SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(X) ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended February 2, 2001
Commission file number 0-4769
DOLLAR GENERAL CORPORATION
(Exact name of Registrant as Specified in its Charter)
TENNESSEE 61-0502302
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
100 MISSION RIDGE
GOODLETTSVILE, TN 37072
(Address of principal executive offices, zip code)
Registrant's telephone number, including area code: (615) 855-4000
Securities registered pursuant to Section 12(b) of the Act:
Name of the Exchange on
Title of Class which Registered
-------------- ----------------
Common Stock New York Stock Exchange
Series B Junior Participating New York Stock Exchange
Preferred Stock Purchase Rights
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the Registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [ ] No [ X ] Note: The Company did
not timely file its Annual Report on Form 10-K for fiscal 2000 and its quarterly
reports on Form 10-Q for the first three quarters of fiscal 2001 as a result of
the restatement of the Company's financial statements described herein. Such
Annual Report on Form 10-K is filed herewith, and such quarterly reports on Form
10-Q are being filed on the date hereof.
Indicate by check mark if disclosure of delinquent filers
pursuant to Item 405 of Regulation S-K is not contained herein, and will not be
contained, to the best of Registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K. [X]
Aggregate market value of the voting stock held by non-affiliates
of the Registrant as of December 14, 2001, was $3,935,877,699, based upon the
last reported sale price on such date by the New York Stock Exchange.
The number of shares of common stock outstanding on December 14,
2001, was 332,577,284.
Documents Incorporated by Reference
Not applicable
2
The following text contains references to years 2002, 2001, 2000,
1999, 1998, 1997 and 1996, which represent fiscal years ending or ended January
31, 2003, February 1, 2002, February 2, 2001, January 28, 2000, January 29,
1999, January 30, 1998, and January 31, 1997, respectively. This discussion and
analysis should be read with, and is qualified in its entirety by the
consolidated financial statements and the notes thereto.
PART I
ITEM 1. BUSINESS
General
Dollar General Corporation (the "Company" or "Dollar General") is
a leading discount retailer of quality general merchandise at everyday low
prices. Through conveniently located stores, the Company offers a focused
assortment of consumable basic merchandise including health and beauty aids,
packaged food products, home cleaning supplies, housewares, stationery, seasonal
goods, basic clothing and domestics. Dollar General stores serve primarily low-,
middle- and fixed-income families.
The Company opened its first store in 1955, in which year the
Company was first incorporated as a Kentucky corporation under the name J.L.
Turner & Son, Inc. The Company changed its name to Dollar General Corporation in
1968, and reincorporated as a Tennessee corporation in 1998. As of February 2,
2001, the Company operated 5,000 stores located in 25 states, primarily in the
southeastern and midwestern United States. As of December 14, 2001, the Company
operated 5,562 stores in 27 states.
Recent Developments
Restatement of Financial Statements. On April 30, 2001, the
Company announced that it had become aware of certain accounting issues that
would cause it to restate its audited financial statements for fiscal years 1999
and 1998, and to restate the unaudited financial information for the fiscal year
2000 that had been previously released by the Company. The Audit Committee of
the Board of Directors promptly assumed oversight of the Company's response to
these issues and commenced an independent review to prepare the Committee for
its role in reviewing the restated financial statements, assisted by the law
firm of Dechert, Price and Rhoads and the independent accounting firm Arthur
Andersen, LLP. The Company further announced on June 7, 2001, that its Chairman
and Chief Executive Officer had directed the Company's financial staff and its
outside professional consultants to review the Company's reporting, record
keeping, accounting and internal control policies and practices, and that until
such review had been concluded, the Company would not be in a position to update
its prior financial guidance. The Company's financial staff conducted its review
of these issues with the
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assistance of the Company's outside counsel, Debevoise & Plimpton, and
accounting consultants from KPMG LLP.
Consistent with the activities of the Audit Committee and the
Company's review of its financial statements for the 1998, 1999 and 2000 fiscal
years, the Company is restating by means of this filing its audited financial
statements for fiscal years 1999 and 1998, and is filing herewith its audited
financial results for fiscal year 2000, which restate the unaudited financial
information for the fiscal year 2000 that had been previously released by the
Company. The Company's previously released financial data should not be relied
upon.
Restated net income and diluted earnings per share for 2000 are
$70.6 million and $0.21, respectively, as compared to the $206.0 million and
$0.62 previously reported. The restated results for 2000 include a pre-tax
expense of $162.0 million to settle the Company's restatement-related litigation
described below. Excluding the litigation settlement expense, restated net
income and diluted earnings per share for 2000 are $169.6 million and $0.51,
respectively. Restated net income totaled $186.7 million in fiscal 1999 and
$150.9 million in fiscal 1998, equaling diluted earnings per share of $0.55 and
$0.45, respectively. The Company originally reported, prior to the restatement,
net income of $219.4 million in fiscal 1999 and $182.0 million in fiscal 1998,
equaling diluted earnings per share for those periods of $0.65 and $0.54,
respectively.
In its April 30, 2001 announcement, based on a preliminary
assessment of the accounting issues involved, the Company estimated that the
reduction in aggregate earnings as a result of the restatement would be
approximately $0.07 per share over the three-year period of 2000, 1999 and 1998.
The review completed by the Company of its financial statements ultimately
identified a number of accounting issues for restatement in addition to those
that formed the basis for the preliminary estimate provided on April 30, 2001.
As a result of these additional issues, and following the completion of the
Company's review of the issues that had been identified originally, the
restatement has resulted in an aggregate effect on diluted earnings per share,
excluding the litigation settlement expense, of $0.30 over the three-year period
of 2000, 1999 and 1998.
The issues for restatement, excluding the litigation settlement
expense, can be broken down into four general categories: (i) items impacting
the cost of goods sold that were recorded incorrectly and/or that reflect more
accurate estimates, (ii) selling, general and administrative ("SG&A") expenses
that were either incurred but not accrued, or recorded incorrectly, (iii)
additional interest expense required as a result of restating certain operating
leases as capital leases and financing obligations, and the addition of capital
lease and financing obligation liabilities to the Company's balance sheets, and
(iv) changes to the Company's income tax provision to correct errors. The
effects of these issues on diluted earnings per share over the three-year period
are summarized in the following table:
4
Year Ended
---------------------------------------------
Adjustments to diluted earnings per share*: 3 Year February 2, January 28, January 29,
Cumulative 2001 2000 1999
Cost of goods sold $ (0.05) $ (0.01) $ (0.01) $ (0.03)
Selling, general & (0.11) (0.02) (0.05) (0.04)
administrative expenses
Interest expense (0.11) (0.06) (0.04) (0.01)
Tax provision (0.02) (0.01) (0.00) (0.01)
---------- ---------- ---------- ----------
$ (0.30) $ (0.11) $ (0.10) $ (0.09)
========== ========== ========== ==========
*Totals may not foot due to rounding; excludes litigation settlement expense.
Although the issues for restatement in total had a negative
aggregate impact on earnings per share over the three-year period, some of the
issues resulted in an increase in diluted earnings per share, while others
affected diluted earnings in individual years but had no impact on aggregate
diluted earnings per share over the three-year period.
In addition to the restatement of the Company's results of
operations, the correction of many of these issues also required an adjustment
to the Company's previously reported balance sheets. Please refer to Note 2 to
the Consolidated Financial Statements for a schedule reconciling the various
restatement-related adjustments with previously released data for 2000, 1999 and
1998.
Restatement-Related Proceedings. Following the April 30, 2001,
announcement discussed above, more than 20 purported class action lawsuits
were filed against the Company and certain current and former officers and
directors of the Company, asserting claims under the federal securities laws.
These lawsuits have been consolidated into a single action pending in the United
States District Court for the Middle District of Tennessee. On July 17, 2001,
the court entered an order appointing the Florida State Board of Administration
and the Teachers' Retirement System of Louisiana as lead plaintiffs and the law
firms of Entwistle & Cappucci LLP; Milberg Weiss Bershad Hynes & Lerach LLP; and
Grant & Eisenhofer, P.A. as co-lead counsel. On January 3, 2002, the lead
plaintiffs filed an amended consolidated class action complaint purporting to
name as plaintiffs a class of persons who held or purchased the Company's
securities and related derivative securities between May 12, 1998, and September
21, 2001. Among other things, plaintiffs have alleged that the Company and
certain of its current and former officers and directors made misrepresentations
concerning the Company's financial results in the Company's filings with the
Securities and Exchange Commission and in various press releases and other
public statements. The plaintiffs seek damages with interest, costs and such
other relief as the court deems proper.
The Company has reached a settlement agreement with the purported
class action plaintiffs, pursuant to which the Company has agreed to pay $140
million to such plaintiffs in settlement for their claims, and to implement
certain enhancements to its corporate governance and internal control
procedures. Such agreement is subject to confirmatory discovery, to the final
approval of the Company's Board of Directors, and to court approval.
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Following the completion of confirmatory discovery, plaintiffs have the right
under the settlement agreement to amend their complaint further to increase the
size of the class, and to negotiate with the Company for additional damages, the
aggregate amount of all damages to be paid in settlement of plaintiffs' claims
not to exceed $162 million. The Company expects that following the completion of
such confirmatory discovery, the plaintiffs will amend their complaint and seek
aggregate damages of $162 million. The Company has accordingly recognized an
expense of $162 million in the fourth quarter of 2000. The Company expects to
receive from its insurers approximately $4.5 million in respect of the class
action settlement, which amount has not been accrued in the Company's financial
statements.
In addition, six purported shareholder derivative lawsuits have
been filed in Tennessee State Court against certain current and former Company
directors and officers and Deloitte & Touche LLP, the Company's former
independent accountant. The Company is named as a nominal defendant in the
actions, which seek restitution and/or compensatory and punitive damages with
interest, equitable and/or injunctive relief, costs and such further relief as
the court deems proper. By order entered October 31, 2001, the court appointed
Michael Dixon, Jr., Carolinas Electrical Workers Retirement Fund and Thomas
Dewey, plaintiffs in one of the six filed cases, as lead plaintiffs and the law
firms of Branstetter, Kilgore Stranch & Jennings, and Stanley, Mandel & Iola as
lead counsel. In the same order, the court stayed the remaining cases pending
completion of the lead case. Among other things, the plaintiffs allege that
certain current and former Company directors and officers breached their
fiduciary duties to the Company and that Deloitte & Touche aided and abetted
those breaches and was negligent in its service as the Company's independent
accountant. During August and September 2001, the Company moved to dismiss all
six cases for failure to make a pre-suit demand on the Board of Directors and,
in the alternative, requested that the court stay the actions pending the
completion of an investigation into the allegations in the complaints by the
Shareholder Derivative Claim Review Committee of the Company's Board of
Directors. The lead plaintiffs filed an opposition to this motion on October 2,
2001. A hearing on the motion has not yet been scheduled.
Two purported shareholder derivative lawsuits also have been
filed in the United States District Court for the Middle District of Tennessee
against certain current and former Company directors and officers alleging that
they breached their fiduciary duties to the Company. The Company is named as a
nominal defendant in these actions, which seek declaratory relief, compensatory
and punitive damages, costs and such further relief as the court deems proper.
