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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended: October 31, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
----------------------- ---------------------
Commission file number: 0-028176
Whitehall Jewellers, Inc.
(Exact name of registrant as specified in its charter)
Delaware 36-1433610
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
155 N. Wacker Drive, Suite 500, Chicago, IL 60606
(Address of principal executive offices) (zip code)
312/782-6800
(Registrant's telephone number, including area code)
(Former name, former address and former fiscal
year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
--- ---
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes X No
--- ---
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.
The number of shares of the Registrant's common stock, $.001 par value per
share, outstanding as of December 12, 2003 was 13,919,409 and the number of
shares of the Registrant's Class B common stock, $1.00 par value per share,
outstanding as of December 12, 2003 was 142.
WHITEHALL JEWELLERS, INC.
INDEX TO FORM 10-Q
FOR THE QUARTER ENDED OCTOBER 31, 2003
PART 1 - FINANCIAL INFORMATION
Item 1. Financial Statements
Statements of Operations for the three months and nine months ended
October 31, 2003 and 2002 (unaudited)
Balance Sheets - October 31, 2003, January 31, 2003 and October 31,
2002 (unaudited)
Statements of Cash Flows for the nine months ended October 31, 2003
and 2002(unaudited)
Notes to Financial Statements
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Item 4. Controls and Procedures
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
Item 5. Other Information
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
(b) Reports on Form 8-K
2
PART 1 - FINANCIAL INFORMATION
Item 1. Financial Statements
Whitehall Jewellers, Inc.
Statements of Operations
for the three months and nine months ended October 31, 2003 and 2002
(unaudited, in thousands, except for per share data)
Three months ended Nine months ended
October October
31, 2002 31, 2002
October (Restated October (Restated
31, 2003 - Note 12) 31, 2003 - Note 12)
-------- ---------- -------- -----------
Net sales $ 66,179 $ 61,831 $208,060 $212,662
Cost of sales (including buying
and occupancy expenses) 45,299 43,069 139,877 140,361
-------- -------- -------- --------
Gross profit 20,880 18,762 68,183 72,301
Selling, general and
administrative expenses 30,541 25,553 84,534 76,431
-------- -------- -------- --------
Loss from operations (9,661) (6,791) (16,351) (4,130)
Interest expense 869 1,168 3,341 3,291
-------- -------- -------- --------
Loss before income taxes (10,530) (7,959) (19,692) (7,421)
Income tax benefit (3,122) (2,849) (6,694) (2,658)
-------- -------- -------- --------
Net loss $ (7,408) $(5,110) $ (12,998) $(4,763)
======== ======== ======== ========
Basic earnings per share:
Net loss $ (0.53) $ (0.35) $ (0.92) $ (0.33)
======== ======== ======== ========
Weighted average common share
and common share equivalents 14,051 14,475 14,156 14,637
======== ======== ======== ========
Diluted earnings per share:
Net loss $ (0.53) $ (0.35) $ (0.92) $ (0.33)
======== ======== ======== ========
Weighted average common share
and common share equivalents 14,051 14,475 14,156 14,637
======== ======== ======== ========
The accompanying notes are an integral part of the financial statements.
3
Whitehall Jewellers, Inc.
