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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, 2005
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: 1-15615
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, 2005 was 13,960,067 and the number of shares of
the Registrant's Class B common stock, $1.00 par value per share, outstanding as
of June 1, 2005 was 142.
PART I - FINANCIAL INFORMATION
Item 1- Financial Statements
Whitehall Jewellers, Inc.
Statements of Operations
for the three months ended April 30, 2005 and 2004
(unaudited)
(in thousands, except per share data)
Three months ended
--------------------------------
April 30, 2005 April 30, 2004
-------------- --------------
Net sales $ 70,998 $ 73,028
Cost of sales (including buying and occupancy expenses) 48,442 48,752
-------------- --------------
Gross profit 22,556 24,276
Selling, general and administrative expenses 27,690 27,036
Professional fees and other charges 1,222 2,653
-------------- --------------
Loss from operations (6,356) (5,413)
Interest expense 1,298 905
-------------- --------------
Loss before income taxes (7,654) (6,318)
Income tax benefit (2,705) (2,622)
-------------- --------------
Net loss $ (4,949) $ (3,696)
============== ==============
Basic earnings per share:
Net loss $ (0.35) $ (0.27)
============== ==============
Weighted average common shares and common share equivalents 13,958 13,930
============== ==============
Diluted earnings per share:
Net loss $ (0.35) $ (0.27)
============== ==============
Weighted average common shares and common share equivalents 13,958 13,930
============== ==============
The accompanying notes are an integral part of the financial statements.
2
Whitehall Jewellers, Inc.
Balance Sheets
As of April 30, 2005, January 31, 2005 and April 30, 2004
(unaudited, in thousands, except share data)
April 30, 2005 January 31, 2005 April 30, 2004
-------------- ---------------- --------------
ASSETS
Current Assets:
Cash $ 1,444 $ 2,206 $ 1,432
Accounts receivable, net 3,034 2,688 1,078
Merchandise inventories 195,150 183,676 197,990
Current income tax benefit 3,714 3,959 4,591
Other current assets 957 383 837
Deferred financing costs 948 360 278
Deferred income taxes, net 2,758 2,255 5,791
--------- --------- --------
Total current assets 208,005 195,527 211,997
Property and equipment, net 52,698 54,200 60,032
Goodwill, net 5,662 5,662 5,662
Deferred income taxes, net 3,402 902 --
Deferred financing costs 237 539 690
--------- --------- --------
Total assets $ 270,004 $ 256,830 $278,381
========= ========= ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Revolver loan $ 84,333 $ 73,793 $104,849
Current portion of long-term debt -- -- 640
Accounts payable 64,380 60,076 32,289
Customer deposits 3,336 3,042 3,587
Accrued payroll 4,651 3,829 4,542
Other accrued expenses 16,581 14,587 23,471
--------- --------- --------
Total current liabilities 173,281 155,327 169,378
Deferred income taxes, net -- -- 3,352
Other long-term liabilities 4,932 4,880 3,534
--------- --------- --------
Total liabilities 178,213 160,207 176,264
Commitments and contingencies -- -- --
Stockholders' equity:
Common stock ($.001 par value;
60,000,000 shares authorized;
18,058,902; 18,058,902 and
18,058,985 shares issued, respectively) 18 18 18
Class B common stock ($1.00 par
value; 26,026 shares authorized;
142 shares issued and outstanding) -- -- --
Additional paid-in capital 106,161 106,123 106,122
Retained earnings 24,479 29,428 35,615
Treasury stock, at cost (4,099,775;
4,108,703 and 4,119,010 shares, respectively) (38,867) (38,946) (39,638)
--------- --------- --------
Total stockholders' equity, net 91,791 96,623 102,117
--------- --------- --------
Total liabilities and stockholders' equity $ 270,004 $ 256,830 $278,381
========= ========= ========
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, 2005 and 2004
(unaudited, in thousands)
Three months ended
------------------------------------
April 30, 2005 April 30, 2004
-------------- --------------
Cash flows from operating activities:
Net loss $ (4,949) $ (3,696)
Adjustments to reconcile net loss to net cash
(used in) operating activities:
Depreciation and amortization 3,179 3,142
Loss on disposition of assets 6 138
Deferred compensation expense 106 25
Changes in assets and liabilities:
(Increase) decrease in accounts receivable, net (346) 1,466
(Increase) decrease in merchandise inventories (11,474) 8,156
(Increase) decrease in other current assets (574) 38
Decrease (increase) in current income tax benefit 245 (2,297)
(Decrease) in deferred income taxes, net (3,003) (366)
(Decrease) in accounts payable (1,993) (28,709)
Increase (decrease) in customer deposits 294 (14)
Increase in accrued payroll 822 85
Increase (decrease) in accrued liabilities 2,121 (1,008)
(Decrease) other long-term liabilities (75) (1)
-------- ---------
Net cash (used in) operating activities (15,641) (23,041)
Cash flows from investing activities:
Capital expenditures (1,544) (2,297)
-------- ---------
Net cash (used in) investing activities (1,544) (2,297)
Cash flows from financing activities:
Borrowing on revolver loan 87,343 275,400
Repayment of revolver loan (76,803) (250,891)
Outstanding checks increase 6,297 460
Financing costs (425) (120)
Proceeds from employee stock purchase plan 11 14
Proceeds from exercise of stock options -- 6
-------- ---------
Net cash provided by financing activities 16,423 24,869
-------- ---------
Net change in cash and cash equivalents (762) (469)
Cash and cash equivalents at beginning of period 2,206 1,901
-------- ---------
Cash and cash equivalents at end of period $ 1,444 $ 1,432
======== =========
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 386 stores as of April
30, 2005, located in 38 states, operating in regional or superregional shopping
malls.
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 adjustments) which are, in the opinion of management, necessary for a
fair statement 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, 2005, as amended on May 31, 2005. References in
the following notes to years and quarters are references to fiscal years and
fiscal quarters.
Consolidation
The consolidated financial statements include the accounts and
transactions of the Company and its subsidiaries. Intercompany accounts and
transactions have been eliminated.
Use of Estimates
The preparation of financial statements in conjunction with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Valuation reserves for inventory, accounts
receivable, sales returns and deferred tax assets are significant examples of
the use of such estimates. Actual results could differ from those estimates.