By motion filed on September 28, 2001, the Company requested that the federal
court abstain from exercising jurisdiction over the purported shareholder
derivative actions in deference to the pending state court actions. By agreement
of the parties and court order dated December 3, 2001, the case has been stayed
until June 3, 2002.
6
The Company and the individual defendants have reached a
settlement agreement with lead counsel to the plaintiffs in the lead Tennessee
state shareholder derivative action. The agreement includes a payment to the
Company from a portion of the proceeds of the Company's director and officer
liability insurance policies as well as certain corporate governance and
internal control enhancements. Pursuant to the terms of such agreement, the
Company anticipates that all of the stayed cases, including the federal
derivative cases described above, will be dismissed with prejudice by the courts
in which they are pending. Such agreement is subject to confirmatory discovery,
to the final approval of the Company's Board of Directors, and to court
approval. If the settlement agreement is approved, the Company expects that it
will result in a net payment to the Company, after attorneys' fees payable to
the plaintiffs' counsel, of approximately $24.8 million, which has not been
accrued in the Company's financial statements.
The Company believes that it has substantial defenses to the
purported class action and the derivative lawsuits and intends to assert these
defenses in the courts in which the actions are pending in the event the
settlement agreements referred to above do not successfully resolve these
matters. These cases are at an early stage and the amount of potential loss, if
any, should the settlement agreements not become effective cannot be reasonably
estimated. An unfavorable outcome for the Company in these actions could have a
material adverse impact on the Company's financial position and results of
operations.
The Company has been notified that the SEC is conducting an
investigation into the circumstances that gave rise to the Company's April 30,
2001 announcement. The Company is cooperating with this investigation by
providing documents and other information to the SEC.
Overall Business Strategy
Dollar General's mission statement is "A Better Life for
Everyone!" To carry out this mission, the Company has developed a business
strategy that focuses on providing its customers with a focused assortment of
consumable basic merchandise in a convenient, small-store format.
Our Customers. The Company serves the consumable basics needs of
customers primarily in the low- and middle-income brackets, and customers on
fixed incomes. Research performed by an outside service on behalf of the Company
in the Spring of 2001 indicated that approximately 55% of its customers live in
households earning less than $30,000 a year, and approximately 36% earn less
than $20,000. The Company's merchandising and operating strategies are designed
to meet the consumable basics needs of the consumers in this group.
7
Our Stores. The average Dollar General store has approximately
6,700 selling square feet and serves customers whose homes are usually located
within three to five miles of the store. Most stores are in small towns with
populations of fewer than 20,000. The Company believes that its target customers
prefer the convenience of a small, neighborhood store. As the discount store
industry continues to move toward larger, "super-center" type stores, which are
often built outside of towns, the Company believes that Dollar General's
convenient discount store format will continue to attract customers and provide
the Company with a competitive advantage.
Our Merchandise. The Company is committed to offering a focused
assortment of quality, consumable basic merchandise in a number of core
categories, such as health and beauty aids, packaged food products, home
cleaning supplies, housewares, stationery, seasonal goods, basic apparel and
domestics. Because the Company offers a focused assortment of consumable basic
merchandise, customers are able to shop at Dollar General stores for their
everyday household needs. In 2000, the average customer transaction was $8.27.
Our Prices. The Company distributes quality, consumable basic
merchandise at everyday low prices. The Company's strategy of a low-cost
operating structure and a focused assortment of merchandise is designed to allow
the Company to offer quality merchandise at highly competitive prices. As part
of this strategy, the Company emphasizes even-dollar price points. The majority
of the Company's products are priced at $10 or less, with approximately 33% of
the products priced at $1 or less. The most expensive items are generally priced
around $35.
Our Cost Controls. The Company places an emphasis on aggressively
managing its overhead cost structure. Additionally, the Company seeks to locate
stores in neighborhoods where rental and operating costs are low. The Company
attempts to control operating costs by implementing new technology where
feasible. Examples of this strategy in fiscal 2000 and 2001 include new IBM
registers designed to capture payroll information and monitor employee
productivity, new handheld store inventory ordering technology which should
result in lower inventory handling and carrying costs, and the introduction of a
new sales audit product which identifies register procedure violations by
providing transactional information about cashier activities.
Growth Strategy
The Company has experienced a rapid rate of expansion in recent
years, increasing its number of stores from 2,059 as of January 31, 1995, to
5,562 as of December 14, 2001. In addition to growth from new store openings,
the Company recorded same-store sales increases of 0.9%, 6.4% and 8.3% in 2000,
1999 and 1998, respectively. Management will continue to seek to grow the
Company's business. The
8
Company believes this growth will come from a combination of new store openings,
infrastructure investments and merchandising initiatives.
New Store Growth. Management believes that the Company's
convenient, small-store format is adaptable to small towns and neighborhoods
throughout the country. The Company currently serves more than 3,000 communities
with populations of fewer than 20,000. The Company intends to continue to focus
on small towns and neighborhoods within its existing market area where
management believes the Company has the potential to expand its store base. By
opening new stores in its existing market area, the Company takes advantage of
brand awareness and maximizes its operating efficiencies.
In addition, the Company expects to explore the potential for
expansion into new geographic markets as opportunities present themselves.
Specifically, in 2001 the Company opened its first stores in New York and New
Jersey. As of December 14, 2001, the Company had 49 stores in New York, and
eight stores in New Jersey. Consistent with its strategy, the Company is
focusing its efforts in these states on small communities.
In 2000, 1999 and 1998, the Company opened 758, 646 and 551 new
stores, and remodeled or relocated 237, 409 and 351 stores, respectively. In
2001, the Company currently plans to open approximately 600 new stores, close 50
to 60 stores, and remodel or relocate approximately 70 stores.
Infrastructure Investments. In recent years, the Company has made
significant investments in its distribution network and management information
systems. In August 2000, the Company opened a 1.0 million square-foot
distribution center ("DC") in Alachua, Florida, and in April 2001, the Company
opened a 1.2 million square-foot DC in Zanesville, Ohio. Subsequent to the DC
opening in Alachua, Florida the Company closed a DC in Homerville, Georgia. In
addition, the Company closed a DC in Villa Rica, Georgia that had only served
new stores. As a result of these openings and closings, the Company has seven
distribution centers located throughout the southeastern and midwestern United
States. Of these seven DCs, four were opened between 1998 and 2001 - Alachua,
Florida; Zanesville, Ohio; Indianola, Mississippi; and Fulton, Missouri. The
remaining three DCs are located in Ardmore, Oklahoma; Scottsville, Kentucky;
and South Boston, Virginia. These significant investments in distribution were
the result of the Company's strategy to reduce transportation expenses and
effectively support the Company's growth. Each DC, on average, services 800
stores with an average distance per delivery of approximately 220 miles.
Recent investments in technology include a new merchandise
planning system designed to assist our merchants with their purchasing and store
allocation decisions (2001 and 2002); satellite technology that provides faster
check authorization and improves communications between the stores and the
corporate office (2001 and 2002); new handheld store-ordering technology to
improve the accuracy of store orders (2000 and 2001); new flatbed scanners to
increase checkout speed and scanning accuracy (2000); new IBM registers that
capture payroll data and monitor employee productivity (2000, 2001 and 2002);
9
an automated distribution center replenishment system to reduce inventory safety
stocks (2000); and the introduction of the Manugistics transportation management
system, which optimizes truck routes and backhaul opportunities (1998 and 1999).
Merchandising Initiatives. The Company's merchandising
initiatives are designed to promote same-store sales increases. In 2000, the
Company modified its merchandise mix by discontinuing approximately 850
slow-performing items and adding approximately 600 new items. The Company also
added soft drink coolers in all of its stores and continued to introduce
promotional items, representing less than 5% of total net sales in 2000. The
Company will continue to evaluate the performance of its merchandise mix and
make changes where appropriate.
Merchandise
Dollar General stores offer a focused assortment of quality,
consumable basic merchandise in a number of core categories. The Company
separates its merchandise into the following four divisions for internal
reporting purposes: (1) highly consumable, (2) hardware and seasonal, (3) basic
clothing, and (4) home products.
Since 1997, the Company has increased its emphasis on the highly
consumable division by adding items in the food, paper, household chemicals, and
health and beauty care categories. During the same period, the Company has
reduced its emphasis on the home products division by eliminating items such as
bath mats, area rugs and bath towels. In 1998, the Company introduced
approximately 400 new stock-keeping units ("SKUs") of family-oriented, basic
apparel including items such as jeans, khakis, T-shirts and knit shirts for men,
women and children at prices of $10 or less. As of December 14, 2001, the
Company continues to carry approximately half of those SKUs, which the Company
considers a part of its core apparel program.
The percentage of total sales of each of the four divisions
tracked by the Company is as follows: in 2000 total sales consisted of 55.3%
highly consumables, 15.5% hardware and seasonal, 12.2% basic clothing and 17.0%
home products; in 1999 total sales consisted of 51.3% highly consumables, 16.5%
hardware and seasonal, 12.4% basic clothing and 19.8% home products; and in 1998
total sales consisted of 42.3% highly consumables, 18.8% hardware and seasonal,
12.2% basic clothing and 26.7% home products. Of the four divisions, the
hardware and seasonal division typically records the highest gross profit rate
and the highly consumables division typically records the lowest gross profit
rate.
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The Company purchases its merchandise from a wide variety of
suppliers. No supplier accounted for more than 13% of the Company's purchases in
2000. Approximately 12% of the Company's purchases in 2000 were imported.
The Company does not run weekly advertising circulars but does
advertise to support new store openings. Advertising expenses are less than 1%
of sales.
The Company maintains approximately 3,500 core SKUs per store.
The Company's average customer purchase in 2000 was $8.27. The average number of
items in each customer purchase was 5.8, and the average price of each purchased
item was $1.42.