Balance Sheets
(unaudited, in thousands except for share data)
January 31, October
2003 31, 2002
October 31, (Restated (Restated
2003 - Note 12) - Note 12)
----------- --------- ----------
ASSETS
Current Assets:
Cash $ 1,251 $ 2,048 $ 1,917
Accounts receivable, net 497 1,621 1,596
Merchandise inventories 229,393 196,694 219,186
Other current assets 1,558 1,470 1,552
Current income tax benefit 7,122 --- 3,649
Deferred financing costs 261 510 510
Deferred income taxes, net 2,577 2,627 2,674
--------- --------- --------
Total current assets 242,659 204,970 231,084
Property and equipment, net 62,002 61,634 62,686
Goodwill 5,662 5,662 5,662
Deferred financing costs 683 213 341
--------- --------- --------
Total assets $311,006 $ 272,479 $299,773
======== ========= ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Revolver loan $107,104 $ 94,490 $ 98,404
Current portion of long-term debt 640 4,500 6,000
Accounts payable 71,169 26,784 63,624
Customer deposits 4,771 3,454 3,789
Accrued payroll 4,778 3,282 4,099
Income taxes payable --- 3,303 ---
Other accrued expenses 14,236 11,380 12,370
-------- -------- --------
Total current liabilities 202,698 147,193 188,286
Long-term debt --- 640 640
Deferred income taxes, net 3,442 3,607 2,191
Other long-term liabilities 3,446 3,138 3,018
--------- --------- --------
Total liabilities 209,586 154,578 194,135
-------- -------- --------
Commitments and contingencies
Stockholders' equity:
Common stock 18 18 18
Class B common stock --- --- ---
Additional paid-in capital 106,041 105,795 105,635
Accumulated earnings 35,027 48,025 33,568
-------- -------- --------
141,086 153,838 139,221
-------- -------- --------
Less:
Treasury stock, at cost (4,135,626,
3,822,637 and 3,629,148 shares,
respectively) (39,666) (35,937) (33,583)
-------- -------- --------
Total stockholders' equity, net 101,420 117,901 105,638
-------- -------- --------
Total liabilities and
stockholders' equity $311,006 $272,479 $299,773
======== ======== ========
The accompanying notes are an integral part of the financial statements.
4
Whitehall Jewellers, Inc.
Statements of Cash Flows
for the nine months ended October 31, 2003 and 2002
(unaudited, in thousands)
Nine months ended
-----------------
October 31,
2002
October 31, (Restated
2003 - Note 12)
----------- -----------
Cash flows from operating activities:
Net loss $ (12,998) $(4,763)
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities:
Depreciation and amortization 8,981 8,342
Loss on disposition of assets 549 120
Write-off of deferred loan cost 516 ---
Changes in assets and liabilities:
Decrease(increase)in accounts receivable, net 1,124 (407)
(Increase) in merchandise inventories, net of (32,699) (25,635)
gold consignment
(Increase) in other current assets (88) (579)
(Increase) in current income tax benefit (7,122) (3,680)
(Decrease) increase in deferred income taxes (115) 534
Increase (decrease) in customer deposits 1,317 (174)
Increase in accounts payable 42,784 7,688
(Decrease) in income taxes payable (3,303) (3,226)
Increase (decrease) in accrued payroll 1,496 (2,171)
Increase (decrease) in accrued liabilities 2,856 (5,799)
Increase in other long-term liabilities 308 358
-------- --------
Net cash provided by (used in) operating 3,606 (29,392)
activities
Cash flows from investing activities:
Capital expenditures (9,492) (6,851)
-------- --------
Net cash used in investing activities (9,492) (6,851)
Cash flows from financing activities:
Borrowing on revolver loan 689,317 696,648
Repayment of revolver loan (676,703) (633,521)
Repayment of term loan (4,500) (3,750)
Purchase of consigned gold --- (20,453)
Purchase of treasury stock (3,832) (4,194)
Proceeds from exercise of stock options 259 1,410
Proceeds under employee stock purchase plan 63 40
Financing costs (1,117) ---
Increase(decrease) in outstanding checks, net 1,602 (761)
-------- --------
Net cash provided by financing activities 5,089 35,419
-------- --------
Net change in cash and cash equivalents (797) (824)
Cash and cash equivalents at beginning of period 2,048 2,741
-------- --------
Cash and cash equivalents at end of period $ 1,251 $ 1,917
======== ========
The accompanying notes are an integral part of the financial statements.
5
Whitehall Jewellers, Inc.