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.
5
Certain of the Company's agreements with merchandise vendors provide
credits for co-op advertising calculated as a percentage of net merchandise
purchases. The Company adopted 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") in fiscal year 2002, which
was effective for all arrangements entered into after December 31, 2002. In
accordance with EITF 02-16, the Company classifies certain merchandise vendor
allowances 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. The Company earned $547,000 and
$426,000 of vendor allowances for advertising for the first quarter of fiscal
years 2005 and 2004, 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.
Property and Equipment
Property and equipment are carried at cost, less accumulated depreciation
and amortization. Furniture and fixtures are depreciated on a straight-line
basis over estimated useful lives ranging from five to ten years. Software costs
are amortized on a straight-line basis over five years. Leasehold improvements
are amortized on a straight-line basis over the lesser of the remaining lease
term or ten years.
Effective beginning in the fourth quarter of fiscal year 2004, the Company
has capitalized straight-line rent incurred during the construction period of a
retail store as a leasehold improvement. Straight-line rent subsequent to the
construction period and prior to the store opening is recognized as expense.
Upon retirement or disposition of property and equipment, the applicable
cost and accumulated depreciation are removed from the accounts and any
resulting gains or losses are included in the results of operations.
Long-Lived Assets
When facts and circumstances indicate potential impairment, the Company
evaluates the recoverability of long-lived asset carrying values, using
projections of undiscounted future cash flows over remaining asset lives. When
impairment is indicated, any impairment loss is measured by the excess of
carrying values over fair values.
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 $1,765,000 and $1,776,000 for the first quarter of
fiscal years 2005 and 2004, respectively.
Direct-response advertising consists primarily of mailings to customers
including special price-off merchandise offers and value-off coupons for
merchandise.
6
Store Pre-opening Expense
Expenses associated with the opening of new store locations are expensed
in the period such costs are incurred.
Lease Expense
The Company leases the premises for its office facilities and all of its
retail stores. Certain leases require increasing annual minimum lease payments
over the term of the lease. The Company's retail store lease term is deemed to
commence on the date the Company has access to and control of the retail space,
which is generally two months earlier than the date the Company becomes legally
obligated for rent payments. Minimum lease expense under these agreements is
recognized on a straight-line basis over the term of the respective leases.
Effective beginning in the fourth quarter of fiscal year 2004, the Company
has capitalized straight-line rent incurred during the construction period of a
retail store as a leasehold improvement. Straight-line rent subsequent to the
construction period and prior to the store opening is recognized as expense.
Virtually all leases covering retail stores provide for additional
contingent rentals based on a percentage of sales. These costs are expensed in
the period incurred.
Income Taxes
Due to the seasonal nature of the business, the Company tends to generate
all or a majority of its income in the fourth quarter. While the 35.3% 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 2005 could vary
significantly from that of the first quarter.
At April 30, 2005, the Company had $7.5 million of federal net operating
loss carryforwards available. The deferred tax asset for net operating loss
carryforwards is reviewed for recoverability based on historical taxable income,
the expected reversals of existing temporary differences and management's
forecast of future taxable income. Management has concluded that no valuation
allowance was necessary on the federal net operating loss carryforward and
remaining net deferred tax assets as utilization is considered more likely than
not to occur.
Stock-Based Compensation
The Financial Accounting Standards Board (the "FASB") issued Statement No.
148 ("SFAS 148"), "Accounting for Stock-Based Compensation-Transition and
Disclosure," during 2002. SFAS 148 amends Statement No. 123 ("SFAS 123"),
"Accounting for Stock-Based Compensation," to provide alternative methods of
transition for a voluntary change to the fair value based method of accounting
for stock-based employee compensation and amends the disclosure requirements to
require prominent disclosures in both annual and interim financial statements
about the method of accounting for stock-based employee compensation and the
effect of the method used on reported results. The Company adopted the
disclosure requirements of SFAS 148 as of January 31, 2003.
The Company accounts for stock-based compensation according to Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees,"
which results in no charge to earnings when options are issued at fair market
value.
7
The following table illustrates the effect on net income and earnings per
share for the three months ended April 30, 2005 and 2004, 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, 2005 April 30, 2004
-------------- --------------
Net loss, as reported $ (4,949) $ (3,696)
Deduct: Total stock-based employee compensation expense
determined under fair value based method, net of
related tax effects 42 156
-------- --------
Pro forma net loss $ (4,991) $ (3,852)
======== ========
Earnings per share:
Basic-as reported $ (0.35) $ (0.27)
======== ========
Basic-pro forma $ (0.36) $ (0.28)
======== ========
Diluted-as reported $ (0.35) $ (0.27)
======== ========
Diluted-pro forma $ (0.36) $ (0.28)
======== ========
The FASB issued SFAS No. 123 (revised 2004), "Shared-Based Payment" ("SFAS
123R"). This statement revised SFAS No. 123 and requires companies to expense
the value of employee stock options and similar awards. The effective date of
this standard is annual periods beginning after June 15, 2005.
Upon the adoption of SFAS No. 123R, the Company will be required to expense
stock options over the vesting period in its statement of operations. In
addition, the Company will need to recognize this expense over the remaining
vesting period associated with unvested options outstanding for fiscal years
beginning after June 15, 2005. The Company is currently evaluating which
transition method to use and the effects on its financial statements in
connection with the adoption of SFAS No. 123R.
8
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 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, 2005, 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, 2005, January 31, 2005 and April 30, 2004, accounts
receivable consisted of (in thousands):
April 30, 2005 January 31, 2005 April 30, 2004
-------------- ---------------- --------------
Accounts receivable $ 3,347 $ 3,083 $ 1,616
Less: allowance for doubtful accounts (313) (395) (538)
-------- --------- --------
Accounts receivable, net $ 3,034 $ 2,688 $ 1,078
======== ========= ========
4. MERCHANDISE INVENTORIES
As of April 30, 2005, January 31, 2005 and April 30, 2004, merchandise
inventories consisted of (in thousands):
April 30, 2005 January 31, 2005 April 30, 2004
-------------- ---------------- --------------
Raw Materials $ 9,932 $ 9,796 $ 9,957
Finished Goods 185,218 173,880 188,033
--------- ---------- ----------
Inventory $ 195,150 $ 183,676 $ 197,990
========= ========== ==========
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 $4,002,000; $4,257,000 and
$4,703,000 as of April 30, 2005, January 31, 2005 and April 30, 2004,
respectively. As of April 30, 2005, January 31, 2005 and April 30, 2004,
consignment inventories held by the Company that were not included in the
balance sheets totaled $72,296,000; $82,819,000 and $86,185,000, respectively.