As indicated in Note 4 to the Consolidated Financial Statements,
the Company believes that it has certain excess inventory that will require a
markdown to assist with its disposition. Accordingly, the Company recorded a
markdown which had the impact of reducing inventory at cost at February 2, 2001,
and increasing cost of goods sold in the fourth quarter of 2000 by approximately
$21.5 million. The Company believes that this markdown will be adequate to
ensure the sale of the excess inventory during fiscal years 2001 and 2002.
However, there can be no assurance that the Company will be able to sell all of
this inventory by the end of 2002 without a further markdown. The Company moved
$116.0 million of inventory out of current assets at February 2, 2001, that it
does not expect to sell during 2001.
The Company's business is modestly seasonal in nature. The only
extended seasonal increase in business that the Company experiences is the
Christmas selling season. During the Christmas selling season, the Company
carries merchandise that it does not carry during the rest of the year such as
gift sets, trim-a-tree, certain baking items, and a broader assortment of toys
and candy. In 2000, 1999 and 1998 the fourth quarter generated 32%, 30% and 31%
of the Company's total annual revenues, respectively. Although all four of the
Company's divisions experienced their highest sales in the fourth quarter, the
hardware and seasonal division had the largest increases.
The Dollar General Store
The typical Dollar General store has approximately 6,700 square
feet of selling space and is operated by a manager, an assistant manager and two
or more sales clerks. Most stores are in small towns with populations of fewer
than 20,000. As of December 14, 2001, approximately 58% of stores were located
in strip shopping centers, 38% were freestanding buildings and less than 4% were
in downtown store buildings. The Company generally has not encountered
difficulty locating suitable store sites in the past, and management does not
currently anticipate experiencing material difficulty in finding suitable
locations at favorable rents.
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The Company's recent store growth is summarized in the following
table:
Stores at Net
Beginning Stores Stores Store Stores at
Year of Year Opened Closed Increase Year End
- --------------------------------------------------------------------------------
1998 3,169 551 33 518 3,687
1999 3,687 646 39 607 4,294
2000 4,294 758 52 706 5,000
In 2001, the Company currently plans to open approximately 600
new stores, close 50 to 60 stores, and remodel or relocate approximately 70
stores. As of December 14, 2001, the Company operated 5,562 retail stores.
Employees
As of February 2, 2001, the Company and its subsidiaries employed
approximately 39,500 full-time and part-time employees, including divisional and
regional managers, area managers, store managers, and DC and administrative
personnel, compared with approximately 34,600 employees on January 28, 2000. The
Company had approximately 45,000 employees, excluding temporary Christmas help,
as of December 14, 2001. Management believes the Company's relationship with its
employees is good.
Competition
The Company is engaged in a highly competitive business. The
Company competes with discount stores and with many other retailers, including
mass merchandise, grocery, drug, convenience, variety and other specialty
stores. Some of the nation's largest retail companies operate stores in areas
where the Company operates. The Company's direct competitors in the dollar store
retail categories include Family Dollar, Dollar Tree, Fred's and various local,
independent operators. Competitors from other retail categories include CVS,
Rite Aid, Walgreens, Eckerds, Wal-Mart and Kmart. Some of the Company's
competitors from outside the dollar store segment are better capitalized than
the Company.
The dollar store category differentiates itself from other forms
of retailing by offering consistently low prices in a convenient, small-store
format. Recently conducted independent research indicates that the average
dollar store customer visits a store approximately 90 times each year. The
Company's prices are competitive because of its low cost operating structure and
the relatively limited assortment of products offered. Labor and marketing
expenses are minimized by not using circulars, limiting price points and
relying on simple merchandise presentation. Occupancy expenses are typically low
because the Company attempts to locate in second tier locations, either in small
towns or in the neighborhoods of more urban areas where such expenses are low.
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The Company believes that its limited assortment of products allows it to focus
its purchasing efforts on fewer SKUs than other retailers, which helps keep the
cost of goods low.
ITEM 2. PROPERTIES
As of February 2, 2001, the Company operated 5,000 retail stores
located in 25 states. As of December 14, 2001, the Company operated 5,562 retail
stores located in 27 states, as follows:
State Number of Stores State Number of Stores
- --------------------------------------------------------------------------------
Alabama 264 Missouri 256
Arkansas 192 Nebraska 60
Delaware 19 New Jersey 8
Florida 320 New York 49
Georgia 308 North Carolina 286
Illinois 239 Ohio 302
Indiana 240 Oklahoma 224
Iowa 125 Pennsylvania 284
Kansas 140 South Carolina 202
Kentucky 236 Tennessee 312
Louisiana 193 Texas 715
Maryland 56 Virginia 216
Michigan 54 West Virginia 110
Mississippi 152
Substantially, all of the Company's stores are located in leased
premises. Individual store leases vary as to their terms, rental provisions and
expiration dates. In 2000, the Company's aggregate store rental expense averaged
$4.77 per square foot of selling space. The Company's policy is to negotiate
low-cost, short-term leases (usually with initial or primary terms of three to
five years) with multiple renewal options when available.
The Company's DCs serve Dollar General stores as described in the
following table:
As of December 14, 2001
----------------------- Approximate
Year Approximate Square Number of Stores
Location Opened Footage Served
- -------------------------------------------------------------------------------
Scottsville, Kentucky 1959 720,000 814
Ardmore, Oklahoma 1994 1,200,000 972
South Boston, Virginia 1997 1,210,000 915
Indianola, Mississippi 1998 820,000 618
Fulton, Missouri 1999 1,150,000 793
Alachua, Florida 2000 980,000 714
Zanesville, Ohio 2001 1,170,000 736
- -------------------------------------------------------------------------------
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The Company owns the DC located in Scottsville, Kentucky and
leases all of its other DCs. The Company opened its Zanesville, Ohio DC in April
of 2001. The Company's executive offices are located in approximately 302,000
square feet of leased space in Goodlettsville, Tennessee.
ITEM 3. LEGAL PROCEEDINGS
Restatement-Related Proceedings
Following the April 30, 2001, announcement discussed above, more
than 20 purported class action lawsuits were filed against the Company and
certain current and former officers and directors of the Company, asserting
claims under the federal securities laws. These lawsuits have been consolidated
into a single action pending in the United States District Court for the Middle
District of Tennessee. On July 17, 2001, the court entered an order appointing
the Florida State Board of Administration and the Teachers' Retirement System of
Louisiana as lead plaintiffs and the law firms of Entwistle & Cappucci LLP,
Milberg Weiss Bershad Hynes & Lerach LLP and Grant & Eisenhofer, P.A. as co-lead
counsel. On January 3, 2002, the lead plaintiffs filed an amended consolidated
class action complaint purporting to name as plaintiffs a class of persons who
held or purchased the Company's securities and related derivative securities
between May 12, 1998, and September 21, 2001. Among other things, plaintiffs
have alleged that the Company and certain of its current and former officers and
directors made misrepresentations concerning the Company's financial results in
the Company's filings with the Securities and Exchange Commission and in various
press releases and other public statements. The plaintiffs seek damages with
interest, costs and such other relief as the court deems proper.
The Company has reached a settlement agreement with the purported
class action plaintiffs, pursuant to which the Company has agreed to pay $140
million to such plaintiffs in settlement for their claims, and to implement
certain enhancements to its corporate governance and internal control
procedures. Such agreement is subject to confirmatory discovery, to the final
approval of the Company's Board of Directors, and to court approval. Following
the completion of confirmatory discovery, plaintiffs have the right under the
settlement agreement to amend their complaint further to increase the size of
the class, and to negotiate with the Company for additional damages, the
aggregate amount of all damages to be paid in settlement of plaintiffs' claims
not to exceed $162 million. The Company expects that following the completion of
such confirmatory discovery, the plaintiffs will amend their complaint and seek
aggregate damages of $162 million. The Company has accordingly recognized an
expense of $162 million in the fourth quarter of 2000. The Company expects to
receive from its insurers approximately $4.5 million in respect of the class
action settlement, which amount has not been accrued in the Company's financial
statements.
14
In addition, six purported shareholder derivative lawsuits have
been filed in Tennessee State Court against certain current and former Company
directors and officers and Deloitte & Touche LLP, the Company's former
independent accountant. The Company is named as a nominal defendant in the
actions, which seek restitution and/or compensatory and punitive damages with
interest, equitable and/or injunctive relief, costs and such further relief as
the court deems proper. By order entered October 31, 2001, the court appointed
Michael Dixon, Jr., Carolinas Electrical Workers Retirement Fund and Thomas
Dewey, plaintiffs in one of the six filed cases, as lead plaintiffs and the law
firms of Branstetter, Kilgore Stranch & Jennings and Stanley, Mandel & Iola as
lead counsel. In the same order, the court stayed the remaining cases pending
completion of the lead case. Among other things, the plaintiffs allege that
certain current and former Company directors and officers breached their
fiduciary duties to the Company and that Deloitte & Touche aided and abetted
those breaches and was negligent in its service as the Company's independent
accountant. During August and September 2001, the Company moved to dismiss all
six cases for failure to make a pre-suit demand on the Board of Directors and,
in the alternative, requested that the court stay the actions pending the
completion of an investigation into the allegations in the complaints by the
Shareholder Derivative Claim Review Committee of the Company's Board of
Directors. The lead plaintiffs filed an opposition to this motion on October 2,
2001. A hearing on the motion has not yet been scheduled.
Two purported shareholder derivative lawsuits also have been
filed in the United States District Court for the Middle District of Tennessee
against certain current and former Company directors and officers alleging that
they breached their fiduciary duties to the Company. The Company is named as a
nominal defendant in these actions, which seek declaratory relief, compensatory
and punitive damages, costs and such further relief as the court deems proper.
By motion filed on September 28, 2001, the Company requested that the federal
court abstain from exercising jurisdiction over the purported shareholder
derivative actions in deference to the pending state court actions. By agreement
of the parties and court order dated December 3, 2001, the case has been stayed
until June 3, 2002.
The Company and the individual defendants have reached a
settlement agreement with lead counsel to the plaintiffs in the lead Tennessee
state shareholder derivative action. The agreement includes a payment to the
Company from a portion of the proceeds of the Company's director and officer
liability insurance policies as well as certain corporate governance and
internal control enhancements. Pursuant to the terms of such agreement, the
Company anticipates that all of the stayed cases, including the federal
derivative cases described above, will be dismissed with prejudice by the courts
in which they are pending. Such agreement is subject to confirmatory discovery,
to the final approval of the Company's Board of Directors, and to court
approval. If the settlement agreement is approved, the Company expects that it
will result in a net payment to the Company, after
15
attorneys' fees payable to the plaintiffs' counsel, of approximately $24.8
million, which has not been accrued in the Company's financial statements.
