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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended August 2, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from ___________ to ______________
Commission file number 1-10767
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VALUE CITY DEPARTMENT STORES, INC.
----------------------------------
(Exact name of registrant as specified in its charter)
Ohio 31-1322832
- ----------------------------------------- ----------------------------------
(State or other jurisdiction of incorpo- (I.R.S. Employer Identification No.)
ration or organization)
3241 Westerville Road, Columbus, Ohio 43224
- ----------------------------------------- ----------------------------------
(Address of principal executive offices) (Zip Code)
(614) 471-4722
--------------------------------------------------
Registrant's telephone number, including area code
Not applicable
--------------------------------------------------
(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 and (2) has been subject to such filing requirements for
the past 90 days. YES X NO
---- ----
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). YES NO X
---- -------
The number of shares outstanding of Common Stock, without par value, as of
September 11, 2003 was 33,912,833.
VALUE CITY DEPARTMENT STORES, INC.
TABLE OF CONTENTS
PAGE NO.
--------
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets at August 2, 2003
and February 1, 2003........................................................................3
Condensed Consolidated Statements of Operations for the
three and six months ended August 2, 2003
and August 3, 2002..........................................................................4
Condensed Consolidated Statements of Cash Flows
for the six months ended August 2, 2003
and August 3, 2002..........................................................................5
Notes to Consolidated Financial Statements......................................................6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations..................................................................14
Item 3. Quantitative and Qualitative Disclosures about Market Risk.....................................25
Item 4. Controls and Procedures..........................................................................25
PART II. OTHER INFORMATION
Item 1. Legal Proceedings..............................................................................26
Item 2. Changes in Securities and Use of Proceeds......................................................26
Item 3. Defaults Upon Senior Securities................................................................26
Item 4. Submission of Matters to a Vote of Security Holders............................................26
Item 5. Other Information..............................................................................26
Item 6. Exhibits and Reports on Form 8-K...............................................................26
Signature........................................................................................................27
-2-
VALUE CITY DEPARTMENT STORES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
(UNAUDITED)
August 2, February 1,
2003 2003
- ------------------------------------------------------------------
ASSETS
Cash and equivalents $ 31,920 $ 11,059
Accounts receivable, net 7,820 10,666
Receivables from affiliates 1,055 933
Inventories 477,194 389,825
Prepaid expenses and other assets 16,823 19,354
Deferred income taxes 59,893 51,317
- ------------------------------------------------------------------
Total current assets 594,705 483,154
- ------------------------------------------------------------------
Property and equipment, net 233,311 233,452
Goodwill 37,619 37,619
Tradenames and other intangibles, net 45,620 47,583
Other assets 28,472 29,991
- ------------------------------------------------------------------
$ 939,727 $ 831,799
==================================================================
LIABILITIES AND SHAREHOLDERS' EQUITY
Accounts payable $ 189,877 $ 160,809
Accounts payable to affiliates 17,463 4,228
Accrued expenses 116,045 135,918
Current maturities of long-term obligations 813 809
- ------------------------------------------------------------------
Total current liabilities 324,198 301,764
- ------------------------------------------------------------------
Long-term obligations, net of current
maturities 361,261 264,664
Other noncurrent liabilities 49,112 44,207
Commitments and contingencies -- --
Common shares, without par value;
80,000,000 authorized; issued, including
treasury shares, 33,920,707 and
33,913,374 shares, respectively 143,183 143,183
Warrants 6,074 6,074
Retained earnings 61,946 78,767
Deferred compensation expense, net (788) (981)
Treasury shares, at cost, 7,651 shares (59) (59)
Accumulated other comprehensive loss (5,200) (5,820)
- ------------------------------------------------------------------
205,156 221,164
- ------------------------------------------------------------------
$ 939,727 $ 831,799
==================================================================
The accompanying notes are an integral part of the consolidated financial
statements.
-3-
VALUE CITY DEPARTMENT STORES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
Three months ended Six months ended
------------------ ----------------
August 2, August 3, August 2, August 3,
2003 2002 2003 2002
- --------------------------------------------------------------------------------------------
Net sales, excluding sales of
licensed departments $ 604,594 $ 569,062 $ 1,193,126 $ 1,154,974
Cost of sales (368,228) (345,463) (740,040) (708,188)
- --------------------------------------------------------------------------------------------
Gross profit 236,366 223,599 453,086 446,786
Selling, general and
administrative expenses (235,875) (219,344) (466,916) (442,614)
License fees and other
operating income 1,291 2,431 2,792 4,593
- --------------------------------------------------------------------------------------------
Operating profit (loss) 1,782 6,686 (11,038) 8,765
Interest expense, net (8,069) (7,863) (17,652) (14,201)
- --------------------------------------------------------------------------------------------
Loss before benefit for income
taxes and cumulative effect of
accounting change (6,287) (1,177) (28,690) (5,436)
Benefit for income taxes 2,639 451 11,869 2,015
- --------------------------------------------------------------------------------------------
Loss before cumulative effect of
accounting change (3,648) (726) (16,821) (3,421)
- --------------------------------------------------------------------------------------------
Cumulative effect of accounting
change, net of income taxes -- -- -- (2,080)
- --------------------------------------------------------------------------------------------
Net loss $ (3,648) $ (726) $ (16,821) $ (5,501)
============================================================================================
Basic and diluted loss per share:
Loss before cumulative effect
of accounting change $ (0.11) $ (0.02) $ (0.50) $ (0.10)
Cumulative effect of accounting
change, net of income taxes -- -- -- (0.06)
- --------------------------------------------------------------------------------------------
Net loss per share $ (0.11) $ (0.02) $ (0.50) $ (0.16)
- --------------------------------------------------------------------------------------------
Basic and diluted weighted
average shares outstanding 33,720 33,651 33,716 33,641
============================================================================================
The accompanying notes are an integral part of the consolidated financial
statements.