Certain merchandise procurement, distribution and warehousing costs are
allocated to inventory. As of April 30, 2005, January 31, 2005 and April 30,
9
2004, the amounts included in inventory were $3,673,000; $3,589,000 and
$3,537,000, respectively.
5. ACCOUNTS PAYABLE
Accounts payable includes outstanding checks, which were $10,330,000;
$4,033,000 and $4,625,000 as of April 30, 2005, January 31, 2005 and April 30,
2004, 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 May 1, 2005, the calculated revolver availability, pursuant to the Credit
Agreement, was $112.7 million. The Company had $84.3 million of outstanding
borrowings under the revolving loan facility as of April 30, 2005.
The Company amended the Credit Agreement effective April 6, 2005 in order
to, among other things, (i) provide for additional availability under the
revolving credit facility through the funding of a $15.0 million additional
facility from LaSalle Bank National Association ("LaSalle") and Back Bay Capital
Funding LLC ("Back Bay") which was funded at closing and will be due July 31,
2006, (ii) add a discretionary overadvance subfacility from LaSalle in the
amount of $2 million, (iii) terminate the precious metal consignment facility,
(iv) change the maturity date for all outstanding amounts under the Credit
Agreement from July 28, 2007 to July 31, 2006, (v) increase the interest rate
payable on LIBOR loans from 2.50% to 3.00% above LIBOR, (vi) amend the Fixed
Charge Coverage Ratio (as defined in the Credit Agreement) covenant not to be
less than 0.75:1.00 as measured at the last day of each of the months during the
period of April 2005 to October 2005, 0.80:1.00 at November 30, 2005 and
1.00:1.00 as measured at the last day of each of the months from December 2005
and each month thereafter, (vii) add additional financial covenants related to
Minimum Accounts Payable, Capital Expenditures and Minimum Borrowing
Availability of $2.0 million (each as defined in the Credit Agreement), (viii)
amend the calculation of the borrowing base to lower the advance rate on
inventory for certain periods and to modify the types of inventory and accounts
receivable included, (ix) add a reserve in the amount of $7.0 million to the
borrowing base pending satisfactory completion of a field examination report by
LaSalle and Back Bay and (x) add a reserve in the amount of $5.0 million to the
borrowing base effective February 1, 2006. The field examination report referred
to in clause (ix) above was subsequently completed during April 2005, and the
$7.0 million reserve was removed in May 2005.
The Company was in compliance with the financial covenants of the amended
Credit Agreement as of April 30, 2005. The Company's business is highly
seasonal, and historically, income generated in the fourth fiscal quarter ending
each January 31 represents all or a significant majority of the income generated
during the fiscal year.
10
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, 2005 and 2004.
Three months ended
April 30, 2005 April 30, 2004
-------------- --------------
(in thousands)
Net loss $ (4,949) $ (3,696)
Weighted average shares for basic EPS 13,958 13,930
Incremental shares upon conversions:
Stock options -- --
Weighted average shares for diluted EPS 13,958 13,930
Stock options excluded from the calculation of diluted earnings per share
for the three months ended April 30, 2005 and 2004, were 2,658,929 and 2,259,661
respectively, due to their antidilutive effect on the calculations.
8. COMMITMENTS AND CONTINGENCIES
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 1107, 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. ("Capital Factors") and settled as disclosed in the
Company's Quarterly Report on Form 10-Q for the fiscal quarter ended October 31,
2004 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
11
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.
On June 14, 2004, lead plaintiff Greater Pennsylvania Carpenters Pension
Fund in Case No. 04C 1107 filed a consolidated amended complaint. On July 14,
2004, the District Court in the Greater Pennsylvania Carpenters action
consolidated the Kaplan complaint with the Greater Pennsylvania Carpenters
action, and dismissed the Kaplan action as a separate action. On August 2, 2004,
Whitehall filed a motion to dismiss the consolidated amended complaint. The
motion to dismiss was granted in part and denied in part, with plaintiffs
granted leave to file an amended complaint by February 10, 2005. On February 10,
2005, the lead plaintiff filed a first amended consolidated complaint. On March
2, 2005, the Company filed a motion to dismiss the amended complaint. Briefing
on this motion is complete and the parties are awaiting the Court's ruling. If
the Company is successful on its motion, the class in this action may be limited
to the period November 19, 2001 through June 6, 2002. On April 19, 2005, the
Court issued an order, sua sponte, directing the parties to submit simultaneous
briefs addressing what impact, if any, the Supreme Court's ruling in Dura
Pharmaceuticals, Inc. v. Broudo, 125 S.Ct. 1627 (2005), has on Plaintiff's loss
causation allegations. In response to this order, the Company filed a brief on
May 4, 2005 in which it requested that the Court dismiss the amended complaint
in its entirety for failure to adequately plead loss causation. The Court has
not yet ruled on this issue.
On June 15, 2004, a shareholder derivative action complaint captioned
Richard Cusack v. Hugh Patinkin, et al., Case No. 04 CH 09705, was filed in the
Circuit Court of Cook County, Illinois, for the alleged benefit of the Company
against certain of the Company's officers and directors. The complaint asserts
claims for breach of fiduciary duty, abuse of control, gross mismanagement,
waste of corporate assets, unjust enrichment, breach of fiduciary duties for
insider selling and misappropriation of information, and contribution and
indemnification. The factual allegations of the complaint are similar to those
made in the Greater Pennsylvania Carpenters Pension Fund complaint discussed
above. The plaintiff has agreed to the filing of a joint motion to stay the
proceedings in this case pending the District Court's determination of the
Defendants' motions to dismiss in the federal securities class actions. On
September 8, 2004, the Court granted a stay motion without argument. The lawsuit
has been stayed through June 30, 2005.