The Company believes that it has substantial defenses to the
purported class action and the derivative lawsuits and intends to assert these
defenses in the courts in which the actions are pending in the event the
settlement agreements referred to above do not successfully resolve these
matters. These cases are at an early stage and the amount of potential loss, if
any, should the settlement agreements not become effective cannot be reasonably
estimated. An unfavorable outcome for the Company in these actions could have a
material adverse impact on the Company's financial position and results of
operations.
The Company has been notified that the SEC is conducting an
investigation into the circumstances that gave rise to the Company's April 30,
2001, announcement. The Company is cooperating with this investigation by
providing documents and other information to the SEC.
Other Litigation
The Company was involved in other litigation, investigations of a
routine nature and various legal matters during 2000, which were and are being
defended and otherwise handled in the ordinary course of business. While the
ultimate results of these matters cannot be determined or predicted, management
believes that they have not had and will not have a material adverse effect on
the Company's results of operations or financial position.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to shareholders during the quarter
ended February 2, 2001, or during the first three quarters of fiscal year 2001.
16
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SECURITY
HOLDER MATTERS
The Company's common stock is traded on the New York Stock
Exchange under the symbol "DG." The following table sets forth the range of the
high and low closing prices of the Company's common stock during each quarter in
2000 and 1999, as reported on the New York Stock Exchange, together with
dividends. All numbers have been restated to reflect common stock splits.
First Second Third Fourth
2000 Quarter Quarter Quarter Quarter
- -------------------------------------------------------------------------------------------------------
High $ 21.80 $ 21.44 $ 23.06 $ 19.81
Low $ 14.65 $ 16.31 $ 14.75 $ 13.50
Dividends $ .026 $ .032 $ .032 $ .032
First Second Third Fourth
1999 Quarter Quarter Quarter Quarter
- -------------------------------------------------------------------------------------------------------
High $ 23.68 $ 24.65 $ 25.80 $ 21.70
Low $ 15.84 $ 21.20 $ 18.60 $ 16.65
Dividends $ .021 $ .026 $ .026 $ .026
The Company's stock price at the close of the market on December
14, 2001, was $13.90.
There were approximately 12,400 shareholders of record of the
Company's common stock as of December 14, 2001. The Company has paid cash
dividends on its common stock since 1975. The Board of Directors regularly
reviews the Company's dividend plans to ensure that they are consistent with the
Company's earnings performance, financial condition, need for capital and other
relevant factors. The Company did not sell any of its equity securities during
2000 without registration under the Securities Act of 1933, as amended.
17
ITEM 6. SELECTED FINANCIAL DATA*
(In thousands except per share and operating data, as restated)
February 2, 2001
(53-week year) January 28, 2000 January 29, 1999
- -----------------------------------------------------------------------------------------------------------
SUMMARY OF OPERATIONS:
Net sales $ 4,550,571 $ 3,887,964 $ 3,220,989
Gross profit $ 1,250,903 $ 1,093,498 $ 892,519
Litigation settlement expense $ 162,000
Income before income taxes $ 108,647 $ 294,697 $ 239,009
Net income $ 70,642 $ 186,673 $ 150,934
Net income as a % of sales 1.6% 4.8% 4.7%
- -----------------------------------------------------------------------------------------------------------
PER SHARE RESULTS:
Diluted earnings per share (a) $ 0.21 $ 0.55 $ 0.45
Basic earnings per share (a) $ 0.21 $ 0.61 $ 0.53
- -----------------------------------------------------------------------------------------------------------
Cash dividends per share of common stock (a) $ 0.12 $ 0.10 $ 0.08
Weighted average diluted shares (a) 333,858 337,904 335,763
- -----------------------------------------------------------------------------------------------------------
FINANCIAL POSITION:
Assets $ 2,282,462 $ 1,923,628 $ 1,376,012
Long-term obligations $ 720,764 $ 514,362 $ 221,694
Shareholders' equity $ 861,763 $ 845,353 $ 674,406
Return on average assets 3.4% 11.3% 12.9%
Return on average equity 8.3% 24.6% 24.4%
- -----------------------------------------------------------------------------------------------------------
OPERATING DATA:
Retail stores at end of period 5,000 4,294 3,687
Year-end selling square feet 33,871,000 28,655,000 23,719,000
Highly consumable sales 55% 51% 42%
Hardware and seasonal sales 16% 17% 19%
Basic clothing sales 12% 12% 12%
Home products sales 17% 20% 27%
- -----------------------------------------------------------------------------------------------------------
(a) As adjusted to give retroactive effect to all common stock splits.
* The Company has determined, in light of the substantial time, effort and
expense required since April of 2001 to prepare and audit its restated
financial statements for fiscal 2000, 1999 and 1998, that unreasonable
further effort and expense would be required to conduct a similar process
to restate its previously released financial data for fiscal 1997 and
1996. Such financial data have not been restated and should not be relied
upon. For a further discussion of the Company's restatement of its
financial statements, see Note 2 to the Consolidated Financial Statements.
18
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
General
Accounting Periods. The following text contains references to
years 2001, 2000, 1999 and 1998, which represent fiscal years ending or ended
February 1, 2002, February 2, 2001, January 28, 2000 and January 29, 1999,
respectively. There were 53 weeks in the fiscal year ended February 2, 2001.
There were 52 weeks in the fiscal years ended January 28, 2000 and January 29,
1999. There will be 52 weeks in the fiscal year ended February 1, 2002. This
discussion and analysis should be read with, and is qualified in its entirety
by, the consolidated financial statements and the notes thereto.
Overview of 2000. During 2000, Dollar General increased its net
sales by 17.0%, primarily as a result of its continued rapid pace of new store
openings. From 1998 through 2000, the Company had a compound annual net sales
growth rate of 18.9%. Same-store sales increased 0.9% in 2000, as compared with
increases of 6.4% and 8.3% in 1999 and 1998, respectively.
As discussed further below, management believes that the
Company's operating performance in 2000 was negatively impacted by out-of-stock
conditions resulting from an extensive system-wide store retrofit program and
changes in the store merchandise ordering process. In addition, the Company's
performance may have been impacted by changes in general economic conditions.
The year 2000 marked the thirteenth consecutive year that the
Company increased its total number of store units. The Company opened 758 new
stores in 2000, compared with 646 in 1999 and 551 in 1998, and remodeled or
relocated 237 stores, compared with 409 in 1999 and 351 in 1998. During the last
three years, the Company has opened, remodeled or relocated 2,952 stores,
accounting for approximately 60% of the total stores as of February 2, 2001. The
Company ended fiscal 2000 with 5,000 stores. The Company currently plans to open
approximately 600 new stores and close 50 to 60 stores in 2001, and to remodel
or relocate approximately 70 stores. The Company will continue to focus on
opening new stores in towns with populations of 20,000 or fewer and within 250
miles of its DCs. The Company expects its new stores to be subject to operating
lease arrangements. Capital expenditures related to new store openings will be
financed through a combination of operating cash flow and credit facilities.
In 2000, new stores, remodels and relocations, net of 52 closed
stores, added an aggregate of approximately 5 million selling square feet to the
Company's total sales space. As a result, the Company had an aggregate of
approximately 34 million selling square feet at the end of the year. The average
new store opened in 2000 had approximately 6,900 selling square feet compared to
19
approximately 7,200 selling square feet for new stores opened in 1999.
In 1998, the Company introduced a preferred development program
to support continued new store growth. This program enabled the Company to
partner with development firms to build stores in markets where existing,
acceptable retail space was not available. The Company opened 163 new stores
through this program in 2000, compared with 141 new stores in 1999 and 52 new
stores in 1998. In 2001, as the Company expands into new markets, management
expects to meet store growth needs primarily through conventional leases.
In the third quarter of 2000, the Company opened a new DC with
dual sortation capacity in Alachua, Florida and closed a DC in Homerville,
Georgia. The Company also closed a DC in Villa Rica, Georgia that had been
dedicated to supplying new stores and prepared the existing DCs to support new
store growth in 2001. In 2000, the Company implemented a new inventory
management system and focused on improving inventory processes in all DCs. This
allowed the Company to increase its DC inventory turns from 11 in 1999 to 14 in
2000, a 27% increase. Continuing to support the growing store base and in an
effort to improve distribution efficiencies, the Company opened its seventh DC
in Zanesville, Ohio in April of 2001.
Store investment and infrastructure upgrades were priorities in
2000. New flatbed scanners were installed in all stores, and new IBM registers
and checkouts were installed in approximately 2,600 stores. By the end of 2001,
management expects to have the systems to support perpetual inventories in
approximately 4,800 stores and expects to establish perpetual inventories in
approximately 500 stores. Management expects to have the systems to support
perpetual inventories in all stores by the end of 2002. A perpetual inventory
allows the Company to track store level inventory at the SKU level, which should
result in better inventory management. Additionally, management expects to
enhance store communications and improve customer service by installing
satellite communications technology in 2,500 stores in 2001, and in all stores
by the end of 2002.
Restatement of Financial Statements
On April 30, 2001, the Company announced that it had become aware
of certain accounting issues that would cause it to restate its audited
financial statements for fiscal years 1999 and 1998, and to restate the
unaudited financial information for the fiscal year 2000 that had been
previously released by the Company. The Audit Committee of the Board of
Directors promptly assumed oversight of the Company's response to the accounting
issues and commenced an independent review of these accounting issues to prepare
the Committee for its role in reviewing the restated financial statements,
assisted by the law firm of Dechert, Price and Rhoads and the independent
accounting firm Arthur Andersen, LLP. The Company further announced on June 7,
2001, that its Chairman and Chief Executive Officer had directed the Company's
20
financial staff and its outside professional consultants to review the Company's
reporting, record keeping, accounting and internal control policies and
practices, and that until such review had been concluded, the Company would not
be in a position to update its prior financial guidance. The Company's financial
staff conducted its review of these issues with the assistance of the Company's
outside counsel, Debevoise & Plimpton, and accounting consultants from KPMG LLP.
Consistent with the activities of the Audit Committee and the
Company's review of its financial statements for the 1998, 1999 and 2000 fiscal
years, the Company is restating by means of this filing its audited financial
statements for fiscal years 1999 and 1998, and is filing herewith its audited
financial results for fiscal year 2000, which restate the unaudited financial
information for the fiscal year 2000 that had been previously released by the
Company. The Company's previously released financial data should not be relied
upon.