-4-
VALUE CITY DEPARTMENT STORES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
Six months ended
-----------------------
August 2, August 3,
2003 2002
- -------------------------------------------------------------------------------
Cash flows from operating activities:
Net loss $ (16,821) $ (5,501)
Adjustments to reconcile net loss to net cash
(used in) provided by operating activities:
Cumulative effect of accounting change -- 2,080
Amortization of discount on debt 1,012 42
Amortization of deferred compensation 193 279
Depreciation and amortization 27,793 30,468
Deferred income taxes and other noncurrent liabilities (7,862) (5,108)
Loss on disposal of asset 279 52
Change in working capital, assets and liabilities:
Receivables 2,724 1,521
Inventories (87,369) (20,479)
Prepaid expenses and other assets 6,189 3,018
Accounts payable 42,303 43,748
Accrued expenses (23,362) (4,669)
- -------------------------------------------------------------------------------
Net cash (used in) provided by operating activities (54,921) 45,451
- -------------------------------------------------------------------------------
Cash flows from investing activities:
Capital expenditures (23,504) (19,989)
Proceeds from sale of assets 13 26
Proceeds from lease incentives 3,684 6,451
- -------------------------------------------------------------------------------
Net cash used in investing activities (19,807) (13,512)
- -------------------------------------------------------------------------------
Cash flows from financing activities:
Proceeds from issuance of debt -- 100,000
Debt issuance costs -- (13,205)
Net increase (decrease) in:
Revolving credit facility 96,000 (101,500)
Capital leases and other debt (411) (21,197)
- -------------------------------------------------------------------------------
Net cash provided by (used in) financing activities 95,589 (35,902)
- -------------------------------------------------------------------------------
Net increase (decrease) in cash and equivalents 20,861 (3,963)
Cash and equivalents, beginning of period 11,059 35,915
- -------------------------------------------------------------------------------
Cash and equivalents, end of period $ 31,920 $ 31,952
===============================================================================
The accompanying notes are an integral part of the consolidated financial
statements.
-5-
VALUE CITY DEPARTMENT STORES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
The accompanying consolidated financial statements include the accounts of
Value City Department Stores, Inc. and its wholly owned subsidiaries. These
entities are herein referred to collectively as the Company. The Company is
managed in three operating segments: Value City Department Stores ("Value
City"), DSW Shoe Warehouse ("DSW"), and Filene's Basement.
VALUE CITY. The Company operates a chain of 116 department stores located
in Ohio, Pennsylvania and 13 other Midwestern, Eastern and Southern states,
principally under the name Value City. For over 80 years, our strategy has
been to provide exceptional value by offering a broad selection of brand
name merchandise at prices substantially below conventional retail prices.
Our Value City stores carry men's, women's and children's apparel,
housewares, giftware, home furnishings, toys, jewelry, health and beauty
care items, shoes and commodities, with apparel comprising well over
one-half of total sales. Our Value City stores average 87,000 square feet
which allow us to offer over 100,000 different items of merchandise similar
to the items found in traditional department, specialty and discount
stores. Our pricing strategy is supported by our ability to purchase large
quantities of goods in a variety of special buying opportunities. For many
years, we have had a reputation in the marketplace as a purchaser of
buy-outs and manufacturers' closeouts.
DSW. The Company also operates a chain of 131 DSW stores located throughout
the United States. Our DSW stores are a chain of upscale shoe stores
offering a wide selection of dress and casual footwear below traditional
retail prices. These stores average 25,000 square feet with up to 45,000
pairs of women's and men's designer brand shoes and athletic footwear per
store. Additionally, Shonac Corporation, the parent company of DSW,
pursuant to license agreements with Value City and Filene's Basement,
operates the license shoe departments in principally all Value City and
Filene's Basement stores. Results of operations of licensed shoe
departments are included with the Value City and Filene's Basement
segments. In July 2002, Shonac Corporation entered into a Supply Agreement
with Stein Mart to supply merchandise to some of Stein Mart's shoe
departments. The Stein Mart Supply Agreement operations are included with
the DSW segment.
FILENE'S BASEMENT. Finally, the Company operates 21 Filene's Basement
stores located principally in the Northeast United States. Our Filene's
Basement stores average 40,000 square feet and specialize in top tier brand
name merchandise of men's and women's apparel, jewelry, shoes, accessories
and home goods.
The accompanying financial statements reflect all adjustments consisting of
only normal recurring adjustments, which are, in the opinion of management,
necessary to present fairly the consolidated financial position and results
of operations for the periods presented. To facilitate comparisons with the
current year, certain previously reported balances have been reclassified
to conform with the current period presentation.
-6-
VALUE CITY DEPARTMENT STORES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
2. SHAREHOLDERS' EQUITY
Six months ended
August 2, 2003
-------------------------------------------------------------------------
Total shareholders' equity, beginning of period $221,164
Net loss (16,821)
Amortization of deferred compensation expense 193
Net unrealized gain on derivative financial
instruments, net of income tax provision of $413 620
-------------------------------------------------------------------------
Total shareholders' equity, end of period $205,156
-------------------------------------------------------------------------
The Company issued warrants ("Warrants") with a fair value of $6.1 million
to purchase 2,954,792 shares of common stock at an exercise price of $4.50
per share to the Term Loan C Lenders. The number of shares issuable upon
the exercise of the Warrants and the per share exercise price are subject
to adjustment upon the occurrence of specified events. The Warrants are
exercisable at any time prior to June 11, 2012. The Company has granted the
Term Loan C Lenders registration rights with respect to the shares issuable
upon exercise of the Warrants. The value placed on the Warrants was $6.1
million and the related debt discount is amortized into interest expense
over the life of the debt.
$75 Million Senior Convertible Loan
The Company amended and restated its $75.0 million Senior Subordinated
Convertible Loan Agreement on June 11, 2002 ("the "Convertible Loan"). As
amended, borrowings under the Convertible Loan will bear interest at 10%
per annum. At the Company's option, interest may be PIK from the closing
date until June 11, 2004, and thereafter, at the option of the Company, up
to 50% of the interest due may be PIK until maturity. The Convertible Loan
is guaranteed by all principal subsidiaries and is secured by a lien on
assets junior to liens granted in favor of the lenders on the Company's
Revolving Credit Agreement and Term Loans. The Convertible Loan is not
subject to prepayment until June 11, 2007. The agent has the right to
designate two observers to the Board of Directors for so long as the agent
is the beneficial owner of at least 50% of the advances initially made by
it and has the right to designate two individuals to the Board of Directors
for so long as the agent is the beneficial owner of at least 50% of the
conversion shares issued upon conversion of the advances initially made by
it.
The Convertible Loan is convertible at the option of the holders into
shares of Value City Department Stores, Inc. common stock at a conversion
price of $4.50. The maturity date is June 10, 2009.
-7-
VALUE CITY DEPARTMENT STORES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
3. EARNINGS PER SHARE
Basic earnings per share is based on the net loss and a simple weighted
average of common shares outstanding.
Diluted earnings per share reflects the potential dilution of common
shares, related to both outstanding stock options and warrants, calculated
using the treasury stock method and convertible debt calculated using the
if-converted method. The numerator for the diluted earnings per share
calculation is the net loss adjusted to remove the effect of interest,
adjusted for tax, on the convertible debt.
The denominator is summarized as follows for the diluted earnings per share
calculation (in thousands):
Three months ended Six months ended
------------------------------ -------------------------------
August 2, August 3, August 2, August 3,
2003 2002 2003 2002
-----------------------------------------------------------------------------------------------------------------------
Weighted average shares outstanding 33,720 33,651 33,716 33,641
Assumed exercise of warrants -- -- -- --
Assumed conversion of debt -- -- -- --
Assumed exercise of dilutive stock options -- -- -- --
-----------------------------------------------------------------------------------------------------------------------
Number of shares for computation of
diluted earnings per share 33,720 33,651 33,716 33,641
-----------------------------------------------------------------------------------------------------------------------
The stock options, warrants and convertible debt are anti-dilutive for the
three months ended August 2, 2003 and August 3, 2002 and the six months
ended August 2, 2003 and August 3, 2002.