Notes to Financial Statements
1. DESCRIPTION OF OPERATIONS
The financial statements of Whitehall Jewellers, Inc. (the "Company")
include the results of the Company's chain of specialty retail fine jewelry
stores. The Company operates exclusively in one business segment, specialty
retail jewelry. The Company has a national presence with 384 stores as of
October 31, 2003, located in 38 states, operating in regional or superregional
shopping malls. The consolidated financial statements include the accounts and
transactions of the Company and its subsidiaries. Intercompany accounts and
transactions have been eliminated.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis for Presentation
The accompanying unaudited financial statements have been prepared in
accordance with Rule 10-01 of Regulation S-X. Consequently, they do not include
all of the disclosures required under generally accepted accounting principles
for complete financial statements. The interim financial statements reflect all
adjustments (consisting only of normal recurring accruals) which are, in the
opinion of management, necessary for a fair presentation of financial position,
results of operations and cash flows for the interim periods presented. In the
current period, the Company has incurred professional fees associated with the
contingencies described in Note 10 of the financial statements, which have been
expensed as the service is incurred. For further information regarding the
Company's accounting policies, refer to the financial statements and footnotes
thereto included in the Whitehall Jewellers, Inc. Annual Report on Form 10-K/A
for the fiscal year ended January 31, 2003, to be filed as soon as practicable.
References in the following notes to years and quarters are references to fiscal
years and fiscal quarters.
Merchandise Inventories
Merchandise inventories are stated principally at the lower of weighted
average cost or market. Purchase cost is reduced to reflect certain allowances
and discounts received from merchandise vendors. Periodic credits or payments
from merchandise vendors in the form of buydowns, volume or other purchase
discounts and other vendor consideration are reflected in the carrying value of
the inventory and recognized as a component of cost of sales as the merchandise
is sold. Additionally, to the extent it is not addressed by established vendor
return privileges, and if the amount of cash consideration received from the
vendor exceeds the estimated fair value of the goods returned, that excess
amount is reflected as a reduction in the purchase cost of the inventory
acquired.
To the extent the Company's agreements with merchandise vendors provide
credits for co-op advertising, the Company has historically classified such
credits as a reduction to advertising expense in selling, general and
administrative expenses. Emerging Issues Task Force Issue No. 02-16, "Accounting
by a Customer (Including a Reseller) for Certain Consideration Received from a
Vendor" ("EITF 02-16"), which was effective for all arrangements entered into
after December 31, 2002, requires certain merchandise vendor allowances to be
classified as a reduction to inventory cost unless evidence exists supporting an
alternative classification. The Company has recorded such merchandise vendor
allowances as a reduction of inventory cost. The total amount of these
6
allowances and other vendor consideration as of October 31, 2003, January 31,
2003 and October 31, 2002 was approximately $3,327,000, $3,254,000 and
$2,054,000, respectively.
The Company also obtains merchandise from vendors under various
consignment agreements. The consigned inventory and related contingent
obligations associated with holding and safekeeping such consigned inventory are
not reflected in the Company's financial statements. At the time of sale of
consigned merchandise to customers, the Company records the purchase liability
and the related consignor cost of such merchandise in cost of sales.
Goodwill
Goodwill represents the excess of cost over the fair value of assets
acquired in purchase business combinations. Under the Financial Accounting
Standards Board Statement No. 142 ("SFAS 142"), "Goodwill and Other Intangible
Assets," goodwill and indefinite lived intangible assets are reviewed at least
annually (or more frequently if impairment indicators arise) for impairment. The
Company adopted SFAS 142 on February 1, 2002 and has discontinued the
amortization of goodwill. The Company reviewed goodwill for impairment as of
October 31, 2003 and determined that no impairment existed.
Income Taxes
Due to the seasonal nature of the business, the Company tends to generate
a significant portion of its income in the fourth quarter. However, significant
professional fees are being incurred with respect to the contingencies described
in Note 10 of the financial statements which will continue into the fourth
quarter. While the 34.0% effective tax rate currently estimated for the year is
management's best estimate, to the extent that income is significantly more or
less than expected, the Company's effective income tax rate for the fourth
quarter and the full year could vary significantly from that of the previous
quarters. The effective rate of 29.6% for the three months ended October 31,
2003 is the result of reducing the estimated annual effective rate from 39.0% to
34.0% in the third quarter. In addition, the Company tends to generate tax
benefits in early quarters, which are expected to be realized in later quarters
or through carry back to prior fiscal years.