Restated net income and diluted earnings per share for 2000 are
$70.6 million and $0.21, respectively, as compared to the $206.0 million and
$0.62 previously reported. The restated results for 2000 include a pre-tax
expense of $162.0 million to settle the Company's restatement-related litigation
described below. Excluding the litigation settlement expense, restated net
income and diluted earnings per share for 2000 are $169.6 million and $0.51,
respectively. Restated net income totaled $186.7 million in fiscal 1999 and
$150.9 million in fiscal 1998, equaling diluted earnings per share of $0.55 and
$0.45, respectively. The Company originally reported, prior to the restatement,
net income of $219.4 million in fiscal 1999 and $182.0 million in fiscal 1998,
equaling diluted earnings per share for those periods of $0.65 and $0.54,
respectively.
The issues for restatement, excluding the litigation settlement
expense, can be broken down into four general categories: (i) items impacting
the cost of goods sold that were recorded incorrectly and/or that reflect more
accurate estimates, (ii) selling, general and administrative ("SG&A") expenses
that were either incurred but not accrued, or recorded incorrectly, (iii)
additional interest expense required as a result of restating certain operating
leases as capital leases and financing obligations, and the addition of capital
lease and financing obligation liabilities to the Company's balance sheets, and
(iv) changes to the Company's income tax provision to correct errors.
Set forth below is a more detailed description of the four
general categories of issues identified and corrected and the earnings per share
impact of such items over the three-year period of 2000, 1999 and 1998:
Cost of Goods Sold. The Company has reduced its diluted earnings
per share by $0.05 over the three-year period to correct items impacting the
cost of goods sold that were recorded incorrectly and/or that reflect more
accurate estimates. Examples of items that fall into this category include the
21
provision for inventory shrinkage, certain expenses associated with the
Company's import program, the markdown to facilitate the sale of excess
inventory, certain vendor allowances for new store openings, the accounting
treatment of markdowns to remove damaged merchandise from stock, and a provision
for uncollectible vendor charge backs. The item with the largest impact on the
restatement affecting cost of goods sold is the recalculation of the shrinkage
provision, which reduced diluted earnings per share by $0.04 over the three-year
restatement period. The restatement of cost of goods sold reduced diluted
earnings per share by $0.01, $0.01 and $0.03 in 2000, 1999 and 1998,
respectively.
Selling, General & Administrative Expenses. The Company has
reduced its diluted earnings per share by $0.11 over the three-year period to
record correctly expenses that were either incurred but not accrued, or recorded
incorrectly. Prior to this restatement, the Company recorded certain expenses
when it processed payment as opposed to when the activity was actually
undertaken. Expense items that fall into this category reduced diluted earnings
per share by $0.02 over the three-year period and include, among other items,
property taxes, rent, supplies, trash removal, advertising costs, maintenance
costs and utilities. A partial list of expenses that were recorded incorrectly
includes the depreciation expense on certain older cash registers, the rent and
depreciation expense associated with certain leases restated from operating
lease classification to capital lease classification, certain store labor costs
and supplies that were capitalized when they should have been expensed, the
impairment of a closed distribution center, compensation expense related to the
use of stock options for excess tax withholding, and various expenses that were
charged against unrelated liability accounts as opposed to being categorized as
SG&A expenses. The restatement of SG&A expenses reduced diluted earnings per
share by $0.02, $0.05 and $0.04 in 2000, 1999 and 1998, respectively.
Interest Expense. The Company has reduced its diluted earnings
per share by $0.11 over the three-year period to correctly record additional
interest expense required as a result of restating certain operating leases as
capital leases or as financing obligations. As part of the restatement process,
the Company examined its accounting practices with regard to certain synthetic
lease facilities entered into in 1997 and 1999 with respect to its use and
occupancy of certain real property, including approximately 400 stores, two of
the Company's distribution centers and the Company's corporate headquarters in
Goodlettsville, Tennessee. The Company determined that the synthetic leases did
not meet the Statement of Financial Accounting Standards ("SFAS") No. 13
requirements for operating lease treatment due primarily to the current
assumption that the Company would incur a penalty, as defined in SFAS No. 98, if
it did not renew the leases. Additionally, the Company identified four
sale-leaseback transactions that were incorrectly classified exclusively as
operating leases. Two of these transactions have now been recorded as financing
obligations, while the equipment portion of the other two transactions have been
accounted for as capital leases. Increases in interest expense as a result of
the various lease
22
classification changes reduced diluted earnings per share by $0.06, $0.04 and
$0.01 in 2000, 1999 and 1998, respectively. As of February 2, 2001, January 28,
2000, and January 29, 1999, the Company added various long-term obligations to
its consolidated balance sheets of $511.0 million, $513.8 million, and $175.7
million, respectively.
Tax Provision. The Company has reduced its diluted earnings per
share by $0.02 over the three-year period to correct errors in the Company's tax
provision. The Company's effective tax rate before the restatement was 36.2% in
2000, 36.2% in 1999, and 35.2% in 1998. The Company's effective tax rate on a
restated basis, excluding the impact of the litigation settlement expense, is
37.3% in 2000, 36.7% in 1999 and 36.9% in 1998. Issues contributing to the
increase in the effective tax rate include a change in the calculation of the
Company's deferred tax liability from a consolidated calculation to a
calculation by individual entity in accordance with SFAS No. 109; a change in
the computation of the income tax benefit allocated to additional paid-in
capital related to the exercise of non-qualified stock options; the correction
of a duplicate deduction related to inventory on a prior income tax return; the
correction of the Company's current income tax liability which had been
improperly reduced for amounts paid relating to professional fees, interest and
certain penalties; and increases to income tax-related accrued liabilities. The
restatement of the Company's income tax provision reduced diluted earnings per
share, excluding the impact of the litigation settlement expense, by $0.01 in
2000 and $0.01 in 1998. A tax rate of 38.9% was applied in 2000 against the
$162.0 million litigation settlement expense. Including the impact of the
litigation settlement expense, the restated effective tax rate in 2000 was
35.0%.
In addition to the restatement of diluted earnings per share, the
correction of many of these issues also required an adjustment to previously
reported balance sheets. Please refer to Note 2 to the Consolidated Financial
Statements for a schedule reconciling the various restatement-related
adjustments with previously released data for 2000, 1999 and 1998.
Critical Accounting Policies
As discussed in Note 1 to the Consolidated Financial Statements,
inventories are stated at the lower of cost or market with cost determined using
the retail last-in, first-out ("LIFO") method. Under the retail inventory method
("RIM"), 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. RIM is an averaging method that has been widely used in the
retail industry due to its practicality. Also, it is recognized that the use of
the retail inventory method will result in valuing inventories at lower of cost
or market if markdowns are currently taken as a reduction of the retail value of
inventories.
23
Inherent in the RIM calculation are certain significant
management judgments and estimates including, among others, merchandise markon,
markups, markdowns and shrinkage, which significantly impact the ending
inventory valuation at cost as well as resulting gross margins. These
significant estimates, coupled with the fact that the RIM is an averaging
process, can, under certain circumstances, produce distorted or inaccurate cost
figures. Factors that can lead to distortion in the calculation of the inventory
balance include applying the RIM to a group of products that is not fairly
uniform in terms of its cost and selling price relationship and turnover, and
applying RIM to transactions over a period of time that includes different rates
of gross profit, such as those relating to seasonal merchandise. To reduce the
potential of such distortions in the valuation of inventory from occurring, the
Company's RIM utilizes 10 departments in which fairly homogenous classes of
merchandise inventories having similar gross margins are grouped. In addition,
failure to take markdowns currently can result in an overstatement of cost under
the lower of cost or market principle. During fiscal 2000, the Company recorded
markdowns that had not been taken and which served to reduce inventories to
lower of cost or market by approximately $21.5 million.
Management believes that the Company's RIM provides an inventory
valuation which reasonably approximates cost and results in carrying inventory
at the lower of cost or market.
Results of Operations
The following discussion of the Company's financial performance
is based on the Consolidated Financial Statements set forth herein.
Net Sales. Net sales totaled $4.55 billion for 2000, $3.89
billion for 1999 and $3.22 billion for 1998, representing annual increases of
17.0% in 2000, 20.7% in 1999 and 22.6% in 1998. The increases resulted primarily
from 706 net new stores and a same-store sales increase of 0.9% in 2000; 607 net
new stores and a same-store sales increase of 6.4% in 1999; and 518 net new
stores and a same-store sales increase of 8.3% in 1998.
The Company believes that the lower same store sales increase in
2000 was due primarily to the disruptive effect of a comprehensive store reset
program designed to improve the product mix and appearance of its stores, which
affected the vast majority of the store base. This program, which commenced in
May and concluded in August of 2000, involved adding items in faster turning
categories such as food, paper products and health and beauty aids, and reducing
the number of SKUs in the apparel and home products categories. In addition to
these changes in the product mix, the reset involved moving center island
fixtures and relocating within the store much of the existing inventory. The
reset program also included widening store aisles in an effort to make the
shopping experience more convenient for customers. The Company believes this
24
program will ultimately lead to an improvement in sales per square foot. The
implementation of the reset program, however, strained store labor resources and
disrupted operations during the affected period. This disruption resulted in
sporadic out-of-stock conditions, mostly in ancillary items such as mops and
brooms, pet supplies, trash bags and domestics, from May 2000 through December
2000.
Other factors that may have had an impact on the lower same store
sales increase in 2000 include a change in store ordering procedures from a
manual process to a new automated system relying on the scanning of shelf tags,
which may have been an additional cause of the sporadic out-of-stock conditions
experienced by the Company, and a general softening of economic conditions.
The relatively strong same store sales increases in 1999 and 1998
were due primarily to the Company's ongoing shift in emphasis to the consumable
basics segment of its business.
The Company tracks its sales internally by four divisions: highly
consumable, hardware and seasonal, basic clothing and home products. Total
sales in the highly consumable department increased by 26.1%, 46.4% and 23.9%
in 2000, 1999 and 1998, respectively. Total sales in the hardware and seasonal
department increased by 10.2%, 6.0%, and 21.1% in 2000, 1999 and 1998,
respectively. Total sales in the basic clothing department increased by 14.9%,
23.2% and 26.3% in 2000, 1999 and 1998, respectively. Total sales in the home
products department experienced annual changes of 0.5%, (10.7)% and 20.0% in
2000, 1999 and 1998, respectively.
Gross Profit. Gross profit for 2000 was $1.25 billion, or 27.5%
of sales, compared with $1.09 billion, or 28.1% of sales in 1999 and $0.89
billion, or 27.7% of sales, in 1998. The decline in the gross profit rate in
2000 as compared to 1999 was due primarily to the $21.5 million effect of a
markdown recorded in 2000. As described in Note 4 to the Consolidated Financial
Statements (see Item 8), the Company believes that it has certain excess
inventories that will require a markdown to assist with its disposition. The
Company believes that this markdown will be adequate to ensure the sale of the
excess inventory during fiscal years 2001 and 2002. However, there can be no
assurance that the Company will be able to sell all of this inventory by the end
of 2002 without marking down the inventory at issue in amounts exceeding the
markdown recorded to date.