4. VALUATION ACCOUNT
Reserves established and used for severance costs are as follows (in
thousands):
Six months Year
ended ended
------------------- ----------------------
August 2, 2003 February 1, 2003
-----------------------------------------------------------------------------------------------------------------------
Balance at beginning of period $3,996 $5,357
Provisions to establish reserves -- 5,950
Reductions for intended purposes (3,996) (7,311)
-----------------------------------------------------------------------------------------------------------------------
Balance at end of period -- $3,996
-----------------------------------------------------------------------------------------------------------------------
-8-
VALUE CITY DEPARTMENT STORES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
5. ADOPTION OF ACCOUNTING STANDARDS
The Financial Accounting Standards Board ("FASB") periodically issues
Statements of Financial Accounting Standards ("SFAS"), some of which
require implementation by a date falling within or after the close of the
fiscal year.
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements
No. 4, 44, and 64, Amendment of FASB Statement No. 13 and Technical
Corrections". SFAS No. 145 is effective for fiscal years beginning after
May 15, 2002. The adoption of SFAS No. 145 did not have a significant
effect on the Company's results of operations or its financial position.
However it did require that the Company reclassify the loss on the
extinguishment of debt of approximately $3.3 million from extraordinary
loss to selling, general and administrative expense, in the Company's
consolidated financial statement of operations.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity".
SFAS No. 150 requires that an issuer classify a financial instrument that
is within its scope as a liability (or an asset in some circumstances),
many of which were previously classified as equity. This statement is
effective for financial instruments entered into or modified after May 31,
2003 and otherwise shall be effective for the Company's 2004 financial
statements. Management does not expect the initial adoption of this
accounting pronouncement will have a material impact on the Company's
consolidated financial statements.
In January 2003, the FASB issued FIN 46, Consolidation of Variable Interest
Entities. FIN 46 clarifies the application of Accounting Research Bulletin
No. 51, Consolidated Financial Statements, to certain entities in which
equity investors do not have the characteristics of a controlling financial
interest or do not have sufficient equity at risk for the entity to finance
its activities without additional subordinated financial support from other
parties. FIN 46 requires a variable interest entity to be consolidated by a
company, if that company is subject to a majority of the risk of loss from
the variable interest entity's activities or entitled to receive a majority
of the entity's residual returns or both. FIN 46 also requires disclosures
about variable interest entities that a company is not required to
consolidate but in which it has a significant variable interest. The
consolidation requirements of FIN 46 apply immediately to variable interest
entities created after January 31, 2003 and to existing entities in the
first fiscal year or interim period beginning after June 15, 2003. Certain
of the disclosure requirements apply to all financial statements issued
after January 31, 2003, regardless of when the variable interest entity was
established. The Company has no variable interest entities as of August 2,
2003.
The FASB's Emerging Issues Task Force ("EITF") Issue No. 02-16, "Accounting
By A Customer (Including A Reseller) For Cash Consideration Received From A
Vendor" addressed the accounting treatment for vendor allowances. The
adoption of EITF Issue No. 02-16 in
-9-
VALUE CITY DEPARTMENT STORES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
2003 did not have a material impact on the Company's financial position or
results of operations.
6. ACCUMULATED OTHER COMPREHENSIVE LOSS
Comprehensive loss represents net loss plus the results of certain
non-shareholders' equity changes not reflected in the Consolidated
Statement of Operations. The components of comprehensive loss, net of tax
are as follows (in thousands):
Three months ended Six months ended
------------------------------- -------------------------------
August 2, August 3, August 2, August 3,
2003 2002 2003 2002
-------------------------------------------------------------------------------------------------------------------------
Net loss $(3,648) $(726) $(16,821) $(5,501)
Net unrealized gain on
derivative financial instruments
net of income tax -- 381 620 832
-------------------------------------------------------------------------------------------------------------------------
Other comprehensive loss $(3,648) $(345) $(16,201) $(4,669)
-------------------------------------------------------------------------------------------------------------------------
The components of the balance sheet caption accumulated other comprehensive
loss are as follows (in thousands):
August 2, 2003 February 1, 2003
--------------------------------------------------------------------------------------------------------------------
Net unrealized loss on derivative
financial instruments, net of income tax $ -- $ (620)
Minimum pension liability, net of income tax (5,200) (5,200)
--------------------------------------------------------------------------------------------------------------------
Accumulated other comprehensive loss $ (5,200) $(5,820)
--------------------------------------------------------------------------------------------------------------------
The Company's interest rate swap expired during the three months ended May
3, 2003, and was not renewed.
7. STOCK BASED COMPENSATION
The Company has various stock-based employee compensations plans. The
Company accounts for those plans in accordance with APB No. 25 "Accounting
For Stock Issued to Employees" and related Interpretations. No stock based
employee compensation cost is reflected in net loss, 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. The following table
illustrates the effect on net loss and loss per share if the Company had
applied the fair value recognition of SFAS 123, "Accounting for
Stock-Based Compensation".
-10-
VALUE CITY DEPARTMENT STORES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Three months ended Six months ended
----------------------------- -------------------------------
August 2, August 3, August 2, August 3,
2003 2002 2003 2002
-------------------------------------------------------------------------------------------------------------------------
Net loss, as reported $(3,648) $(726) $(16,821) $(5,501)
Deduct: Total stock-based employee
compensation expense determined
under fair value based method for
all awards, net of tax (1,280) (1,252) (2,309) (2,450)
-------------------------------------------------------------------------------------------------------------------------
Pro forma net loss $(4,928) $(1,978) $(19,130) $(7,951)
-------------------------------------------------------------------------------------------------------------------------
Loss per share:
Basic and diluted as reported $(0.11) $(0.02) $(0.50) $ (0.16)
Basic and diluted pro forma $(0.15) $(0.06) $(0.57) $ (0.24)
8. TAX VALUATION
The Company establishes valuation allowances for our deferred tax assets
when the amount of expected future taxable income is not likely to support
the use of the deduction or credit. At August 2, 2003, an allowance of $9.8
million has been provided. On February 1, 2003, no allowance was recorded.
The tax rate prior to the allowance was 75.5%, and reflects the impact of
the non-deductible warrant amortization included for book income but not
tax.
9. SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
A supplemental schedule of non-cash investing and financing activities is
presented below (in thousands):
6 months ended
-------------------------------------------
August 2, August 3,
2003 2002
Cash paid during the period for:
Interest $20,187 $17,867
Income taxes 1,558 1,086
Issue of warrants $-- $6,074
-11-
VALUE CITY DEPARTMENT STORES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The Company issued warrants with a fair value of $6.1 million to the
holders of the Term Loan C Lenders to purchase 2,954,792 shares of common
stock at the initial exercise price of $4.50 per share, subject to
adjustment. The Warrants are exercisable at any time prior to June 11,
2012. The Company has granted the Term Loan C Lenders registration rights
with respect to the shares issuable upon exercise of the Warrants.
10. SEGMENT REPORTING
The Company is managed in three operating segments: Value City Department
Stores, DSW and Filene's Basement. All of the operations are located in the
United States. The Company has identified such segments based on management
responsibility and measures segment profit as operating (loss) profit,
which is defined as income before interest expense and income taxes.
Three-month period ended August 2, 2003 (in thousands):
Value City DSW Filene's Total
---------- --- -------- -----
Net sales $336,522 $192,338 $75,734 $604,594
Operating (loss) profit (10,598) 10,931 1,449 1,782
Capital expenditures 9,452 2,023 1,182 12,657
Depreciation and amortization 9,169 3,269 1,551 13,989
Three-month period ended August 3, 2002 (in thousands):
Value City DSW Filene's Total
---------- --- -------- -----
Net sales $336,456 $158,833 $73,773 $569,062
Operating (loss) profit (1,459) 8,327 (182) 6,686
Capital expenditures 5,623 8,079 679 14,381
Depreciation and amortization 12,852 2,327 2,316 17,495
Six-month period ended August 2, 2003 (in thousands):
Value City DSW Filene's Total
---------- --- -------- -----
Net sales $679,416 $375,389 $138,321 $1,193,126
Operating (loss) profit (23,952) 13,532 (618) (11,038)
Identifiable assets 713,621 118,901 107,205 939,727
Capital expenditures 13,478 8,216 1,810 23,504
Depreciation and amortization 18,267 6,374 3,152 27,793
-12-
VALUE CITY DEPARTMENT STORES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Six-month period ended August 3, 2002 (in thousands):
Value City DSW Filene's Total
---------- --- -------- -----
Net sales $695,681 $314,809 $144,484 $1,154,974
Operating (loss) profit (5,753) 13,314 1,204 8,765
Identifiable assets 546,891 237,246 118,120 902,257
Capital expenditures 8,033 10,637 1,319 19,989
Depreciation and amortization 22,629 3,799 4,040 30,468
11. COMMITMENTS AND CONTINGENCIES
The Company is involved in various legal proceedings that are incidental to
the conduct of its business. The Company estimates the range of liability
related to pending litigation where the amount and range of loss can be
estimated. The Company records its best estimate of a loss when the loss is
considered probable. Where a liability is probable and there is a range of
estimated loss, the Company records the minimum estimated liability related
to the claim. In the opinion of management, the amount of any liability
with respect to these proceedings will not be material. As additional
information becomes available, the Company assesses the potential liability
related to its pending litigation and revises the estimates. Revisions in
the Company's estimates and potential liability could materially impact its
results of operations.
-13-
VALUE CITY DEPARTMENT STORES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
RISK FACTORS AND SAFE HARBOR STATEMENT
We caution that any forward-looking statements (as such term is defined in the
Private Securities Litigation Reform Act of 1995) contained in this Report
and/or other risk factors that may be described in the Safe Harbor Statement and
Business Risks section of the Company's Annual Report on Form 10-K for the year
ended February 1, 2003, or contained in other filings with the Securities and
Exchange Commission or made by our management involve risks and uncertainties,
and are subject to change based on various important factors. The following
factors, among others, in some cases have affected and in the future could
affect our financial performance and actual results and could cause actual
results for 2003 and beyond to differ materially from those expressed or implied
in any such forward-looking statements: decline in demand for our merchandise,
our ability to attain our fiscal 2003 business plan, expected cash from
operations, vendor and their factor relations, flow of merchandise, compliance
with our credit agreements, our ability to strengthen our liquidity and increase
our credit availability, the availability of desirable store locations on
suitable terms, changes in consumer spending patterns, consumer preferences and
overall economic conditions, the impact of competition and pricing, changes in
weather patterns, changes in existing or potential duties, tariffs or quotas,
paper and printing costs, and the ability to hire and train associates. One or
more of these factors have affected, and in the future could affect, our
business and financial results and could cause actual results to differ from
plans and projections. Although we believe that the assumptions underlying the
forward-looking statements contained herein are reasonable, any of the
assumptions could be inaccurate. Therefore, there can be no assurance that the
forward-looking statements included in this Quarterly Report on Form 10-Q will
prove to be accurate. In light of the significant uncertainties inherent in the
forward-looking statements included herein, the inclusion of such information
should not be regarded as representations by us or any other person that our
objectives and plans will be achieved. All forward-looking statements made in
this Quarterly Report are based on information presently available to our
management. We assume no obligations to update any forward-looking statements
contained herein.
Historically, our operations have been seasonal, with a disproportionate amount
of sales and a majority of net income occurring in the back-to-school and
Christmas selling seasons. As a result of this seasonality, any factors
negatively affecting us during this period, including adverse weather, the
timing and level of markdowns or unfavorable economic conditions, could have a
material adverse effect on our financial condition and results of operations for
the entire year.
CRITICAL ACCOUNTING POLICIES
Management's Discussion and Analysis discusses the results of operations and
financial condition as reflected in our consolidated financial statements, which
have been prepared in accordance with generally accepted accounting principles.
As discussed in Notes to Consolidated Financial Statements that are included in
our Annual Report on Form 10-K for the year ended February 1, 2003 that is filed
with the Securities and Exchange Commission, the preparation of
-14-
VALUE CITY DEPARTMENT STORES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
financial statements requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
commitments and contingencies at the date of the financial statements and
reported amounts of revenues and expenses during the reporting period. On an
ongoing basis, management evaluates its estimates and judgments, including, but
not limited to, those related to inventory valuation, depreciation,
amortization, recoverability of long-lived assets including intangible assets,
the calculation of retirement benefits, estimates for self insurance reserves
for health and welfare, workers' compensation and casualty insurance, income
taxes, contingencies, litigation and revenue recognition. Management bases its
estimates and judgments on its historical experience and other relevant factors,
the results of which form the basis for making judgments about the carrying
values of assets and liabilities that are not readily apparent from other
sources. The process of determining significant estimates is fact specific and
takes into account factors such as historical experience, current and expected
economic conditions, product mix, and in some cases, actuarial and appraisal
techniques. We constantly re-evaluate these significant factors and make
adjustments where facts and circumstances dictate.