Stock-Based Compensation
The Financial Accounting Standards Board issued Statement No. 148 ("SFAS
148"), "Accounting for Stock-Based Compensation-Transition and Disclosure,"
during 2002. SFAS 148 amends Statement No. 123 ("SFAS 123"), "Accounting for
Stock-Based Compensation," to provide alternative methods of transition for a
voluntary change to the fair value based method of accounting for stock-based
employee compensation and amends the disclosure requirements to require
prominent disclosures in both annual and interim financial statements about the
method of accounting for stock-based employee compensation and the effect of the
method used on reported results. The Company adopted the disclosure requirements
of SFAS 148 as of January 31, 2003.
The Company accounts for stock-based compensation according to Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees,"
which results in no charge to earnings when options are issued at fair market
value.
7
The following table illustrates the effect on net income and earnings per
share for the three and nine months ended October 31, 2003 and 2002, if the
Company had applied the fair value recognition provisions of SFAS 123, as
amended by SFAS 148, to stock-based employee compensation.
Three months ended Nine months ended
October 31, October 31,
2002 2002
October 31, (Restated October 31, (Restated
2003 - Note 12) 2003 - Note 12)
------------------------------------------------------------
(in thousands, except for per share amounts)
------------------------------------------------------------
Net loss, as reported $ (7,408) $ (5,110) $ (12,998) $ (4,763)
Deduct: Total
stock-based employee
compensation expense 306 508 863 1,586
determined under fair
value based method,
net of related tax
effects
------------------------ ------------------------
Pro forma net loss $ (7,714) $ (5,618) $ (13,861) $ (6,349)
======================== ========================
Earnings per share:
Basic-as reported $ (0.53) $ (0.35) $ (0.92) $ (0.33)
======================== ========================
Basic-pro forma $ (0.55) $ (0.39) $ (0.98) $ (0.43)
======================== ========================
Diluted-as reported $ (0.53) $ (0.35) $ (0.92) $ (0.33)
======================== ========================
Diluted-pro forma $ (0.55) $ (0.39) $ (0.98) $ (0.43)
======================== ========================
For purposes of pro forma net income and earnings per share calculation in
accordance with SFAS 123, the fair value of each option granted during the three
and nine months ended October 31, 2003 and 2002 is estimated using the
Black-Scholes option-pricing model. The assumptions used are as follows:
For the three months ended For the nine months ended
October 31, October 31, October 31, October 31,
2003 2002 2003 2002
------------------------------------------------------------
Risk-free interest 3.6% 3.7% 3.1% 4.6%
rate
Dividend yield 0 0 0 0
Option life 5.5 years 5.5 years 5.5 years 5.5 years
Volatility 59% 62% 60% 62%
Accounting for Costs Associated with Exit or Disposal Activities
In June 2002, the Financial Accounting Standards Board issued Statement
No. 146 ("SFAS 146"), "Accounting for Costs Associated with Exit or Disposal
Activities." SFAS 146 requires that costs associated with disposal or exit
activities after December 31, 2002 be recorded at fair value in the period the
liability is incurred. The Company adopted SFAS 146 effective January 1, 2003.
During the three months ended October 31, 2003, the Company closed one
store resulting in a charge of $10,000 related to closing costs. In addition,
the Company recorded $130,000 of accelerated depreciation expense in connection
with this store closing.
During the nine months ended October 31, 2003, the Company closed 7 stores
resulting in a charge of $34,000 related to closing costs, net of reversal of
$225,000 in prior period accruals for store closing costs and minimum rent. In
addition, the Company recorded $504,000 of accelerated depreciation expense in
connection with these store closings.
8
In the normal course of business, the Company closes stores. To the extent
such closings are not located in the same general geographic area of existing
store sites, discontinued operations disclosure would be presented if material
to the financial statement presentation.
