the
Company will be able to reach a settlement with any of the parties to the
consolidated Capital Factors actions or that such a settlement or settlements,
as the case may be, will be for the amount recorded as a reserve. However, the
Company currently believes that it is more likely than not that it will reach a
settlement or settlements, as the case may be, pertaining to the consolidated
Capital Factors actions in the near term. Given the amounts sought in the
consolidated Capital Factors actions, and the inherent unpredictability of
litigation, it is possible that an adverse outcome in excess of the amount
recorded could occur and these actions could have a material adverse effect on
the Company's results of operations, financial condition or liquidity. The
Company is unable at this time to predict the ultimate outcome of the
consolidated Capital Factors actions or the United States Attorney and SEC
investigations.
As of March 22, 2004, the Company and its lenders entered into a letter
agreement pursuant to which the lenders under the Credit Agreement have agreed
that, as of March 23, 2004, the consolidated Capital Factors actions, the SEC
investigation and the United States Attorney's investigation have not resulted
in a breach of the Credit Agreement. In addition, the lenders have agreed that
none of these matters will give rise to a default or event of default
28
under the Credit Agreement so long as the resolution of such matters does not
involve the payment by the Company of Restitution (which is defined below) in an
amount in excess of $15.0 million, or does not result in the indictment of the
Company or any of its current officers, directors or employees with principal
financial or accounting responsibilities. The letter agreement also states that
any settlement involving the payment of Restitution in excess of $15.0 million
shall constitute a default under the Credit Agreement or any indictment of the
Company or any of the persons described above may constitute a default under the
Credit Agreement.
"Restitution" is defined as any restitution paid by the Company (whether
cash or non-cash or current or deferred consideration) arising from a civil
settlement or award and/or criminal penalties paid or payable in connection with
the Capital Factors litigation, the SEC investigation and/or the United States
Attorney investigation and any other actions or proceedings directly related
thereto; excluding, however, (i) amounts paid by the Company for consignment
inventory held on behalf of the parties involved in the Capital Factors
litigation and (ii) amounts already accrued on the books of the Company for the
purchase of merchandise from the parties involved in the Capital Factors
litigation and (iii) the value of any consigned inventory returned to parties
involved in the Capital Factors litigation.
At this time the Company does not expect the payment of Restitution to
exceed $15.0 million and, based on the Company's current financial plan, expects
to be in compliance with all financial covenants as set forth in the Credit
Agreement for the remainder of fiscal year 2004.
On February 12, 2004, a putative class action complaint captioned Greater
Pennsylvania Carpenters Pension Fund, et al. v. Whitehall Jewellers, Inc. et
al., Case No. 04 C 1007, was filed in the U.S. District Court for the Northern
District of Illinois against the Company and certain of the Company's current
and former officers. The complaint makes reference to the litigation filed by
Capital Factors, Inc. above and to the Company's November 21, 2003 announcement
that it had discovered violations of Company policy by the Company's Executive
Vice President, Merchandising, with respect to Company documentation regarding
the age of certain store inventory. The complaint further makes reference to the
Company's December 22, 2003 announcement that it would restate results for
certain prior periods. The complaint purports to allege that the Company and its
officers made false and misleading statements and falsely accounted for revenue
and inventory during the putative class period of November 19, 2001 to December
10, 2003. The complaint purports to allege violations of Sections 10(b) and
20(a) of the Securities Exchange Act of 1934 ("1934 Act") and Rule 10b-5
promulgated thereunder.
On February 18, 2004, a putative class action complaint captioned Michael
Radigan, et al., v. Whitehall Jewellers, Inc. et al., Case No. 04 C 1196, was
filed in the U.S. District Court for the Northern District of Illinois against
the Company and certain of the Company's current and former officers, charging
violations of Sections 10(b) and 20(a) of the 1934 Act and Rule 10b-5
promulgated thereunder, and alleging that the Company and its officers made
false and misleading statements and falsely accounted for revenue and inventory
during the putative class period of November 19, 2001 to December 10, 2003. The
factual allegations of this complaint are similar to those made in the Greater
Pennsylvania Carpenters Pension Fund complaint discussed above.