While we believe that our historical experience and other factors considered
provide a meaningful basis for the accounting policies applied in the
preparation of the consolidated statements, we cannot guarantee that our
estimates and assumptions will be accurate. As the determination of these
estimates requires the exercise of judgement, actual results inevitably will
differ from those estimates, and such differences may be material to the
financial statements.
We believe the following represent the most critical estimates and assumptions,
among others, used in the preparation of our consolidated financial statements.
We have discussed the selection, application and disclosure of the critical
accounting policies with our audit committee.
- Revenue recognition. Revenues from our retail operations are
recognized at the latter of point of sale or the delivery of goods to
the customer. Retail revenues are reduced by a provision for
anticipated returns based on our historical trends by our customers.
- Cost of sales and merchandise inventories. We use the retail method of
accounting for substantially all of our merchandise inventories.
Merchandise inventories are stated at the lower of cost, determined
using the first-in, first-out basis, or market using the retail
inventory method. The retail method is widely used in the retail
industry due to its practicality. Under the retail inventory method,
the valuation of inventories at cost and the resulting gross margins
are calculated by applying a calculated cost to retail ratio to the
retail value of inventories. The cost of the inventory reflected on
our consolidated balance sheet is decreased by charges to cost of
sales at the time the retail value of the inventory is lowered through
the use of markdowns. Hence, earnings are negatively impacted as
merchandise is marked down prior to sale, or when reserves are
established. The amount of the reserve is equal to the difference
between "retail method cost" of the inventory and the estimated market
value based on significant assumptions about future demand and market
conditions.
-15-
VALUE CITY DEPARTMENT STORES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Reserves to value inventory at the lower of cost or market were $36.8
million on August 2, 2003 and $32.5 million at the end of fiscal 2002.
Inherent in the calculation of inventories are certain significant
management judgements and estimates including, setting the original
merchandise retail value or markon, markups of initial prices
established, reduction of pricing due to customer's value perception
or perceived value known as markdowns and estimates of losses between
physical inventory counts or shrinkage, which combined with the
averaging process within the retail method, can significantly impact
the ending inventory valuation at cost and the resulting gross
margins.
- Long-lived assets. In evaluating the fair value and future benefits of
long-lived assets, excluding goodwill, we perform an analysis of the
anticipated undiscounted future cash flows of the related long-lived
asset. If an impairment is indicated, we reduce the carrying value by
the excess of the recorded value over the fair value. Goodwill is
tested on an annual basis using a fair value based approach.
For the six months ended August 2, 2003, we recorded no impairments
related to long-lived assets. During fiscal 2002, we implemented SFAS
142 which required that goodwill no longer be amortized, but would be
subject to annual fair value based impairment tests. The initial tests
for goodwill impairment, as of February 3, 2002, resulted in a
non-cash charge of $3.4 million, $2.1 million net of taxes that was
recorded effective for the quarter ended May 4, 2002.
We believe at this time that the long-lived assets' carrying values
and useful lives continue to be appropriate. To the extent these
future projections or our strategies change, the conclusion regarding
impairment may differ from our current estimates.
- Self-insurance reserves. We record estimates for certain health and
welfare, workers compensation and casualty insurance costs that are
self-insured programs. These estimates are based on actuarial
assumptions and are subject to change based on actual results. Should
a greater amount of claims occur compared to what was estimated for
costs of certain health and welfare, workers compensation or casualty
insurance increase beyond what was anticipated, reserves recorded may
not be sufficient and additional costs to the consolidated financial
statements could be required.
- Pension. The obligations and related assets of defined benefit
retirement plans are included in the Condensed Consolidated Financial
Statements. Plan assets, which consist primarily of marketable equity
and debt instruments, are valued using market quotations. Plan
obligations and the annual pension expense are determined by
independent actuaries and through the use of a number of assumptions.
Key assumptions in measuring the plan obligations include the discount
rate, the rate of salary increases and the estimated future
-16-
VALUE CITY DEPARTMENT STORES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
return on plan assets. In determining the discount rate, we utilize
the yield on fixed-income investments currently available with
maturities corresponding to the anticipated timing of the benefit
payments. Salary increase assumptions are based upon historical
experience and anticipated future management actions. Asset returns
are based upon the anticipated average rate of earnings expected on
the invested funds of the plans. At August 2, 2003, the actual
assumption of our plans has remained unchanged from our Annual Report
on Form 10-K for the year ended February 1, 2003 filed with the
Securities and Exchange Commission. To the extent actual results vary
from assumptions, earnings would be impacted.
- Customer loyalty program. We maintain a customer loyalty program for
our DSW operations in which customers receive a future discount on
qualifying purchases. Upon reaching the target level, customers may
redeem these discounts on a future purchase. Generally, these future
discounts must be redeemed in one year. We accrue the estimated costs
of the anticipated redemptions of the discount earned at the time of
the initial purchase and charge such costs to selling, general and
administrative expense based on historical experience. The estimates
of the costs associated with the loyalty program require us to make
assumptions related to customer purchase levels and redemption rates.
The accrued liability was $2.8 million as of August 2, 2003 and $2.2
million as of February 1, 2003. To the extent assumptions of purchases
and redemption rates vary from actual results, earnings would be
impacted.
- Income taxes. We do business in numerous jurisdictions that impose
taxes. Management is required to determine the aggregate amount of
income tax expense to accrue and the amount which will be currently
payable based upon tax statutes of each jurisdiction. The estimation
process involves adjusting net income (loss) determined by the
application of generally accepted accounting principles for items that
are treated differently by the applicable taxing authorities. We
establish valuation allowances for our deferred tax assets when the
amount of expected future taxable income is not likely to support the
use of the deduction or credit. At August 2, 2003 an allowance of $9.8
million has been provided. On February 1, 2003, no allowance was
recorded. Deferred tax assets and liabilities are reflected on our
balance sheet for temporary differences that will reverse in
subsequent years. If different management judgements had been made,
our tax expense, assets and liabilities could be different.
-17-
VALUE CITY DEPARTMENT STORES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, the percentage
relationships to net sales of the listed items included in the Company's
Consolidated Statements of Operations.