Accounting for Guarantees
In November 2002, the Financial Accounting Standards Board issued FASB
Interpretation No. 45 ("FIN 45"), "Guarantor's Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of
Others," an interpretation of FASB Statements No. 5, 57 and 107 and rescission
of FASB Interpretation No. 34. The Company has adopted the guidance of FIN 45
and has reflected the required disclosures in its financial statements
commencing with the financials statements for the year ended January 31, 2003.
Under its bylaws, the Company has agreed to indemnify its officers and
directors for certain events or occurrences while the officer or director is, or
was serving, at its request in such capacity. The maximum potential amount of
future payments the Company could be required to make pursuant to these
indemnification obligations is unlimited; however, the Company has a directors
and officers liability insurance policy that, under certain circumstances,
enables it to recover a portion of any future amounts paid. As a result of its
insurance coverage, the Company believes the estimated fair value of these
indemnification obligations is minimal. The Company has no liabilities recorded
for these obligations as of October 31, 2003.
3. ACCOUNTS RECEIVABLE, NET
As of October 31, 2003, January 31, 2003 and October 31, 2002, accounts
receivable consisted of:
October 31, January 31, October 31,
2003 2003 2002
----------- ----------- -----------
(in thousands)
Accounts receivable $1,006 $2,165 $2,043
Less: allowance for
doubtful accounts (509) (544) (447)
------ ------ ------
Accounts receivable, net $ 497 $1,621 $1,596
====== ====== ======
9
4. INVENTORY
As of October 31, 2003, January 31, 2003 and October 31, 2002, merchandise
inventories consisted of:
January 31, October 31,
2003 2002
October 31, (Restated (Restated
2003 - Note 12) - Note 12)
----------- -------------- -----------
(in thousands)
Raw materials $ 9,070 $ 7,657 $ 7,483
Finished goods 220,323 189,037 211,703
-------- -------- --------
Merchandise inventories $229,393 $196,694 $219,186
======== ======== ========
Raw materials primarily consist of diamonds, precious gems, semi-precious
gems and gold. Included within finished goods inventory are allowances for
inventory shrink and scrap costs of $3,457,000, $3,567,000, and $4,313,000 as of
October 31, 2003, January 31, 2003 and October 31, 2002, respectively. As of
October 31, 2003, January 31, 2003 and October 31, 2002, consignment inventories
held by the Company that were not included in the balance sheets total
$90,765,000, $74,924,000, and $76,099,000, respectively.
In addition, gold consignments are not included in the Company's balance
sheet (see Note 6, Financing Arrangements) as the title to such gold passes to
the consignor and is subject to the same risk of physical loss as other
inventory held on consignment by the Company. On August 22, 2002, the Company
purchased 66,500 troy ounces of gold at an average gold price of $307.56 per
ounce for a total of approximately $20.5 million. The Company delivered the gold
to its banks and extinguished all existing Company gold consignment obligations
to the banks under the Credit Agreement (see Note 6). The purchase had the
effect of increasing the weighted average cost of gold available for retail sale
by the Company and resulted in a higher weighted average cost of sales in
subsequent periods. The Company estimated subsequent cost of sales as a result
of this transaction to be approximately $1.5 million greater based on the effect
of the transaction on the weighted average cost of gold product in its inventory
prior to this purchase. Approximately $236,000 and $798,000 of this increase in
cost of sales is reflected in the three and nine months ended October 31, 2003,
respectively, and approximately $236,000 is reflected in cost of sales for both
the three and nine months ended October 31, 2002. This purchase increased the
Company's inventory by $20.5 million and was funded by revolver loan borrowings.
The total amount available to borrow under the Company's Credit Agreement is
unchanged.
Certain merchandise procurement, distribution and warehousing costs were
allocated to inventory. As of October 31, 2003, January 31, 2003 and October 31,
2002, the amounts included in inventory were $3,831,000, $3,364,000 and
$3,567,000, respectively.
5. ACCOUNTS PAYABLE
Accounts payable includes outstanding checks, which were $8,114,000,
$6,512,000 and $6,379,000 as of October 31, 2003, January 31, 2003 and October
31, 2002, respectively.