On February 20, 2004, a putative class action complaint captioned Milton
Pfeiffer, et al., v. Whitehall Jewellers, Inc. et al., Case No. 04 C 1285, was
filed in the U.S. District Court for the Northern District of Illinois against
the Company and certain of the Company's current and former officers, charging
violations of Sections 10(b) and 20(a) of the 1934 Act and Rule 10b-5
29
promulgated thereunder, and alleging that the Company and its officers made
false and misleading statements and falsely accounted for revenue, accounts
payable, inventory, and vendor allowances during the putative class period of
November 19, 2001 to December 10, 2003. The factual allegations of this
complaint are similar to those made in the Greater Pennsylvania Carpenters
Pension Fund complaint discussed above.
On April 6, 2004, the District Court in the Greater Pennsylvania
Carpenters case, No. 04 C 1107 consolidated the Pfeiffer and Radigan complaints
with the Greater Pennsylvania Carpenters action, and dismissed the Radigan and
Pfeiffer actions as separate actions. On April 14, 2004, the court granted the
plaintiffs up to 60 days to file an amended consolidated complaint. The Court
also designated the Greater Pennsylvania Carpenters Pension Fund as the lead
plaintiff in the action and designated Greater Pennsylvania's counsel as lead
counsel.
On June 10, 2004, a putative class action complaint captioned Joshua
Kaplan, et al., v. Whitehall Jewellers, Inc. et al., Case No. 04 C 3971, was
filed in the U.S. District Court for the Northern District of Illinois against
the Company and certain of the Company's current and former officers, charging
violations of Sections 10(b) and 20(a) of the 1934 Act and Rule 10b-5
promulgated thereunder, and alleging that the Company and its officers made
false and misleading statements and falsely accounted for revenue, accounts
payable, inventory, and vendor allowances during the putative class period of
November 19, 2001 to December 10, 2003. The factual allegations of this
complaint are similar to those made in the Greater Pennsylvania Carpenters
Pension Fund complaint discussed above.
The Company intends to vigorously contest these putative class action
complaints and exercise all of its available rights and remedies. Given that
these cases are in their early stages, and no substantive proceedings have
occurred, it is not possible to evaluate the likelihood of an unfavorable
outcome in any of these matters, or to estimate any amount or range of potential
loss, if any. While there are many potential outcomes, an adverse outcome in any
of these actions could have a material adverse effect on the Company's results
of operations, financial condition or liquidity. It cannot be determined at this
stage whether these claims will be resolved in the fiscal year ending January
31, 2005.
On January 16, 2004, the Company was named as a defendant in a copyright
infringement lawsuit filed in the United States District Court for the District
of Minnesota by Janel Russell Designs, Inc. ("Janel Russell Designs"). Janel
Russell Designs asserts that the Company is infringing its copyright in a
jewelry design by selling infringing merchandise. Janel Russell Designs seeks
unquantified damages. Two of the allegedly infringing pieces are supplied to the
Company by Samuel Aaron Inc. and one is supplied by Princess Pride Creations.
Each of the suppliers has also been sued by Janel Russell Designs in separate
lawsuits. Pursuant to language in certain Vendor Trading Agreements the Company
entered into with each supplier, the Company tendered the defense of the cases
to Samuel Aaron and Princess Pride and demanded indemnification. Both vendors
have agreed to defend and indemnify the Company. The Company filed its answer on
March 3, 2004.
The Company is also involved from time to time in certain other legal
actions and regulatory investigations arising in the ordinary course of
business. Although there can be no certainty, it is the opinion of management
that none of these other actions or investigations will have a material adverse
effect on our results of operations or financial condition.