Three months ended Six months ended
-------------------------------- ------------------------------
August 2, August 3, August 2, August 3,
2003 2002 2003 2002
- ------------------------------------------------------------------------------------------------------------------------------
Net sales, excluding sales of
licensed departments 100.0% 100.0% 100.0% 100.0%
Cost of sales (60.9) (60.7) (62.0) (61.3)
- ------------------------------------------------------------------------------------------------------------------------------
Gross profit 39.1 39.3 38.0 38.7
Selling, general and administrative
expenses (39.0) (38.5) (39.1) (38.3)
License fees and other
operating income 0.2 0.4 0.2 0.4
- ------------------------------------------------------------------------------------------------------------------------------
Operating profit (loss) 0.3 1.2 (0.9) 0.8
Interest expense, net (1.3) (1.4) (1.5) (1.3)
- ------------------------------------------------------------------------------------------------------------------------------
Loss before benefit for income taxes
and cumulative effect of
accounting change (1.0) (0.2) (2.4) (0.5)
Benefit for income taxes 0.4 0.1 1.0 0.2
- ------------------------------------------------------------------------------------------------------------------------------
Loss before cumulative effect of
accounting change (0.6) (0.1) (1.4) (0.3)
- ------------------------------------------------------------------------------------------------------------------------------
Cumulative effect of accounting
change, net of income taxes -- -- -- (0.2)
- ------------------------------------------------------------------------------------------------------------------------------
Net loss (0.6)% (0.1)% (1.4)% (0.5)%
- ------------------------------------------------------------------------------------------------------------------------------
THREE MONTHS ENDED AUGUST 2, 2003 COMPARED TO THREE MONTHS ENDED AUGUST 3, 2002
Net sales increased $35.5 million, or 6.2%, from $569.1 million to $604.6
million. Comparable stores sales for the quarter were positive for each segment.
Comparable store sales by segment were:
Three months ended
----------------------------------------------
August 2, 2003 August 3, 2002
- ------------------------------------------------------------------------------------------------------------------------------
Value City Department Stores 0.6% (6.1)%
DSW 4.5% (2.1)%
Filene's Basement 0.3% 1.2%
- ------------------------------------------------------------------------------------------------------------------------------
Total 1.6% (4.3)%
=============================================================================================================================
-18-
VALUE CITY DEPARTMENT STORES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Value City's sales were $336.5 million, unchanged from the prior year quarter.
Value City's non-apparel comparable sales increased 5.3% while apparel sales
decreased 2.0%. Non-apparel sales were positively impacted by increases in
domestics and housewares up 8.3% and 18.4%, respectively. Increases were the
result of deals and buyouts in these departments complemented by new business
items within these categories. Value City's Men's and Ladies apparel divisions
had negative comparable sales for the quarter of 4.8% and 1.2%, respectively.
The Children's division had positive comparable sales of 2.0%. Apparel sales
were negatively impacted by cooler weather patterns across our markets.
DSW sales were $192.3 million, a 21.1% increase in the quarter, which includes a
net increase of 14 DSW stores and the addition of 153 leased locations.
Filene's Basement sales were $75.7 million, a 2.7% increase in the quarter.
Gross profit increased by $12.8 million to $236.4 million, from $223.6 million,
and decreased as a percentage of sales from 39.3% to 39.1%. The decrease is
attributable primarily to increased markdowns during the quarter due to cooler
spring weather. Gross profit, as a percent to sales by segment in the second
quarter, were:
Three months ended
----------------------------------------------
August 2, 2003 August 3, 2002
- ------------------------------------------------------------------------------------------------------------------------------
Value City Department Stores 39.2% 39.7%
DSW 41.0% 40.9%
Filene's Basement 33.7% 33.9%
- ------------------------------------------------------------------------------------------------------------------------------
Total 39.1% 39.3%
=============================================================================================================================
Selling, general and administrative expenses ("SG&A") increased $16.6 million,
from $219.3 million to $235.9 million, and increased as a percentage of sales
from 38.5% to 39.0%. This increase includes $9.3 million attributable to new
stores and leased shoe departments in operation at DSW. The increase of SG&A as
a percentage of sales is due primarily to additional efforts made in marketing
to promote sales and create brand awareness. The prior year SG&A expenses
include the $3.3 million debt extinguishment expense reported in the prior year
quarter as an extraordinary item. SG&A as a percent of sales by segment in the
second quarter were:
Three months ended
----------------------------------------------
August 2, 2003 August 3, 2002
- ------------------------------------------------------------------------------------------------------------------------------
Value City Department Stores 42.6% 40.6%
DSW 35.5% 35.7%
Filene's Basement 32.2% 35.1%
- ------------------------------------------------------------------------------------------------------------------------------
Total 39.0% 38.5%
=============================================================================================================================
License fees and other operating income decreased $1.1 million, from $2.4
million to $1.3 million, and decreased as a percentage of sales to 0.2%. The
decrease is attributable to a decline
-19-
VALUE CITY DEPARTMENT STORES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
in license fees and layaway fees received from leased departments and layaway
sales at Value City.
Operating profit decreased to $1.8 million, from $6.7 million and decreased as a
percentage of sales from 1.2% to 0.3%.
Net interest expense for the quarter increased $0.2 million to $8.1 million. The
increase is due primarily to a 1.4% increase in our weighted average borrowing
rate, a result of new term debt entered into June 11, 2002, and the increase of
$18.0 million in average borrowings from last year to this year.
The effective tax rate for the three months ended August 2, 2003 is 42.0% versus
38.3% for the three months ended August 3, 2002. During the period, the Company
established a valuation allowance for our deferred tax assets of $9.8 million.
The tax rate prior to the allowance was 75.5%, and reflects the impact of the
non-deductible warrant amortization included for book income but not tax.
SIX MONTHS ENDED AUGUST 2, 2003 COMPARED TO SIX MONTHS ENDED AUGUST 3, 2002
Net sales increased $38.1 million, or 3.3%, from $1,155.0 million to $1,193.1
million. Comparable stores sales for the six-month period were negative for
Value City and Filene's Basement and positive for DSW. Comparable store sales by
segment were:
Six months ended
---------------------------------------------
August 2, 2003 August 3, 2002
- -----------------------------------------------------------------------------------------------------------------------------
Value City Department Stores (1.8)% (3.6)%
DSW 0.4% (0.4)%
Filene's Basement (3.8)% 3.0%
- -----------------------------------------------------------------------------------------------------------------------------
Total (1.5)% (2.1)%
=============================================================================================================================
Value City's sales were $679.4 million, a 2.3% decrease in the six-month period.
Value City's non-apparel comparable sales increased 2.2% while apparel sales
decreased 4.1%. Non-apparel sales were positively impacted by increases in
domestics and housewares up 5.7% and 14.6%, respectively. Increases were the
result of deals and buyouts in these departments complemented by new business
items within these categories. Each of the three apparel divisions: Children's,
Men's and Ladies, had negative comparable sales for the six-month period of
3.8%, 5.0% and 3.4%, respectively. Apparel sales were negatively impacted by
cooler weather patterns across our markets.
DSW sales were $375.4 million, a 19.2% increase in the six-month period, which
includes a net increase of 14 DSW stores and the addition of 153 leased
locations. Year-to-date sales and particularly comparative stores sales have
been impacted by cooler seasonal weather.
Filene's Basement sales were $138.3 million, a 4.3% decrease in the six-month
period.