12
On February 22, 2005, a verified derivative complaint captioned Myra
Cureton v. Richard K. Berkowitz, et. al., Case No. 05 C 1050, was filed in the
United States District Court, Northern District of Illinois, Eastern Division,
for the alleged benefit of the Company against certain of the Company's officers
and directors. The complaint asserts a claim for breach of fiduciary duty. The
factual allegations of the complaint are similar to those made in the Richard
Cusack and Greater Pennsylvania Carpenters Pension Fund complaints discussed
above. The defendants' time to answer or otherwise plead has not yet come.
On April 13, 2005, a verified derivative complaint captioned Tai Vu v.
Richard Berkowitz, et al., Case No. 05 C 2197, was filed in the United States
District Court, Northern District of Illinois, Eastern Division, for the alleged
benefit of the Company against certain of the Company's officers and directors.
The complaint asserts a claim for breach of fiduciary duty. The factual
allegations of the complaint are similar to those made in the Richard Cusack and
Greater Pennsylvania Carpenters Pension Fund complaints discussed above. The
defendants' time to answer or otherwise plead has not yet come. On May 11, 2005,
plaintiffs in the Cureton and Vu actions filed an unopposed motion to
consolidate those two actions, and these cases were consolidated on May 25,
2005.
On April 19, 2005, a shareholder derivative action complaint captioned
Marilyn Perles v. Executor of the Estate of Hugh M. Patinkin, et al., Case No.
05 CH 06926, was filed in the Circuit Court of Cook County, Illinois, for the
alleged benefit of the Company against, inter alia, certain of the Company's
officers and directors. The complaint asserts claims for breach of fiduciary
duty, abuse of control, gross mismanagement, waste of corporate assets, unjust
enrichment, breach of fiduciary duties for insider selling and misappropriation
of information, and contribution and indemnification. The factual allegations of
the complaint are similar to those made in the Cusack complaint discussed above.
The defendants' time to answer or otherwise plead has not yet come.
The Company intends to contest vigorously these putative class action
complaints and the shareholder derivative complaints and exercise all of its
available rights and remedies. Given that these cases are in their early stages
and may not be resolved for some time, it is not possible to evaluate the
likelihood of an unfavorable outcome in any of these matters, or to estimate the
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
and/or liquidity.
As previously disclosed, in September 2003 the Securities and Exchange
Commission (the "SEC") initiated a formal inquiry of the Company with respect to
matters that were the subject of the consolidated Capital Factors actions. The
Company has fully cooperated with the SEC in connection with this formal
investigation.
By letter from counsel dated October 26, 2004, A.L.A. Casting Company,
Inc. ("ALA"), a supplier and creditor of Cosmopolitan Gem Corporation
("Cosmopolitan"), informed the Company that it had been defrauded by
Cosmopolitan and was owed $506,081.55 for goods shipped to Cosmopolitan for
which payment was never received. ALA claimed that the Company is jointly and
severally liable for the full amount of $506,081.55 owed by Cosmopolitan because
the Company aided and abetted Cosmopolitan's fraud and participated in, induced
or aided and abetted breaches of fiduciary duty owed to ALA by Cosmopolitan. ALA
has indicated its intention to pursue its claim, but the Company has not
received notice that litigation has been filed. The Company intends to
vigorously contest this claim and exercise all of its available rights and
remedies.
13
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 the Company's results of operations or financial condition.
9. RELATED PARTY TRANSACTIONS
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.
10. SALES BY MERCHANDISE CATEGORY
The following table sets forth our percentage of total merchandise sales
by category for the following periods:
Three Months Ended
---------------------------------
April 30, 2005 April 30, 2004
-------------- --------------
Diamonds 67.8% 65.8%
Gold 16.2 16.1
Precious/Semi-Precious 11.5 13.8
Watches 4.5 4.3
----- -----
Total Merchandise Sales 100.0% 100.0%
===== =====
Along with our merchandise assortments, we provide jewelry repair services
to our customers (sales from which represented 2.9% of net sales in each of the
three months ended April 30, 2005 and 2004, respectively) and jewelry service
plans provided through a third party provider (sales from which represented 3.2%
and 3.0% in the three months ended April 30, 2005 and 2004, respectively).
Jewelry repair services are provided through independent jewelers under
contract.
14
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 mall-based national retailer of fine jewelry operating
386 stores in 38 states as of April 30, 2005. The Company offers a selection of
merchandise in the following categories: diamond, gold, precious and
semi-precious jewelry and watches. 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.
On March 30, 2005, Hugh M. Patinkin, the Company's Chairman and Chief
Executive Officer, passed away unexpectedly. The Company's Board of Directors
appointed Daniel H. Levy, a member of the Company's Board of Directors since
1997, as Chairman and Lucinda M. Baier, the Company's President and Chief
Operating Officer as Chief Executive Officer, President and Chief Operating
Officer.
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 store remodels
and closures; timing of certain holidays and Company-initiated special events;
changes in the Company's merchandise; inventory availability and the Company's
ability to fund inventory purchases and to time such purchases correctly;
changes in the Company's cost of financing; marketing or credit programs;
general economic, industry, weather conditions and disastrous national events
that affect consumer spending and the pricing, merchandising, marketing, credit
and other programs of competitors.
15
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
----------------------------------------
Percentage of net sales April 30, 2005 April 30, 2004
- ----------------------- -------------- --------------
Net sales 100.0% 100.0%
Cost of sales (including buying and occupancy expenses) 68.2 66.8
----- -----
Gross profit 31.8 33.2
Selling, general and administrative expenses 39.0 37.0
Professional fees and other charges 1.8 3.6
----- -----
Loss from operations (9.0) (7.4)
Interest expense 1.8 1.2
----- -----
Loss before income taxes (10.8) (8.6)
Income tax benefit (3.8) (3.6)
----- -----
Net loss (7.0%) (5.0%)
===== =====
Net Sales
Net sales for the first quarter of fiscal 2005 decreased $2.0 million, or
2.8%, to $71.0 million from $73.0 million in the first quarter of fiscal 2004.