Item 5. Forward Looking Statements
This release contains certain forward-looking statements (as such term is
defined in Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934) and information relating to the Company that
are based on the current beliefs of management of the Company as well as
assumptions made by and information currently available to management including
statements related to the markets for our products, general trends and trends in
our operations or financial results, plans, expectations, estimates and beliefs.
In addition, when used in this release, the words "anticipate," "believe,"
"estimate," "expect," "intend," "plan," "predict" and similar expressions and
their variants, as they relate to the Company or our management, may identify
forward-looking statements. Such statements reflect
30
our judgment as of the date of this release with respect to future events, the
outcome of which is subject to certain risks, including the factors described
below, which may have a significant impact on our business, operating results or
financial condition. Investors are cautioned that these forward-looking
statements are inherently uncertain. Should one or more of these risks or
uncertainties materialize, or should underlying assumptions prove incorrect,
actual results or outcomes may vary materially from those described herein.
Whitehall Jewellers, Inc. undertakes no obligation to update forward-looking
statements. The following factors, among others, may impact forward-looking
statements contained in this release: (1) a change in economic conditions or the
financial markets which negatively impacts the retail sales environment and
reduces discretionary spending on goods such as jewelry; (2) reduced levels of
mall traffic caused by economic or other factors; (3) our ability to execute our
business strategy and the related effects on comparable store sales and other
results; (4) the extent and results of our store expansion strategy and
associated occupancy costs, and access to funds for new store openings; (5) the
high degree of fourth quarter seasonality of our business; (6) the extent and
success of our marketing and promotional programs; (7) personnel costs and the
extent to which we are able to retain and attract key personnel; (8) the effects
of competition; (9) the availability and cost of consumer credit; (10)
relationships with suppliers; (11) our ability to maintain adequate information
systems capacity and infrastructure; (12) our leverage and cost of funds and
changes in interest rates that may increase such costs; (13) our ability to
maintain adequate loss prevention measures; (14) fluctuations in raw material
prices, including diamond, gem and gold prices; (15) developments relating to
the consolidated Capital Factors actions and the related Securities and Exchange
Commission (the "SEC") and U.S. Attorney's office investigations, and
shareholder and other civil litigation including the impact of such developments
on our results of operations and financial condition and relationship with our
lenders or with our vendors; (16) regulation affecting the industry generally,
including regulation of marketing practices; (17) the successful integration of
acquired locations and assets into our existing operations; and (18) the risk
factors identified from time to time in our filings with the SEC.
31
Item 6. - Exhibits and Reports on Form 8-K
(a) Exhibits
(b) Reports on Form 8-K
On February 13, 2004, the Company filed a Current Report on Form 8-K with
the SEC to file a press release regarding a securities fraud action filed
against it and certain of its officers in the U.S. District Court for the
Northern District of Illinois on February 12, 2004.
On March 23, 2004, the Company filed a Current Report on Form 8-K with the
SEC to file a letter agreement and an amendment with respect to its Credit
Agreement and to furnish a press release regarding financial results for the
fourth quarter ended January 31, 2004.
Exhibit No. Description
- ----------- -----------
10.1 Employment Agreement dated June 1, 2004 between the Company
and Debbie Nicodemus-Volker
31.1 Certification of the Chief Executive Officer pursuant to Rule
13a - 14(a) of the Securities Exchange Act of 1934.
31.2 Certification of the Chief Financial Officer pursuant to Rule
13a - 14(a) of the Securities Exchange Act of 1934.
32.1 Certification of the Chief Executive Officer pursuant to 18
United States Code Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification of the Chief Financial Officer pursuant to 18
United States Code Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
32
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
WHITEHALL JEWELLERS, INC.
(Registrant)
Date: June 14, 2004 By: /s/ John R. Desjardins
-------------------------
John R. Desjardins
Executive Vice President;
Chief Financial Officer and Treasurer
(Duly authorized officer and principal
` financial officer)
33