-20-
VALUE CITY DEPARTMENT STORES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Gross profit increased by $6.3 million to $453.1 million, from $446.8 million,
and decreased as a percentage of sales from 38.7% to 38.0%. The decrease is
attributable to increased markdowns during the six-month period as a result of a
highly competitive retail environment and the unseasonably cooler early
spring/summer season. Gross profit, as a percent of sales by segment in the
six-month period, were:
Six months ended
----------------------------------------------
August 2, 2003 August 3, 2002
- ------------------------------------------------------------------------------------------------------------------------------
Value City Department Stores 37.9% 38.8%
DSW 39.9% 40.0%
Filene's Basement 33.3% 35.4%
- -----------------------------------------------------------------------------------------------------------------------------
Total 38.0% 38.7%
=============================================================================================================================
Selling, general and administrative expenses ("SG&A") increased $24.3 million,
from $442.6 million to $466.9 million, and increased as a percentage of sales
from 38.4% to 39.1%. This increase includes $16.8 million attributable to new
stores and leased shoe departments in operation at DSW. The increase in SG&A as
a percentage of sales is due in part to additional marketing efforts to promote
sales and create brand awareness. The prior year SG&A expenses include the $3.3
million debt extinguishment expense reported in the prior year six-month period
as extraordinary item. SG&A as a percent of sales by segment in the six-month
period were:
Six months ended
----------------------------------------------
August 2, 2003 August 3, 2002
- ------------------------------------------------------------------------------------------------------------------------------
Value City Department Stores 41.7% 40.1%
DSW 36.3% 35.8%
Filene's Basement 34.2% 35.3%
- -----------------------------------------------------------------------------------------------------------------------------
Total 39.1% 38.3%
=============================================================================================================================
License fees and other operating income decreased $1.8 million, from $4.6
million to $2.8 million, and decreased as a percentage of sales to 0.2%. The
decrease is attributable to a decline in license fees and layaway fees received
from leased departments and layaway sales in Value City.
Operating (loss) profit decreased to a loss of $11.0 million, from a profit of
$8.8 million and decreased as a percentage of sales from a profit of 0.7% to a
loss of 0.9%. The decrease is attributable to the margin shortfall and increase
in SG&A, primarily advertising in the current year.
Net interest expense for the six-month period increased $3.5 million to $17.7
million. The increase is due primarily to a 2.7% increase in our weighted
average borrowing rate, a result of new term debt entered into June 11, 2002,
offset by a decrease of $0.8 million in average borrowings from last year to
this year.
-21-
VALUE CITY DEPARTMENT STORES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The effective tax rate for the six months ended August 2, 2003 is 41.4% versus
37.1% for the six months ended August 3, 2002. During the period the Company
established a valuation allowance for our deferred tax assets of $9.8 million.
Our tax rate prior to the allowance was 75.5%, and reflects the impact of the
non-deductible warrant amortization included for book income but not tax.
LIQUIDITY AND CAPITAL RESOURCES
Net working capital was $270.5 million at August 2, 2003 and $209.0 million at
August 3, 2002. Current ratios at those dates were 1.8 and 1.6, respectively.
Net cash used in operating activities totaled $54.9 million in year-to-date
fiscal 2003 compared to $45.5 million provided by operations in year-to-date
fiscal 2002. Net cash used for capital expenditures was $23.5 million for the
six-month period ended August 2, 2003 and $20.0 million for the six-month period
ended August 3, 2002. During the six-month period ended August 2, 2003, capital
expenditures included $7.8 million for new stores, $10.9 million for
improvements in existing stores and $4.8 million for Home Office, MIS equipment
upgrades and new systems. Proceeds from lease incentives are amortized as a
reduction of rent expense over the life of the lease.
On June 11, 2002, we, together with our principal subsidiaries, entered into a
$525.0 million refinancing that consists of three separate credit facilities:
(i) a new three-year $350.0 million revolving credit facility (the "Revolving
Credit Facility"), (ii) two $50.0 million term loan facilities (the "Term
Loans") provided equally by Cerberus Partners, L.P. and Schottenstein Stores
Corporation ("SSC") , and (iii) an amended and restated $75.0 million senior
convertible loan, initially entered into by us on March 15, 2000, which is held
equally by Cerberus Partners, L.P. and SSC (the "Convertible Loan").
$350 Million Revolving Credit Facility
Under the Revolving Credit Facility, the borrowing base formula is structured in
a manner that allows us and our subsidiaries availability based on the value of
inventories and receivables. Primary security for the Revolving Credit Facility
is provided by a first priority lien on all of our inventory and accounts
receivable, as well as certain intercompany notes and payment intangibles. The
Revolving Credit Facility also has a second priority perfected interest in all
of the collateral securing the Term Loans. Interest on borrowings is calculated
at the bank's base rate or Eurodollar rate plus 2.00% to 2.75%, depending upon
the level of average excess availability we maintain. At August 2, 2003, $133.0
million was available under the Revolving Credit Facility. Direct borrowings
aggregated $160.0 million. Additionally, $22.0 million of letters of credit were
issued and outstanding.
$100 Million Term Loans
The Term Loans are comprised of a $50.0 million Term Loan B and a $50.0 million
Term Loan C. All obligations under the Term Loans are senior debt, ranking pari
passu with the Revolving
-22-
VALUE CITY DEPARTMENT STORES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Credit Facility and the Convertible Loan. We and our principal subsidiaries are
obligated on the Term Loans.
The Term Loans stated rate of interest per annum during the initial two years of
the agreement is 14% if paid in cash and 15% if we elect a paid-in-kind ("PIK")
option. Until June 11, 2004, we may pay all interest by PIK. During the final
year of the Term Loans, the stated rate of interest is 15.0% if paid in cash or
15.5% by PIK and the PIK option is limited to 50% of the interest due.
We issued 2,954,792 warrants ("Warrants") to purchase shares of common stock, at
an exercise price of $4.50 per share, to the Term Loan C Lenders. The number of
shares issuable upon the exercise of the Warrants and the per share exercise
price are subject to adjustment upon the occurrence of specified events. The
Warrants are exercisable at any time prior to June 11, 2012. We have granted the
Term Loan C Lenders registration rights with respect to the shares issuable upon
exercise of the Warrants. The value placed on the Warrants was $6.1 million and
the related debt discount is amortized into interest expense over the life of
the debt.
$75 Million Senior Convertible Loan
We have amended and restated our $75.0 million Senior Subordinated Convertible
Loan Agreement on June 11, 2002 ("the "Convertible Loan"). As amended,
borrowings under the Convertible Loan bear interest at 10% per annum. At our
option, interest may be PIK until June 11, 2004, and thereafter, at our option,
up to 50% of the interest due may be PIK until maturity. The Convertible Loan is
guaranteed by all principal subsidiaries and is secured by a lien on assets
junior to liens granted in favor of the Revolving Credit Facility and Term
Loans. The Convertible Loan is not prepayable until June 11, 2007. The agent has
the right to designate two observers to our Board of Directors for so long as
the agent is the beneficial owner of at least 50% of the advances initially made
by it and has the right to designate two individuals to our Board of Directors
for so long as the agent is the beneficial owner of at least 50% of the
conversion shares issued upon conversion of the advances initially made by it.