10
6. FINANCING ARRANGEMENTS
Effective July 29, 2003, the Company entered into a Second Amended and
Restated Revolving Credit, Term Loan and Gold Consignment Agreement (the "Credit
Agreement") with certain members of its prior bank group which provides for a
total facility of up to $125.0 million through July 28, 2007. Interest rates and
the commitment fee charged on the unused portion of the facility float based
upon the Company's financial performance as calculated quarterly.
Under this Credit Agreement, the banks have a collateral security interest
in substantially all of the assets of the Company. The Credit Agreement contains
certain restrictions, including restrictions on investments, payment of
dividends, assumption of additional debt, acquisitions and divestitures. The
Credit Agreement also requires the Company to maintain a specified ratio of the
sum of earnings before interest, taxes, depreciation and amortization plus
minimum store rent to the sum of minimum store rent plus cash interest expense
if the Company's borrowing base availability drops below a certain level. As of
October 31, 2003, the calculated revolver availability, pursuant to the Credit
Agreement, exceeded the maximum availability of $125.0 million. The Company had
$107.1 million of outstanding borrowings under the revolving loan facility as of
October 31, 2003.
On October 29, 2003, the Company entered into a letter agreement with its
lenders which clarified and supplements the existing provisions of the Company's
Credit Agreement with respect to the consolidated Capital Factors actions, the
Securities and Exchange Commission (the "SEC") investigation and the
investigation by the United States Attorney described in Note 10 to the
financial statements. Pursuant to the letter agreement, the lenders under the
Credit Agreement have reserved their rights to determine that the consolidated
Capital Factors actions, the SEC investigation or the United States Attorney's
investigation constitutes a breach of the Credit Agreement. If the required
lenders were to make such a determination, they would have the right to declare
an event of default and cease funding under the revolving loan facility, under
the Credit Agreement, among other things. If the existing lenders were to cease
funding under the revolving loan facility the Company would be required to seek
new financing. There is no assurance that such financing would be available on
acceptable terms or at all. If the existing lenders were to cease funding under
the revolving loan facility and if the Company were not able to arrange new
financing on acceptable terms, this would have a material adverse effect on the
Company, as described in Note 10 of the financial statements.
On December 15, 2003, the Company entered into a second letter agreement
with respect to the Credit Agreement, pursuant to which the lenders have
extended the date by which the Company is required to deliver its financial
statements for the third quarter of fiscal 2003 from December 15, 2003 to
December 31, 2003. In addition, as scheduled under the terms of the original
Credit Agreement, the interest rate at which London Interbank Offered Rate
("LIBOR") based borrowings are available under the Credit Agreement increased
from LIBOR plus 1.5% to LIBOR plus 2.0% as of December 15, 2003. Also, the
Company has agreed to provide a semi-monthly borrowing base certificate.
Revolver Loan
The revolving loan facility under the Credit Agreement is available up to
a maximum of $125.0 million, including amounts consigned under the gold
consignment facility, and is limited by a borrowing base computed based on the
value of the Company's inventory and accounts receivables. Availability under
the revolver is based on amounts outstanding thereunder, including the value of
consigned gold, which fluctuates based on gold prices. Interest rates and
11
commitment fees on the unused facility float based on the Company's quarterly
financial performance.
The interest rates for borrowings under the Credit Agreement are, at the
Company's option, based on LIBOR rates or the banks' prime rate. Interest is
payable monthly for prime borrowings and upon maturity for LIBOR borrowings.
Gold Consignment Facility
The Company has the opportunity to enter into gold consignments with
certain third party financial institutions. At this time the Company has no
obligations under the gold consignment facility. In the event of a consignment
of gold, the Company provides the third party financial institution with title
to a certain number of troy ounces of gold held in the Company's existing
merchandise inventory in exchange for cash at the current market price of gold.