Comparable store sales decreased $2.7 million, or 3.8%, in the first quarter of
fiscal year 2005 compared to the same period in fiscal year 2004. Additionally,
sales decreased by $0.1 million due to store closings and stores closed for
remodeling for limited periods. These decreases were partially offset by sales
from new store openings of $0.7 million. In addition, sales increased by $0.1
million due to changes in the provision for sales returns and allowances
primarily due to a decrease in sales in the first quarter of fiscal year 2005 as
compared to the first quarter of fiscal year 2004. The comparable store sales
decrease was primarily due to lower unit sales in the first quarter of fiscal
year 2005 in comparison to the prior year period. The total number of
merchandise units sold decreased by 21.1% in the first quarter of fiscal year
2005 compared to the first quarter of fiscal year 2004 while the average price
per item sold increased by approximately 22.8% to $341 in the first quarter of
fiscal year 2005 from $278 in the prior year period. The decline in the number
of merchandise units sold was due in part to a decrease in the number of lower
price-point items sold during the first quarter of fiscal year 2005 compared to
the first quarter of fiscal year 2004. Credit sales as a percentage of net sales
increased to 41.3% in the first quarter of fiscal year 2005 from 39.6% in the
first quarter of fiscal year 2004. The Company opened 4 new stores in the first
quarter of fiscal year 2005, and on April 30, 2005 operated 386 stores. As of
April 30, 2004, the Company operated 385 stores.
Gross Profit
Gross profit decreased $1.7 million, or 7.1%, to $22.6 million from $24.3
million in the first quarter of fiscal 2005 compared to the same period in
fiscal 2004. Gross profit as a percentage of sales decreased to 31.8% in the
first quarter of fiscal 2005 compared to 33.2% in the first quarter of fiscal
2004. The gross profit rate decreased by approximately 80 basis points due to
increases in store occupancy, depreciation and buying costs, and the
de-leveraging of such costs due to the decrease in first quarter fiscal year
2005 sales. Merchandise gross margins declined by approximately 130 basis points
resulting primarily from price reductions on certain discontinued merchandise
beginning mid-July 2004. In addition, the gross profit rate decreased by
approximately 40 basis points due to lower vendor discounts and allowances
recognized during the first quarter of fiscal year 2005 compared to the first
quarter of fiscal year 2004. These declines in the gross margin
16
rate were partially offset by an increase of approximately 140 basis points due
to a lower provision recorded for damaged inventory in comparison to the prior
year period.
The Company has historically offered clearance merchandise for sale,
representing merchandise identified from time to time that will not be part of
its future merchandise presentation. During the second and third quarters of
fiscal year 2004, the Company reviewed its merchandise inventory presentation
and determined that, in addition to the items remaining in the Company's
clearance program, $70.4 million of its merchandise inventory at cost would not
be part of its future merchandise presentation. Price reductions were taken on
these items which have resulted in and will continue to result in lower than
historical margins on such merchandise. Sales of these items totaled
approximately $5.7 million with an approximate merchandise cost of $3.6 million
in the first quarter of fiscal year 2005. In addition, the Company has reduced
such discontinued merchandise by approximately $2.2 million due in part to
vendor returns during the first quarter of fiscal year 2005. As of April 30,
2005, the Company had approximately $44.0 million, at cost, of such discontinued
merchandise inventory. The impact of these sales accounted for a margin decline
of approximately 130 basis points during the first quarter of fiscal year 2005.
Based on currently anticipated selling prices, the Company expects to achieve
positive, but lower than historical merchandise margins on such merchandise. It
is the Company's current expectation to continue to offer for sale in all or a
portion of its stores the remaining amount of this merchandise in future
periods, which will negatively impact margins. The Company in future periods may
consider alternative methods of disposition for this inventory. Such
alternatives may result in additional valuation allowances.
Expenses
Selling, general and administrative expenses, excluding professional fees
and other charges, increased $0.7 million, or 2.4%, to $27.7 million from $27.0
million in the first quarter of fiscal 2005 compared to the same period in
fiscal 2004. Selling, general and administrative expense as a percent of sales
increased to 39.0% versus 37.0% in first quarter 2004. The dollar increase
primarily related to higher personnel expense ($0.7 million) partially offset by
lower credit expense ($0.1 million). The increase in personnel expense is
primarily attributable to the addition of support office positions and higher
salary and wage rates. The decrease in credit expense is primarily due to a
shift in the mix of private label credit card promotions that carried a lower
discount rate partially offset by an increase in credit card sales in comparison
to the prior year period.
Professional fees and other charges decreased by $1.5 million to a total
of $1.2 million in the first quarter of fiscal 2005 from $2.7 million in the
prior year period, primarily attributable to the decrease in legal fees and
charges associated with the consolidated Capital Factors actions and the related
United States Attorney and Securities and Exchange Commission (the "SEC")
investigations.
Loss from Operations
As a result of the factors discussed above, loss from operations was $6.4
million in the first quarter of fiscal 2005 compared to a loss of $5.4 million
in the first quarter of fiscal 2004. As a percentage of net sales, loss from
operations was 9.0% in the first quarter of fiscal 2005 as compared to 7.4% in
the prior year period.
Interest Expense
Interest expense increased $0.4 million, or 43.4%, to $1.3 million in the
first quarter of fiscal year 2005 from $0.9 million in the prior year period.
The increase in interest expense resulted from higher average
17
interest rates and higher amortization of deferred loan costs associated with
the amended Credit Agreement, which were partially offset by lower average
outstanding borrowings.
Income Tax Benefit
Income tax benefit of $2.7 million in the first quarter of 2005 compared
to an income tax benefit of $2.6 million in the first quarter of 2004, reflects
an expected annual effective tax rate of 35.3% for fiscal 2005. While the 35.3%
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 2005
could vary significantly from that of the first quarter. The Company's annual
effective tax rate was 30.6% for fiscal 2004.
At April 30, 2005, the Company had $7.5 million of federal net operating
loss carryforwards available. The deferred tax asset for net operating loss
carryforwards is reviewed for recoverability based on historical taxable income,
the expected reversals of existing temporary differences and management's
forecast of future taxable income. Management has concluded that no valuation
allowance was necessary on the federal net operating loss carryforward and
remaining net deferred tax assets as utilization is considered more likely than
not to occur. However, should actual taxable income for fiscal year 2005 differ
unfavorably in comparison to management's forecast of future taxable income, a
valuation allowance against the full amount of the federal net operating loss
may be required.