The increase in the gross profit rate in 1999 as compared to 1998
is due primarily to a 62 basis point increase in the initial margin recognized
on inventory purchases resulting, in part, from an increase in 1999 in the
purchase of higher margin private label items and "price" brands, and a
reduction in 1999 in the purchase of lower margin basic clothing items.
25
Inventory shrinkage calculated at the retail value of the
inventory, as a percentage of sales, was 2.80% in 2000, 2.62% in 1999 and 2.59%
in 1998. The Company's goal is to maintain a shrink rate in the range of 1.75%
to 2.00%. In 2001 the Company appointed approximately 25 financial control
specialists to assist its stores with various shrinkage reduction efforts. These
financial control specialists are focusing on activities such as investigating
missing cash deposits and evaluating the processes in stores with consistently
poor shrinkage results.
Distribution and transportation costs increased by 16 basis
points as a percentage of sales in 2000 as compared to 1999, and increased by 5
basis points in 1999 as compared to 1998. The increase in distribution and
transportation costs as a percentage of sales is due in part to the additional
fixed costs associated with the Fulton and Alachua distribution centers, which
were opened in 1999 and 2000, respectively.
Selling, General and Administrative Expense. Total SG&A expense
as a percentage of net sales was 20.5% in 2000, compared with 19.9% in 1999 and
19.9% in 1998. SG&A expense for 2000 was $934.9 million, an increase of 21.0%
compared to 1999. SG&A expense in 1999 was $772.9 million, an increase of 20.9%
over the 1998 total of $639.5 million.
The 66 basis point increase in SG&A expense as a percentage of
net sales experienced in 2000 was due in part to the fact that store labor,
store depreciation and amortization, and store utilities experienced annual
increases of 22.9%, 44.4% and 27.8%, respectively, which were all in excess of
the Company's sales increase of 17.0%. The increase in store labor as a
percentage of sales was due principally to the additional hours required to
complete the store reset program and the general weakness of same store sales.
The increase in store depreciation and amortization expense as a percentage of
sales was a result of the number of new stores subject to capital leases.
Litigation Settlement Expense. The Company recorded $162.0
million in 2000 for the proposed settlement of the restatement-related
litigation. See Note 2 to the Consolidated Financial Statements.
Interest Expense. In 2000, interest expense was $45.4 million
compared with $25.9 million in 1999 and $14.0 million in 1998. The increase in
interest expense in 2000 resulted from the net addition of $213.6 million in
various long-term obligations during 2000.
The average daily total debt outstanding in 2000 was $710.3
million at an average interest rate of 7.2%. The increase in interest expense in
1999 resulted from the addition in 1999 of $293.8 million in various long-term
obligations. The average daily total debt outstanding in 1999 was $454.0 million
at an average interest rate of 6.0%. The average total debt outstanding in 1998
was $253.8 million at an average interest rate of 5.8%.
26
Provision for Taxes on Income. The effective income tax rates for
2000, 1999 and 1998 were 35.0%, 36.7% and 36.9%, respectively. The reduction in
the effective tax rate in 2000 was due to the 38.9% marginal tax rate applied
against the litigation settlement expense. Excluding the tax impact of the
litigation settlement expense, the effective tax rate in 2000 was 37.3%.
Liquidity and Capital Resources
Capital Structure. The Company has accessed capital through
public debt, bank financings, long-term leases and financing obligations. In
2000, the Company financed its short-term working capital needs through
borrowings under the Company's $175 million revolving credit facility and
seasonal bank lines of credit totaling $80 million at February 2, 2001. The
revolving credit facility has two financial covenants, a fixed charge test and a
leverage test. The leverage test was amended in 2000 to provide the Company with
increased operating flexibility. As of December 14, 2001, the revolving credit
facility was priced at LIBOR plus 102.5 basis points. As of February 2, 2001
the Company had no revolving or seasonal loans outstanding and was in compliance
with the financial covenants under the revolving credit facility. As of December
14, 2001, the Company has not renewed its seasonal lines of credit. Until the
restatement-related legal proceedings referred to previously and in Note 9 to
the Consolidated Financial Statements are resolved, the Company may need waivers
in order to draw on the revolving credit facility. The Company's total debt as
of February 2, 2001, was $729.8 million, compared with $516.2 million as of
January 28, 2000, and $222.4 million as of January 29, 1999.
In June 2000, the Company issued $200 million of 8 5/8% notes to
repay outstanding short-term borrowings and for general corporate purposes. The
notes are unsecured and guaranteed by all of the Company's subsidiaries. The
notes have certain restrictive covenants, including limitations on secured
indebtedness and certain sale and leaseback transactions.
As of February 2, 2001, the Company had $383 million outstanding
under two synthetic lease facilities (the "Facilities") maturing in September
2002, one with $212 million in outstanding capital leases and the other with
$171 million in outstanding capital leases. The leases allow for the use and
occupancy of certain real property, including approximately 400 retail stores,
two distribution centers and the Company's headquarters in Goodlettsville,
Tennessee. The Company plans to purchase the properties from the lessor at the
maturity of the Facilities. The Company is currently working on a plan to
refinance the lease obligations. The Facilities have the same two financial
covenants as the revolving credit facility, a fixed charge test and a leverage
test. The facility with $212 million in outstanding capital leases is funded by
a syndicate of financial institutions; borrowings under the facility were priced
at LIBOR plus 102.5 basis points as of December 14, 2001. The pricing spread
over LIBOR fluctuates based on the Company's debt ratings as published by the
27
debt rating agencies. The Company's spread over LIBOR increased to 102.5 basis
points from 15 basis points as part of the October 19, 2001, waiver and
amendment as described below. The facility with $171 million in outstanding
capital leases is funded by commercial paper issued at prevailing market rates
by a commercial paper funding entity and is secured by a letter of credit
facility.
In June 2000, distribution centers in Indianola, Mississippi and
Fulton, Missouri were purchased from the Facilities and sold in sale-leaseback
transactions resulting in twenty-two year, triple net leases with renewal
options for an additional thirty years. These were refinanced to bolster
liquidity and diversify sources of funds.
Throughout 2001, the Company obtained waivers from its lenders
to, among other things, extend the requirement to deliver its audited 2000
financial statements, and unaudited 2001 quarterly financial statements, as a
result of delays related to the restatement described herein. The Company
executed waivers with its lenders under the Facilities and revolving credit
facility on May 10, 2001, June 8, 2001, and July 27, 2001, a waiver and
amendment on October 19, 2001, and waivers on December 28, 2001, and January 10,
2002. The June 8, 2001, waiver prohibited the Company from repurchasing its
shares and limited its capital expenditures to $160 million for the period
commencing on February 2, 2001, and concluding with the delivery of the restated
financial statements. The October 19, 2001, amendment increased the pricing on
the synthetic lease with $212 million in outstanding capital leases and the
revolving credit facility from 15 basis points over LIBOR to 102.5 basis points
over LIBOR, and accelerated the maturity of the second synthetic lease to
September 2002 from June 2004. The Company executed waivers with the lenders
under the Indianola, Mississippi and Fulton, Missouri distribution center leases
on May 7, 2001, May 11, 2001, June 8, 2001, July 30, 2001, October 31, 2001,
December 31, 2001, and January 10, 2002. In addition, the Company executed
waivers with the lenders under the Ardmore and South Boston distribution center
leases on January 10, 2002, and the lender under the Company's airplane lease on
December 21, 2001, and January 7, 2002. The Company paid a total of
approximately $1.6 million in fees for all of the waivers and amendments.
The Company has entered into a settlement agreement with the lead
plaintiffs in the restatement-related class action lawsuits brought against the
Company and its officers and directors. See Item 3 (Restatement-Related
Proceedings), above. Such agreement, which is subject to confirmatory discovery,
court approval and the consent of the Company's insurers, will require a
disbursement by the Company, most likely in the second half of the 2002 fiscal
year, of up to $162 million. The Company expects to fund such amounts out of
operating cash flow, on-hand cash balances and the proceeds of insurance
relating to the settlement of the class action and derivative litigation (see
Note 9 to the Consolidated Financial Statements).
Cash Flow. In 2000, cash provided from operations, long-term
financings and funds available under the Company's credit facilities provided
the resources required to support operations, capital expenditures and working
28
capital requirements. The Company's cash flows enabled it to repay all
short-term borrowings under its credit facility prior to February 2, 2001. As of
December 14, 2001, the Company has not needed to utilize its revolving credit
facility and has not renewed its seasonal lines of credit. Until the
restatement-related legal proceedings referred to previously and in Note 9 to
the Consolidated Financial Statements are resolved, the Company may need a
waiver in order to draw on the revolving credit facility.
Net cash provided by operating activities for fiscal 2000 was
$215.5 million, as compared to $196.7 million for fiscal 1999 and $173.7 million
for fiscal 1998. Cash flow from operations for fiscal 2000 compared to fiscal
1999 increased by $18.8 million, due principally to a reduction in the amount of
cash used to purchase inventory and an increase in accrued expenses and other.
Cash flow from operations increased by $23.0 million in 1999 as compared to
1998, due principally to an increase in net income of $35.7 million in 1999.
Net cash flows used in investing activities was $119.0 million in
2000 versus $139.0 million in 1999 and $143.2 million in 1998. Capital
expenditures for 2000 totaled $216.6 million, compared with $142.1 million for
1999 and $143.4 million for 1998. The Company opened 758 new stores and
relocated or remodeled 237 stores at a cost of $112.7 million in 2000, compared
with opening 646 new stores and relocating or remodeling 409 stores at a cost of
$72.7 million in 1999. The increase in 2000 in store-related capital
expenditures was due principally to the construction of approximately 72
Company-owned stores. Capital expenditures for new, relocated and remodeled
stores totaled $58.0 million during 1998.
Distribution-related capital expenditures totaled $49.3 million
in 2000, resulting primarily from costs associated with the new DCs in Alachua,
Florida, and Zanesville, Ohio. In 1999, distribution-related expenditures
totaled $43.2 million, resulting primarily from costs associated with the
expansion of the Ardmore, Oklahoma DC and the purchase of new delivery trailers.
In 1998, the Company spent $46.3 million, resulting primarily from costs
associated with the expansion of the South Boston, Virginia DC and the purchase
of new delivery trailers.