The Company then consigns the gold from the third party financial institution,
pursuant to a gold consignment agreement. This agreement entitles the Company to
use the gold in the ordinary course of its business. The gold consignment
facility is a transfer of title in specified quantities of the gold content of
the Company's inventory (a non-financial asset) to a financial institution in
exchange for cash. The Company continues to bear responsibility for damage to
the inventory, as is the case in all of its consigned inventory arrangements
with its other vendors.
The Company has accounted for gold consignment transactions as a reduction
in its inventories, as it has transferred title to the gold to the financial
institution. Similar to other consigned inventories in the possession of the
Company (for which the Company bears risk of loss but does not possess title),
the value of the inventory is not included in the assets of the Company. The
terms of the gold consignment agreement require the Company to deliver the
specified quantities of consigned gold back to the third party financial
institution at the end of the facility (which currently expires in 2007).
Physical delivery can be made from the Company's inventory or from gold acquired
by the Company in the open market. As an alternative to physical delivery of
these specific troy ounces of gold, the Company can elect to purchase the
consigned quantities at the current market price for gold on that date.
Beginning August 23, 2002, the Company had no obligations under the gold
consignment facility. The facility provides for the sale of a maximum 115,000
troy ounces or $40.0 million. Under the agreement, the Company pays consignment
fees based on the LIBOR payable monthly. Consignment rates and commitment fees
on the unused portion of the gold consignment facility float based upon the
Company's quarterly financial performance. On August 22, 2002, the Company
purchased 66,500 troy ounces of gold at an average gold price of $307.56 per
ounce for a total of $20.5 million. The Company delivered gold to its banks and
extinguished all of the Company's existing gold obligations under the Credit
Agreement.
7. DEFERRED FINANCING COSTS
In conjunction with the Company's refinancing of its prior credit
agreement with certain members of its prior bank group, deferred financing costs
of $516,000 related to the prior credit facility were written off and included
in interest expense in the second quarter of fiscal 2003. Costs associated with
the second amended and restated credit facility totaling approximately $1.0
million are being amortized over the term of the Credit Agreement.
12
8. DILUTIVE SHARES THAT WERE OUTSTANDING DURING THE PERIOD
The following table summarizes the reconciliation of the numerators and
denominators for the basic and diluted EPS computations at October 31, 2003 and
2002.
Three months ended Nine Months Ended
October 31, October 31,
2002 2002
October 31, (Restated- October 31, (Restated-
2003 Note 12) 2003 Note 12)
------------- ------------ ------------- -----------
(in thousands)
Net loss $ (7,408) $ (5,110) $ (12,998) $ (4,763)
Weighted average
shares for basic EPS 14,051 14,475 14,156 14,637
Incremental shares upon
conversions:
Stock options --- --- --- ---
Weighted average
shares for diluted EPS 14,051 14,475 14,156 14,637
Stock options excluded
from the calculation
of diluted earnings
per share due to their 2,951 2,818 2,960 2,853
antidilutive effect on
the calculations
9. RECLASSIFICATIONS
Certain Balance Sheet amounts from prior periods were reclassified to
conform to the current year presentation. These reclassifications had no impact
on earnings.
10. COMMITMENTS AND CONTINGENCIES
The Company entered into a three-year purchase agreement with one of its
merchandise inventory vendors in February 2003. Under the terms of the
agreement, the Company is committed to future minimum purchases of $16,000,000
in 2003, and $8,000,000 for each of the next two calendar years but only to the
extent the Company returns and the vendor accepts merchandise inventory from the
Company in specified proportions to the purchase commitment. In exchange for
this purchase agreement, the vendor agreed to accept from the Company $5,000,000
of merchandise inventory, some of which was damaged. As of October 31, 2003, the
Company had purchased approximately $9,950,000 and returned approximately
$3,140,000 of merchandise inventory under this agreement.
The Company entered into a purchase agreement with one of its other
merchandise inventory vendors in October 2003. Under the terms of this
agreement, the Company is committed to future minimum purchases of $2,377,500
through September 2004. The Company has the right to return to the vendor an
amount of inventory equal up to fifty percent of the inventory purchased under
this agreement. As of October 31, 2003, the Company had not made any inventory
purchases or returns under this agreement.