The Convertible Loan is convertible at the option of the holders into shares of
Value City common stock at a conversion price of $4.50. The maturity date is
June 10, 2009.
Achievement of expected cash flows from operations and compliance with the
covenants of our credit agreements (as discussed in the Notes to Consolidated
Financial Statements that are included in our 2002 Annual Report on Form 10-K
filed with the Securities and Exchange Commission) are dependent upon a number
of factors, including the attainment of sales, gross profit, expense levels,
vendor relations, and flow of merchandise that are consistent with our financial
projections. Future limitations of credit availability by factor organizations
and/or vendors will restrict our ability to obtain merchandise and services and
may impair operating results. Although operating results for the six-month
period ended August 2, 2003 were below plan, we believe that cash generated by
operations, along with the available proceeds from our credit agreements and
other sources of financing will be sufficient to meet our obligations for
working capital, capital expenditures, and debt service. However, there is no
assurance that we will be able to meet our projections. Further, there is no
assurance that extended financing will be available in the future if we fail to
meet our projections or on terms acceptable to us.
-23-
VALUE CITY DEPARTMENT STORES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
ADOPTION OF ACCOUNTING STANDARDS
The Financial Accounting Standards Board ("FASB") periodically issues Statements
of Financial Accounting Standards ("SFAS"), some of which require implementation
by a date falling within or after the close of the fiscal year.
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No.
4, 44, and 64, Amendment of FASB Statement No. 13 and Technical Corrections".
SFAS No. 145 is effective for fiscal years beginning after May 15, 2002. The
adoption of SFAS No. 145 did not have a significant effect on the Company's
results of operations or its financial position. However it did require that the
Company reclassify the loss on the extinguishment of debt of approximately $3.3
million from extraordinary loss to selling, general and administrative expense,
in the Company's consolidated financial statement of operations.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity". SFAS No. 150
requires that an issuer classify a financial instrument that is within its scope
as a liability (or an asset in some circumstances), many of which were
previously classified as equity. This statement is effective for financial
instruments entered into or modified after May 31, 2003 and otherwise shall be
effective for the Company's 2004 financial statements. Management does not
expect the initial adoption of this accounting pronouncement will have a
material impact on the Company's consolidated financial statements.
In January 2003, the FASB issued FIN 46, Consolidation of Variable Interest
Entities. FIN 46 clarifies the application of Accounting Research Bulletin No.
51, Consolidated Financial Statements, to certain entities in which equity
investors do not have the characteristics of a controlling financial interest or
do not have sufficient equity at risk for the entity to finance its activities
without additional subordinated financial support from other parties. FIN 46
requires a variable interest entity to be consolidated by a company, if that
company is subject to a majority of the risk of loss from the variable interest
entity's activities or entitled to receive a majority of the entity's residual
returns or both. FIN 46 also requires disclosures about variable interest
entities that a company is not required to consolidate but in which it has a
significant variable interest. The consolidation requirements of FIN 46 apply
immediately to variable interest entities created after January 31, 2003 and to
existing entities in the first fiscal year or interim period beginning after
June 15, 2003. Certain of the disclosure requirements apply to all financial
statements issued after January 31, 2003, regardless of when the variable
interest entity was established. We have no variable interest entities as of
August 2, 2003.
The FASB's Emerging Issues Task Force ("EITF") Issue No. 02-16, "Accounting By A
Customer (Including A Reseller) For Cash Consideration Received From A Vendor"
addressed the accounting treatment for vendor allowances. The adoption of EITF
Issue No. 02-16 in 2003 did not have a material impact on our financial position
or results of operations.
-24-
VALUE CITY DEPARTMENT STORES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
INFLATION
The results of operations and financial condition are presented based upon
historical cost. While it is difficult to accurately measure the impact of
inflation because of the nature of the estimates required, management believes
that the effect of inflation, if any, on the results of operations and financial
condition has been minor.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our primary market risk results from fluctuations in interest rates. The Company
is exposed to interest rate risk through borrowings under its revolving credit
agreement.
Our interest rate swap expired during the three months ended May 3, 2003, and
was not renewed.
ITEM 4. CONTROLS AND PROCEDURES
As of the end of the period covered by this report, we carried out an
evaluation, under the supervision and with the participation of our management,
including our President and Chief Executive Officer along with our Chief
Financial Officer of the effectiveness of the design and operation of the
Company's disclosure controls and procedures pursuant to Exchange Act Rule
13a-15. Based upon this evaluation, our President and Chief Executive Officer
along with our Chief Financial Officer concluded that our disclosure controls
and procedures are effective in timely alerting them to material information
relating to us (including our consolidated subsidiaries) required to be included
in our periodic SEC filings. It should be noted that the design of any system of
controls is based in part upon certain assumptions about the likelihood of
future events, and there can be no assurance that any design will succeed in
achieving its stated goals under all potential future conditions, regardless of
how remote.
As of the end of the period covered by this report, there has been no change in
our internal control over financial reporting (as defined in Rules 13a-15(f) and
15d-15(f) of the Securities Exchange Act of 1934, as amended) during our fiscal
quarter ended August 2, 2003, that has materially affected or is reasonably
likely to materially affect, our internal control over financial reporting.
-25-
PART II. OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS. Not applicable
Item 2. CHANGES IN SECURITIES AND USE OF PROCEEDS. Not applicable
Item 3. DEFAULTS UPON SENIOR SECURITIES. Not applicable
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. Not applicable
Item 5. OTHER INFORMATION. Not applicable
Item 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits.
Exhibit No. Document
----------- --------
31.1* Certification of Chief Executive Officer to Section
302 of the Sarbanes-Oxley Act of 2002.
31.2* Certification of Chief Financial Officer to Section
302 of the Sarbanes-Oxley Act of 2002.
32.1* Certification of Chief Executive Officer to Section
906 of the Sarbanes-Oxley Act of 2002.
32.2* Certification of Chief Financial Officer to Section
906 of the Sarbanes-Oxley Act of 2002.
*Filed with this report.
(b) Reports on Form 8-K.
A current report on Form 8-K, dated June 9, 2003, was filed with
the Securities and Exchange Commission on June 9, 2003 (Items 7 and
12 furnished under Item 9).
A current report on Form 8-K, dated September 8, 2003, was filed
with the Securities and Exchange Commission on September 8, 2003
(Items 7 and 12).
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
VALUE CITY DEPARTMENT STORES, INC.
(REGISTRANT)
Date: September 15, 2003 By: /s/ James A. McGrady
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James A. McGrady,
Executive Vice President, Chief
Financial Officer, Treasurer and
Secretary of Value City Department
Stores, Inc.
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