Capital expenditures during 2001 are projected to be
approximately $135 million. The Company anticipates funding its 2001 capital
requirements with cash flow from operations.
Net cash provided/(used) by financing activities was $11.0
million, $(30.6) million and $(20.8) million in fiscal 2000, 1999 and 1998,
respectively. Cash provided in fiscal 2000 from financing activities reflected
the $200 million of notes issued in June 2000, partially offset by the payment
of $42.2 million of cash dividends, the repurchase of $63.0 million of common
stock, and the repayment of $112.3 million of long-term obligations related
29
primarily to two of the Company's DCs. Cash used in fiscal 1999 by financing
activities reflected the repurchase of $50.8 million of common stock and the
payment of $33.8 million of dividends, offset partially by $38.8 million of cash
proceeds from the exercise of stock options. Cash used in financing activities
in 1998 reflected the repurchase of $73.2 million of common stock, the payment
of $26.7 million of dividends and net repayments of short-term borrowings,
offset partially by $30.7 million of cash proceeds from the exercise of options
and $72.3 million of proceeds from the financing of a distribution center.
As noted above, in September 2002 the Company's synthetic leases,
in the amount of $383 million, will mature and the Company's $175 million
revolving credit facility will expire. The Company expects to refinance the
synthetic lease obligations and to replace the revolving credit facility prior
to such date. The Company may also have to fund during the second half of 2002
the settlement of the class action litigation in an amount of up to $162
million, as further discussed above. The Company believes that its existing cash
balances, cash flow from operations and its ongoing access to the capital
markets will provide sufficient financing to meet these obligations, as well as
the Company's other foreseeable liquidity and capital resource needs. However,
there can be no assurance that the Company will be able to obtain financing in
the amounts that it requires or that the terms of such financing will be as
attractive as the terms on which the Company has obtained financing in the past.
Please refer to "Forward Looking Statements / Risk Factors" for a discussion of
issues that could adversely impact the Company's financial position or its
ability to obtain financing.
Effects of Inflation and Changing Prices
The Company believes that inflation and/or deflation had a
minimal impact on its overall operations during 2000, 1999 and 1998.
Accounting Pronouncements
SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities," is effective for all fiscal years beginning after June 15, 2000.
SFAS No. 133, as amended, establishes accounting and reporting standards for
derivative instruments, including certain derivative instruments embedded in
other contracts and for hedging activities. Under SFAS No. 133, certain
contracts that were not formerly considered derivatives may now meet the
definition of a derivative. The Company adopted SFAS No. 133 effective February
3, 2001. The adoption of SFAS No. 133 did not have a significant impact on the
financial position, results of operations or cash flows of the Company.
In June 2001, the Financial Accounting Standards Board (the
"FASB") issued SFAS No. 141, "Business Combinations," and SFAS No. 142,
"Goodwill and Other Intangible Assets." Under the new rules, goodwill and
30
indefinite lived intangible assets are no longer amortized but are reviewed
annually for impairment. Separable intangible assets that are not deemed to have
an indefinite life will continue to be amortized over their useful lives. The
Company will apply the new accounting rules beginning February 2, 2002. The
adoption of SFAS No. 141 and No. 142 will not have a material impact on the
Company's financial position or results of operations.
The FASB issued SFAS No. 143, "Accounting for Asset Retirement
Obligations" in June 2001. SFAS No. 143 applies to legal obligations associated
with the retirement of certain tangible long-lived assets. This statement is
effective for fiscal years beginning after June 15, 2002. Accordingly, the
Company will adopt this statement on February 1, 2003. The Company believes the
adoption of SFAS 143 will not have a material impact on its Consolidated
Financial Statements.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." SFAS No. 144 is effective for
fiscal years beginning after December 15, 2001, and interim periods within those
fiscal years. The Company will adopt this statement on February 2, 2002. This
statement addresses financial accounting and reporting for the impairment or
disposal of long-lived assets. It supersedes SFAS No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of."
The Company believes the adoption of SFAS No. 144 will not have a material
impact on its Consolidated Financial Statements.
Forward Looking Statements / Risk Factors
This discussion and analysis contains historical and
forward-looking information. The forward-looking statements are made pursuant to
the safe harbor provisions of the Private Securities Litigation Reform Act of
1995. The Company believes the assumptions underlying these forward-looking
statements are reasonable; however, any of the assumptions could be inaccurate,
and therefore, actual results may differ materially from those projected in the
forward-looking statements as a result of certain risks and uncertainties. These
risks include, but are not limited to, the following:
The Company's reputation and financial condition could be
affected by the restatement. On April 30, 2001, the Company announced that it
had become aware of certain accounting issues that would cause it to restate its
audited financial statements for fiscal years 1998 and 1999, and to revise the
unaudited financial information for the fiscal year 2000 that had been
previously released by the Company. Following this announcement, more than 20
purported class action lawsuits have been filed against the Company and certain
current and former officers and directors of the Company, asserting claims under
the federal securities laws. These lawsuits have been consolidated into a single
action pending in the United States District Court for the Middle District of
Tennessee. In addition, six purported shareholder derivative lawsuits have been
filed in Tennessee State Court against certain current and
31
former Company directors and officers and Deloitte & Touche LLP, the Company's
former independent accountant, and two purported shareholder derivative lawsuits
have been filed in the United States District Court for the Middle District of
Tennessee against certain current and former Company directors and officers
alleging that they breached their fiduciary duties to the Company. The Company
has also been notified that the SEC is conducting an investigation into the
circumstances that gave rise to the Company's April 30, 2001, announcement.
As discussed above, the Company has entered into settlement
agreements with the purported class action plaintiffs and with the lead counsel
in the lead shareholders derivative action. However, such settlement agreements
are subject to conditions, including the completion of confirmatory due
diligence and court approval. In the event that these settlement agreements do
not become effective, the Company will incur additional significant expenditures
in defending itself and the Company may be exposed to financial losses in excess
of the amounts that the Company has agreed to pay in the settlement agreements.
In addition, the publicity surrounding the litigation and the SEC investigation
could affect the Company's reputation and have an impact on its financial
condition.
The Company's business is modestly seasonal with the highest
sales occurring during the fourth quarter, and adverse events during the fourth
quarter could therefore affect the Company's financial condition. The Company
realizes a large portion of its net sales and net income during the Christmas
selling season. In anticipation of the holidays, the Company purchases
substantial amounts of seasonal inventory and hires many temporary employees. If
for any reason the Company's net sales during the Christmas selling season were
to fall below seasonal norms, a seasonal merchandise inventory imbalance could
result. If such an imbalance were to occur, markdowns might be required to
minimize this imbalance. The Company's profitability and operating results could
be adversely affected by unbudgeted markdowns.
Adverse weather conditions or other disruptions during the peak
Christmas season could also affect the Company's net sales and could make it
more difficult for the Company to obtain sufficient quantities of merchandise
from its suppliers.
Competition in the retail industry could limit the Company's
growth opportunities and reduce its profitability. The Company competes in the
discount retail merchandise business, which is highly competitive. This
competitive environment subjects the Company to the risk of reduced
profitability resulting from reduced margins required to maintain the Company's
competitive position. The Company competes with discount stores and with many
other retailers, including mass merchandise, grocery, drug, convenience, variety
and other specialty stores. Some of the nation's largest retail companies
operate stores in areas where the Company operates. The Company's direct
competitors in the dollar store retail category include Family Dollar, Dollar
Tree, Fred's and various local, independent operators. Competitors from other
32
retail categories include CVS, Rite Aid, Walgreens, Eckerds, Wal-Mart and Kmart.
The discount retail merchandise business is subject to excess capacity and some
of the Company's competitors are much larger and have substantially greater
resources than the Company. The competition for customers has intensified in
recent years as larger competitors, such as Wal-Mart and Kmart, have moved into
the Company's geographic markets. The Company remains vulnerable to the
marketing power and high level of consumer recognition of these major national
discount chains. The Company expects a further increase in competition from
these national discount retailers.
The Company's financial performance is sensitive to changes in
overall economic conditions that may impact consumer spending. The general
slowdown in the United States economy may adversely affect the spending of the
Company's consumers, which would likely result in lower net sales than expected
on a quarterly or annual basis. Future economic conditions affecting disposable
consumer income, such as employment levels, business conditions, fuel and energy
costs, interest rates and tax rates, could also adversely affect the Company's
business by reducing consumer spending or causing consumers to shift their
spending to other products.
The Company's business is dependent on its vendors. The Company
believes that it has generally good relations with its vendors and that it is
generally able to obtain attractive pricing and other terms from vendors. If the
Company fails to maintain good relations with its vendors, it may not be able to
obtain attractive pricing with the consequence that its net sales or profit
margins would be reduced. The Company may also face difficulty in obtaining
needed inventory from its vendors because of interruptions in production or for
other reasons, which would adversely affect the Company's business.
The efficient operation of the Company's business is heavily
dependent on its information systems. As part of its technology update, the
Company installed new flatbed scanners in all its stores and is in the process
of installing new IBM registers and checkouts. The Company depends on a variety
of other information technology systems for the efficient functioning of its
business. The Company relies on certain software vendors to maintain and
periodically upgrade many of these systems so that they can continue to support
the Company's business. The software programs supporting many of the Company's
systems were licensed to the Company by independent software developers. The
inability of these developers to continue to maintain and upgrade these
information systems and software programs would disrupt or reduce the efficiency
of the Company's operations if it were unable to convert to alternate systems in
an efficient and timely manner.
The Company is subject to interest rate risk. The Company is
subject to market risk from exposure to changes in interest rates based on its
financing, investing and cash management activities. The Company utilizes a
33
credit facility to fund working capital requirements, which is comprised of
variable rate debt. See "Item 7A - Quantitative and Qualitative Disclosures
About Market Risk."
The Company is dependent upon the smooth functioning of its
distribution network. The Company relies upon the ability to replenish depleted
inventory through deliveries to its distribution centers from vendors, and from
the distribution centers to its stores by various means of transportation,
including shipments by air, sea and truck on the roads and highways of the
United States. Long-term disruptions to the national and international
transportation infrastructure that lead to delays or interruptions of service
will adversely affect the Company's business.
The Company is dependent on the continued availability of capital
to support its business. As discussed above, in September 2002 the Company's
synthetic leases, in the amount of $383 million, will mature and the Company's
$175 million revolving credit facility will expire. The Company may also have to
fund during the second half of 2002 the settlement of the class action
litigation discussed above in an amount of up to $162 million. In addition, the
Company will continue to need capital to support its plans for future growth. A
decline in the Company's generation of cash flow or the inability of the Company
to obtain financing from third parties would have a material adverse effect on
the Company.