Liquidity and Capital Resources
The Company's cash requirements consist principally of funding inventory
for 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
Agreement dated July 29, 2003 (the "Credit Agreement"), as amended. The Company
had $84.3 million of outstanding borrowings under the revolving loan facility as
of April 30, 2005.
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
May 1, 2005, the maximum availability under the credit facility was $112.7
million as determined by the borrowing base formula. The credit facility
covenants also require the Company to attain certain operating results.
A net loss of $4.9 million and increases in merchandise inventories ($11.5
million), other current assets ($0.6 million) and accounts receivable ($0.3
million) and decreases in deferred income taxes ($3.0 million) and accounts
payable ($2.0 million) were partially offset by increases in accrued liabilities
($2.1 million), accrued payroll ($0.8 million) and customer deposits ($0.3
million). The increase in merchandise inventories was attributable to the
purchase of goods previously held on consignment and increased purchasing
activity related to new merchandise assortments.
Cash used in investing activities included the funding of capital
expenditures of $1.5 million, related primarily to the opening of 4 new stores
during the first quarter of fiscal 2005, compared to $2.3 million used for
capital expenditures primarily related to the opening of 5 new stores during the
first quarter of 2004.
The Company generated cash from financing activities in the first quarter
of fiscal 2005 by increases in its revolver borrowing ($10.5 million)
18
and outstanding checks ($6.3 million). The Company paid financing costs ($0.4
million) associated with the amendment to the Credit Agreement.
The Company amended the Credit Agreement effective April 6, 2005 in order
to, among other things, (i) provide for additional availability under the
revolving credit facility through the funding of a $15.0 million additional
facility from LaSalle Bank National Association ("LaSalle") and Back Bay Capital
Funding LLC ("Back Bay") which was funded at closing and will be due July 31,
2006, (ii) add a discretionary overadvance subfacility from LaSalle in the
amount of $2 million, (iii) terminate the precious metal consignment facility,
(iv) change the maturity date for all outstanding amounts under the Credit
Agreement from July 28, 2007 to July 31, 2006, (v) increase the interest rate
payable on LIBOR loans from 2.50% to 3.00% above LIBOR, (vi) amend the Fixed
Charge Coverage Ratio (as defined in the Credit Agreement) covenant not to be
less than 0.75:1.00 as measured at the last day of each of the months during the
period of April 2005 to October 2005, 0.80:1.00 at November 30, 2005 and
1.00:1.00 as measured at the last day of each of the months from December 2005
and each month thereafter, (vii) add additional financial covenants related to
Minimum Accounts Payable, Capital Expenditures and Minimum Borrowing
Availability of $2.0 million (each as defined in the Credit Agreement), (viii)
amend the calculation of the borrowing base to lower the advance rate on
inventory for certain periods and to modify the types of inventory and accounts
receivable included, (ix) add a reserve in the amount of $7.0 million to the
borrowing base pending satisfactory completion of a field examination report by
LaSalle and Back Bay and (x) add a reserve in the amount of $5.0 million to the
borrowing base effective February 1, 2006. The field examination report referred
to in clause (ix) above was subsequently completed during April 2005, and the
$7.0 million reserve was removed in May 2005. The Company expects to have
adequate availability under its revolving credit facility throughout fiscal year
2005. However, should actual financial results differ unfavorably from the
Company's current expectations, the availability under its revolving credit
facility may be adversely impacted.
The Company was in compliance with the financial covenants of the amended
Credit Agreement as of April 30, 2005. The Company's business is highly
seasonal, and historically, income generated in the fourth fiscal quarter ending
each January 31 represents all or a significant majority of the income generated
during the fiscal year. The Fixed Charge Coverage Ratio is sensitive to changes
in the level of the Company's profitability. Should actual financial results
differ unfavorably from the Company's current expectations, such results may
have an adverse impact on the Fixed Charge Coverage Ratio. If an event of
default occurs pursuant to the Credit 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.
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 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 and seasonal
working capital needs.
The Company is involved in certain putative class action claims and
derivative suits as described in Note 8 to the financial statements. The Company
intends to contest vigorously the putative class action complaints and the
shareholder derivative complaints and exercise all of its available rights and
remedies. Given that these cases are in their early stages and may not be
resolved for some time, it is not possible to evaluate the likelihood of an
19
unfavorable outcome in any of these matters, or to estimate the 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 and/or liquidity.
Contractual Obligations
The following summarizes the Company's contractual obligations at April
30, 2005:
PAYMENTS DUE BY PERIOD
----------------------------------------------------------------
Less
than 1 - 3 4 - 5 More than
(in thousands) Total 1 year Years Years 5 years
- -------------- --------- -------- -------- -------- ---------
Revolver $ 84,333 $ -- $ 84,333 $ -- $ --
Operating leases 178,480 30,210 82,095 36,398 29,777
--------- -------- -------- -------- ---------
Total contractual obligations $ 262,813 $ 30,210 $166,428 $ 36,398 $ 29,777
--------- -------- -------- -------- ---------
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. In addition, the Company is party to
employment and severance agreements, previously filed with the SEC, with certain
executive officers.
During fiscal year 2005, the Company entered into a letter agreement with
one of its merchandise vendors. Under the terms of this letter agreement, the
merchandise vendor has the sole option to require the Company to purchase
certain consignment goods up to a maximum of $2,010,000, based on current
prices, held by the Company as of February 1, 2006. The Company fulfilled the
terms of this letter agreement during the first quarter of fiscal year 2005
through the purchase of such consignment goods.
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, 2005. 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.
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.
20
Certain of the Company's agreements with merchandise vendors provide
credits for co-op advertising, as calculated as a percentage of net merchandise.
The Company adopted 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") in fiscal year 2002, which was effective
for all arrangements entered into after December 31, 2002. In accordance with
EITF 02-16, the Company classifies certain merchandise vendor allowances 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 costs.
The Company earned $547,000 and $426,000 of vendor allowances for
advertising during the first quarter of fiscal years 2005 and 2004,
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.
NEW ACCOUNTING PRONOUNCEMENTS
ACCOUNTING FOR EXCHANGES OF NONMONETARY ASSETS
The Financial Accounting Standards Board (the "FASB") issued Statement of
Financial Accounting Standards No. 153 ("SFAS No. 153"), "Exchanges of
Nonmonetary Assets - An Amendment of Accounting Principles Board Opinion No. 29
("APB No. 29"), "Accounting for Nonmonetary Transactions." SFAS No. 153
eliminated the exception from fair value measurement for nonmonetary exchanges
of similar productive assets in paragraph 21(b) of APB No. 29, and replaces it
with an exception for exchanges that do not have commercial substance. SFAS No.
153 is effective for fiscal periods beginning after June 15, 2005. The Company
does not expect SFAS No. 153 to have a material impact on the Company.
ACCOUNTING FOR STOCK BASED COMPENSATION
The FASB issued SFAS No. 123 (revised 2004), "Shared-Based Payment" ("SFAS No.
123R"). This statement revised SFAS No. 123, "Accounting for Stock-Based
Compensation," and requires companies to expense the value of employee stock
options and similar awards. The effective date of this standard is annual
periods beginning after June 15, 2005. Historically, the Company has elected to
follow the intrinsic value method in accounting for its employee stock options
and employee stock purchase plans. No stock option based compensation costs were
reflected in net income, as no options granted under those plans had an exercise
price less than the market value of the underlying common stock on the date of
grant.
Upon the adoption of SFAS No. 123R, the Company will be required to
expense stock options over the vesting period in its statement of operations. In
addition, the Company will need to recognize this expense over the remaining
vesting period associated with unvested options outstanding for fiscal years
beginning after June 15, 2005. The Company is currently evaluating which
transition method to use and the effects on its financial statements in
connection with the adoption of SFAS No. 123R.
ACCOUNTING FOR CONDITIONAL ASSET RETIREMENT OBLIGATIONS
In March 2005, the FASB issued FASB Interpretation No. 47 ("FIN 47"),
"Accounting for Conditional Asset Retirement Obligations, an interpretation of
FASB Statement No. 143." FIN 47 clarifies that conditional asset retirement
obligations meet the definition of liabilities and should be recognized when
incurred if their fair values can be reasonably estimated. FIN 47 is effective
no later than the end of fiscal years ending after December 15,
21
2005. The Company is in the process of evaluating the expected effects of the
adopting of FIN 47 on its financial statements.
Transactions with Affiliates and Related Parties
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.
Accounting for Guarantees
In November 2002, the Financial Accounting Standards 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, 2005, however,
reference should be made to Note 8 to the financial statements with respect to
legal contingencies.
22
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 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.
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.
23
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) and 15d - 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,
2005. There were no changes in the Company's internal control over financial
reporting that occurred during the Company's fiscal quarter ended April 30, 2005
that have materially affected, or are reasonably likely to materially affect,
the Company's internal control over financial reporting.
24
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
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 1107, 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. ("Capital Factors") and settled as disclosed in the
Company's Quarterly Report on Form 10-Q for the fiscal quarter ended October 31,
2004 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
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
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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 June 14, 2004, lead plaintiff Greater Pennsylvania Carpenters Pension
Fund in Case No. 04C 1107 filed a consolidated amended complaint. On July 14,
2004, the District Court in the Greater Pennsylvania Carpenters action
consolidated the Kaplan complaint with the Greater Pennsylvania Carpenters
action, and dismissed the Kaplan action as a separate action. On August 2, 2004,
Whitehall filed a motion to dismiss the consolidated amended complaint. The
motion to dismiss was granted in part and denied in part, with plaintiffs
granted leave to file an amended complaint by February 10, 2005. On February 10,
2005, the lead plaintiff filed a first amended consolidated complaint. On March
2, 2005, the Company filed a motion to dismiss the amended complaint. Briefing
on this motion is complete and the parties are awaiting the Court's ruling. If
the Company is successful on its motion, the class in this action may be limited
to the period November 19, 2001 through June 6, 2002. On April 19, 2005, the
Court issued an order, sua sponte, directing the parties to submit simultaneous
briefs addressing what impact, if any, the Supreme Court's ruling in Dura
Pharmaceuticals, Inc. v. Broudo, 125 S.Ct. 1627 (2005), has on Plaintiff's loss
causation allegations. In response to this order, the Company filed a brief on
May 4, 2005 in which it requested that the Court dismiss the amended complaint
in its entirety for failure to adequately plead loss causation. The Court has
not yet ruled on this issue.
On June 15, 2004, a shareholder derivative action complaint captioned
Richard Cusack v. Hugh Patinkin, et al., Case No. 04 CH 09705, was filed in the
Circuit Court of Cook County, Illinois, for the alleged benefit of the Company
against certain of the Company's officers and directors. The complaint asserts
claims for breach of fiduciary duty, abuse of control, gross mismanagement,
waste of corporate assets, unjust enrichment, breach of fiduciary duties for
insider selling and misappropriation of information, and contribution and
indemnification. The factual allegations of the complaint are similar to those
made in the Greater Pennsylvania Carpenters Pension Fund complaint discussed
above. The plaintiff has agreed to the filing of a joint motion to stay the
proceedings in this case pending the District Court's determination of the
Defendants' motions to dismiss in the federal securities class actions. On
September 8, 2004, the Court granted a stay motion without argument. The lawsuit
has been stayed through June 30, 2005.
On February 22, 2005, a verified derivative complaint captioned Myra
Cureton v. Richard K. Berkowitz, et. al., Case No. 05 C 1050, was filed in the
United States District Court, Northern District of Illinois, Eastern Division,
for the alleged benefit of the Company against certain of the Company's officers
and directors. The complaint asserts a claim for breach of fiduciary duty. The
factual allegations of the complaint are similar to those made in the Richard
Cusack and Greater Pennsylvania Carpenters Pension Fund complaints discussed
above. The defendants' time to answer or otherwise plead has not yet come.
On April 13, 2005, a verified derivative complaint captioned Tai Vu v.