On October 2, 2001, Standard & Poor's lowered the Company's
corporate credit, senior unsecured debt and senior unsecured bank loan ratings
from BBB+ to BBB-; as the date hereof, these ratings remain on CreditWatch with
negative implications. On October 2, 2001, Moody's Investors Service, Inc. also
lowered the Company's senior unsecured credit rating, from Baa2 to Ba1, which
rating is on review for further possible downgrades. Credit ratings are
generally used by investors to assess the ability of a company to meet its
obligations. The downgrade in the Company's credit ratings may affect the
Company's ability to obtain financing in the future, and will also affect the
terms of any such financing.
Moreover, in order to issue debt securities to the public, the
Company will have to comply with the registration requirements of the Securities
and Exchange Commission, including among other things the requirement that the
Company disclose "Selected Financial Information" for a period of five fiscal
years. This may require the Company to restate its financial statements for
periods prior to the 1998 fiscal year. Unless and until it is able to do so, the
Company will not be able to access the public capital markets and as a result
will be limited to non-public sources of financing, which may result in
increased costs, less favorable terms, and/or lesser availability than might be
obtainable in the public capital markets.
34
Caution should be taken not to place undue reliance on
forward-looking statements made herein, since the statements speak only as of
the date they are made. The Company undertakes no obligation to publicly release
any revisions to any forward-looking statements contained herein to reflect
events or circumstances occurring after the date of this report or to reflect
the occurrence of unanticipated events.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Financial Risk Management
The Company is exposed to market risk primarily from adverse
changes in interest rates. To minimize such risk, the Company may periodically
use financial instruments, including derivatives. As a matter of policy, the
Company does not buy or sell financial instruments for speculative or trading
purposes and all financial instrument transactions must be authorized and
executed pursuant to Board of Directors approval. All financial instrument
positions taken by the Company are used to reduce risk by hedging an underlying
economic exposure. Because of high correlation between the financial instrument
and the underlying exposure being hedged, fluctuations in the value of the
financial instruments are generally offset by reciprocal changes in the value of
the underlying economic exposure. The financial instruments used by the Company
are straightforward instruments with liquid markets.
The Company has cash flow exposure relating to variable interest
rates, primarily associated with revolving and seasonal lines of credit and
certain lease obligations, and seeks to manage this risk through the use of
interest rate swaps. The primary interest rate exposure on variable rate
obligations is based on the London Interbank Offered Rate ("LIBOR").
At February 2, 2001, and January 28, 2000, the fair value of the
Company's debt, excluding capital lease obligations, was estimated at
approximately $295.9 million and $87.7 million, respectively, based on the
estimated market value of the debt at those dates. Such fair value is less than
the carrying value of the debt at February 2, 2001, and January 28, 2000, by
approximately $0.7 million and $10.4 million, respectively.
At February 2, 2001, the Company was party to an interest rate
swap agreement with a notional amount of $100 million. The Company designated
this agreement as a hedge of floating rate commitments relating to its synthetic
lease agreements. Under the terms of the agreement, the Company will pay a fixed
rate of 5.60% on the $100 million notional amount through September 1, 2002. The
fair value of the interest rate swap agreement was $(0.4) million at February 2,
2001. The counterparty to the Company's interest rate swap agreement was a major
financial institution. The Company is exposed to credit risk in the event of
non-performance by such counterparty, the amount of which exposure is limited to
35
the unpaid portion of amounts due to the Company pursuant to the interest rate
swap agreement, if any. Although there are no collateral requirements if a
downgrade in the credit rating of the counterparty occurs, the Company believes
that its exposure is mitigated by provisions in the interest rate swap agreement
that allow the Company to offset any amounts payable by the Company to the
counterparty with any amounts due to the Company from the counterparty.
At January 28, 2000, the Company was party to two interest rate
swap agreements with notional amounts totaling $200 million. These agreements
fixed the Company's floating rate commitments relating to a portion of its
synthetic lease agreements. Under the terms of these agreements, the Company
paid a weighted average fixed rate of 5.14% on the $200 million notional amount
during fiscal years 1999 and 2000. The fair value of these agreements at January
28, 2000, was $3.1 million. As of that date the maturity date for both
agreements was expected to occur in September 2002. In January 2001, the Company
paid $0.2 million to terminate one of those interest rate swap agreements.
In both 1999 and 2000, the Company recognized any differences
paid or received on interest rate swap agreements as adjustments to interest
expense.
Based upon the Company's variable rate borrowing levels, a 1%
change in interest rates would have resulted in a pre-tax fluctuation of
approximately $1.6 million and $2.6 million, including the effects of interest
rate swaps, in 1999 and 2000, respectively. In 2001, the Company does not
anticipate this expense fluctuation to vary materially from the estimated impact
in 2000.
36
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands except per share amounts)
January 28, 2000
February 2, 2001 (Restated)
---------------- ----------------
ASSETS
Current assets:
Cash and cash equivalents $ 162,310 $ 54,742
Merchandise inventories 896,235 952,432
Deferred income taxes 21,514 20,486
Other current assets 44,868 46,455
- --------------------------------------------------------------------------------------------------------------------
Total current assets 1,124,927 1,074,115
- --------------------------------------------------------------------------------------------------------------------
Property and equipment, at cost:
Land 119,410 91,491
Buildings 286,476 250,919
Furniture, fixtures and equipment 823,234 651,656
Construction in progress 110,434 115,310
- --------------------------------------------------------------------------------------------------------------------
1,339,554 1,109,376
Less accumulated depreciation and amortization 366,460 271,987
- --------------------------------------------------------------------------------------------------------------------
Net property and equipment 973,094 837,389
- --------------------------------------------------------------------------------------------------------------------
Merchandise inventories 116,000 --
- --------------------------------------------------------------------------------------------------------------------
Deferred income taxes 52,708 --
- --------------------------------------------------------------------------------------------------------------------
Other assets, net 15,733 12,124
- --------------------------------------------------------------------------------------------------------------------
Total assets $2,282,462 $1,923,628
====================================================================================================================
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current portion of long-term obligations $ 9,035 $ 1,828
Accounts payable 297,262 344,598
Accrued expenses and other 214,192 166,290
Income taxes 17,446 26,991
- --------------------------------------------------------------------------------------------------------------------
Total current liabilities 537,935 539,707
- --------------------------------------------------------------------------------------------------------------------
Long-term obligations 720,764 514,362
- --------------------------------------------------------------------------------------------------------------------
Deferred income taxes -- 24,206
- --------------------------------------------------------------------------------------------------------------------
Litigation settlement payable 162,000 --
- --------------------------------------------------------------------------------------------------------------------
Commitments and contingencies
Shareholders' equity:
Series B junior participating preferred stock, stated value $0.50 per share;
Shares authorized: 10,000,000; Issued: None -- --
Common stock, par value $.50 per share;
Shares authorized: 500,000,000; Issued: 2000-331,292,000;
1999-330,822,000 165,646 165,411
Additional paid-in capital 283,925 229,906
Retained earnings 414,318 450,036
- --------------------------------------------------------------------------------------------------------------------
863,889 845,353
Less common stock purchased by employee deferred compensation trust:
2000-94,000; 1999-None 2,126 --
- --------------------------------------------------------------------------------------------------------------------
Total shareholders' equity 861,763 845,353
- --------------------------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $2,282,462 $1,923,628
====================================================================================================================
The accompanying notes are an integral part of the consolidated financial
statements.
37
CONSOLIDATED STATEMENTS OF INCOME
(Dollars in thousands except per share amounts)
For the years ended
-----------------------------------------------------------------------------
January 28, 2000 January 29, 1999
February 2, 2001 (Restated) (Restated)
---------------------- ----------------------- --------------------------
% of % of % of
Net Net Net
Amount Sales Amount Sales Amount Sales
- ----------------------------------------------------------------------------------------------------------------------
Net sales $4,550,571 100.00% $3,887,964 100.00% $3,220,989 100.00%
Cost of goods sold 3,299,668 72.51 2,794,466 71.87 2,328,470 72.29
- ----------------------------------------------------------------------------------------------------------------------
Gross profit 1,250,903 27.49 1,093,498 28.13 892,519 27.71
Selling, general and
administrative 934,899 20.54 772,928 19.88 639,534 19.86
Litigation settlement expense 162,000 3.56 -- --
- ----------------------------------------------------------------------------------------------------------------------
Operating profit 154,004 3.39 320,570 8.25 252,985 7.85
Interest expense 45,357 1.00 25,873 0.67 13,976 0.43
- ----------------------------------------------------------------------------------------------------------------------
Income before taxes on income 108,647 2.39 294,697 7.58 239,009 7.42
Provisions for taxes on income 38,005 .84 108,024 2.78 88,075 2.73
- ----------------------------------------------------------------------------------------------------------------------
Net income $ 70,642 1.55% $ 186,673 4.80% $ 150,934 4.69%
======================================================================================================================
Diluted earnings per share $ 0.21 $ 0.55 $ 0.45
Weighted average diluted shares (000) 333,858 337,904 335,763
Basic earnings per share $ 0.21 $ 0.61 $ 0.53
======================================================================================================================
The accompanying notes are an integral part of the consolidated financial
statements.
38
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
For the years ended February 2, 2001, January 28, 2000, and January 29, 1999
(Dollars in thousands except per share amounts)
Additional
Preferred Common Paid-in Retained Treasury
Stock Stock Capital Earnings Stock Total
- ---------------------------------------------------------------------------------------------------------------------------
Balances, January 30, 1998
(as previously reported) $ 858 $ 163,149 $ 301,558 $ 318,858 $(200,527) $ 583,896
Restatement adjustments -- -- 761 (23,791) -- (23,030)
- ---------------------------------------------------------------------------------------------------------------------------
Balances, January 30, 1998
(restated) $ 858 $ 163,149 $ 302,319 $ 295,067 $(200,527) $ 560,866
Net income -- -- -- 150,934 -- 150,934
Cash dividends, $0.08 per
common share -- -- -- (24,428) -- (24,428)
Cash dividends, $2.04 per
preferred share -- -- -- (3,497) -- (3,497)
Issuance of common stock
under stock incentive
plans (5,717,000 shares) -- 2,858 27,902 -- -- 30,760
Tax benefit from exercise
of options -- -- 32,252 -- -- 32,252
Repurchase of common
stock (3,901,000 shares) -- (1,950) -- (71,286) -- (73,236)
Transfer to 401(k) plan
(51,000 shares) -- 16