Richard Berkowitz, et al., Case No. 05 C 2197, was filed in the United States
District Court, Northern District of Illinois, Eastern Division, for the alleged
benefit of the Company against certain of the Company's officers and directors.
The complaint asserts a claim for breach of fiduciary duty. The factual
allegations of the complaint are similar to those made in the Richard Cusack and
Greater Pennsylvania Carpenters Pension Fund complaints discussed above. The
defendants' time to answer or otherwise plead has not yet come. On May 11, 2005,
plaintiffs in the Cureton and Vu actions filed an unopposed motion to
consolidate those two actions and these cases were consolidated on May 25, 2005.
On April 19, 2005, a shareholder derivative action complaint captioned
Marilyn Perles v. Executor of the Estate of Hugh M. Patinkin, et al., Case No.
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05 CH 06926, was filed in the Circuit Court of Cook County, Illinois, for the
alleged benefit of the Company against certain of the Company's officers and
directors. The complaint asserts, inter alia, claims for breach of fiduciary
duty, abuse of control, gross mismanagement, waste of corporate assets, unjust
enrichment, breach of fiduciary duties for insider selling and misappropriation
of information, and contribution and indemnification. The factual allegations of
the complaint are similar to those made in the Cusack complaint discussed above.
The defendants' time to answer or otherwise plead has not yet come.
The Company intends to contest vigorously these putative class action
complaints and the shareholder derivative complaints and exercise all of its
available rights and remedies. Given that these cases are in their early stages
and may not be resolved for some time, it is not possible to evaluate the
likelihood of an unfavorable outcome in any of these matters, or to estimate the
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
and/or liquidity.
As previously disclosed, in September 2003 the Securities and Exchange
Commission (the "SEC") initiated a formal inquiry of the Company with respect to
matters that were the subject of the consolidated Capital Factors actions. The
Company has fully cooperated with the SEC in connection with this formal
investigation.
By letter from counsel dated October 26, 2004, A.L.A. Casting
Company, Inc. ("ALA"), a supplier and creditor of Cosmopolitan Gem Corporation
("Cosmopolitan"), informed the Company that it had been defrauded by
Cosmopolitan and was owed $506,081.55 for goods shipped to Cosmopolitan for
which payment was never received. ALA claimed that the Company is jointly and
severally liable for the full amount of $506,081.55 owed by Cosmopolitan because
the Company aided and abetted Cosmopolitan's fraud and participated in, induced
or aided and abetted breaches of fiduciary duty owed to ALA by Cosmopolitan. ALA
has indicated its intention to pursue its claim, but the Company has not
received notice that litigation has been filed. The Company intends to
vigorously contest this claim and exercise all of its available rights and
remedies.
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 the Company's results of operations or financial condition.
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Item 5. Other Information
Forward Looking Statements
This report contains certain forward-looking statements (as such term is defined
in Section 27A of the Securities Act of 1933 and Section 21E of the Securities
Exchange Act of 1934) and information relating to the Company that are based on
the current beliefs of management of the Company as well as assumptions made by
and information currently available to management including statements related
to the markets for our products, general trends and trends in our operations or
financial results, plans, expectations, estimates and beliefs. In addition, when
used in this report, the words "anticipate," "believe," "estimate," "expect,"
"intend," "plan," "predict," "opinion" and similar expressions and their
variants, as they relate to the Company or our management, may identify
forward-looking statements. Such statements reflect our judgment as of the date
of this report with respect to future events, the outcome of which is subject to
certain risks, including the factors described below, which may have a
significant impact on our business, operating results or financial condition.
Investors are cautioned that these forward-looking statements are inherently
uncertain. Should one or more of these risks or uncertainties materialize, or
should underlying assumptions prove incorrect, actual results or outcomes may
vary materially from those described herein. The Company undertakes no
obligation to update forward-looking statements. The following factors, among
others, may impact forward-looking statements contained in this report: (1) a
change in economic conditions or the financial markets 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) increased competition from specialty jewelry retail stores, the Internet and
mass merchant discount stores which may adversely impact our sales and gross
margin; (4) our ability to execute our business strategy and the related effects
on comparable store sales and other results; (5) the extent and results of our
store expansion strategy and associated occupancy costs, and access to funds for
new store openings and the ability to exit underperforming stores; (6) the high
degree of fourth quarter seasonality of our business and the impact on the
Company's sales, profitability and liquidity; (7) the extent and success of our
merchandising, marketing and/or promotional programs; (8) personnel costs and
the extent to which we are able to retain and attract key personnel; (9) the
effects of competition on the Company including merchandise availability, real
estate opportunities and retention of personnel; (10) the availability, terms
and cost of consumer credit; (11) relationships with suppliers including the
timely delivery to the Company of appropriate merchandise and services on
payment and other terms consistent with past practice; (12) our ability to
maintain adequate information systems capacity and infrastructure; (13) our
continued ability to secure sufficient financing on acceptable terms, including,
if an event of default were to occur pursuant to the Company's revolving loan
facility, that the Company may be required to negotiate relief with its lenders
or seek new financing with respect to which there may be no assurance that new
financing agreements would be available on acceptable terms or at all; (14) our
leverage, liquidity, and cost of funds and changes in interest rates that may
increase such costs; (15) our ability to maintain adequate loss prevention
measures; (16) fluctuations in raw material prices, including diamond, gem and
gold prices; (17) the impact of current or future price reductions on margins
and resultant valuation allowances taken on certain merchandise inventory
identified from time to time as items which would not be part of the Company's
future merchandise presentation as well as alternative methods of disposition of
this merchandise inventory and resultant valuations taken; (18) developments
relating to settlement of the consolidated Capital Factors actions, the
non-prosecution agreement entered into with the United States Attorney's Office,
the Securities and Exchange Commission (the "SEC") investigation, 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; (19) regulation affecting
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the industry generally, including regulation of marketing practices; and (20)
the risk factors identified from time to time in our filings with the SEC.
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Item 6. - Exhibits
Exhibit No. Description
- ----------- -----------------------------------------------------------
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.
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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 9, 2005 By: /s/ John R. Desjardins
----------------------
John R. Desjardins
Executive Vice President;
Chief Financial Officer and Treasurer
(Duly authorized officer and principal
financial officer)
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