On July 25, 2002, the Company was named a defendant in a wage hour class
action suit filed in California by three former store managers. The case was
based principally upon the allegation that store managers employed by the
Company in California should have been classified as non-exempt for overtime
purposes. In April 2003, the parties reached a preliminary agreement to settle
the matter resulting in a pre-tax charge of $1,000,000, inclusive of the
13
plaintiffs' attorneys' fees, interest, penalties, administrative costs and other
Company costs. This settlement covers the period from July 25, 1998 through the
date of final settlement approval by the court. The court granted final approval
to the settlement on December 11, 2003.
The Company was named a defendant in a wage hour suit filed in California
by a former employee on May 6, 2003. The case was based principally upon the
allegation that the amount of overtime paid to certain California employees was
less than the amount actually earned. The suit asserts a claim for $1,000,000.
The parties have reached a settlement of the suit for an amount that is not
significant in relation to the Company's financial statements.
The Company has been named as one of 14 defendants in a lawsuit originally
filed in the United States District Court for the Southern District of New York,
now pending in New York State Supreme Court, Commercial Division. The case is
brought by Capital Factors, Inc. ("Capital Factors"), which provided financing
to defendant Cosmopolitan Gem Corp. ("Cosmopolitan"), an entity with which the
Company has certain consignment and other commercial arrangements. The complaint
alleges that Cosmopolitan defrauded Capital Factors into advancing funds to
Cosmopolitan by misrepresenting Cosmopolitan's finances and the profitability of
its operations, and that the Company, along with other persons and entities,
including other jewelry retailers, aided and abetted or participated in the
alleged fraud. The complaint asserts against the defendants, including the
Company, claims under common law and the Racketeer Influenced and Corrupt
Organizations Act ("RICO"). Capital Factors seeks aggregate damages from all of
the defendants, including the Company, of $30,000,000, plus unspecified punitive
damages, interest and fees. Damages, excluding punitive damages, awarded
pursuant to claims asserted under RICO as well as interest on such damages are
subject to trebling, within the discretion of the court.
The Company has also been named as one of 13 defendants in an amended
complaint filed on December 2, 2003 by International Diamonds, L.L.C.
("International") and its affiliate, Astra Diamonds Manufacturers, Ltd.
("Astra"). Astra is an Israeli diamond wholesaler that supplied diamonds to
Cosmopolitan; International is a joint venture formed by Cosmopolitan and Astra
to sell high quality finished diamond jewelry in the United States. The amended
complaint, consolidated with the Capital Factors action described above (the
"consolidated Capital Factors actions"), alleges that the Company, along with
other jewelry retailers and business affiliates of Cosmopolitan, participated in
Cosmopolitan's fraudulent scheme to defraud Capital Factors, and thus injured
International and Astra. The complaint asserts claims under common law and RICO,
seeking aggregate damages from all of the defendants, including the Company, of
$6,800,000 plus interest and fees. Damages awarded pursuant to claims under RICO
as well as interest on such damages are subject to trebling, within the
discretion of the court. In addition, the complaint alleges claims against the
Company for breach of contract for approximately $2,520,000 in goods delivered
and invoiced to the Company, for which International has not received payment.
In connection with the consolidated Capital Factors actions in New York
state court, the Company has filed an interpleader action for declaratory
relief, asking the Court to determine the proper parties to whom the Company
must pay amounts and deliver goods that are not in dispute related to goods
received from Cosmopolitan and certain other entities. In its answer to the
interpleader, Capital Factors has asserted that Whitehall owes Cosmopolitan
$8,600,000 in accounts receivable on invoices assigned to Capital Factors. This
amount may be included in the $30,000,000 of losses that Capital Factors seeks
in its RICO claims, although the Company is not certain at this time. The
Company is not currently aware of any accounts payable due and owing to
14
any of the claimants in this action that are not already reflected in the
Company's accounts payable and accrued liabilities.
In these consolidated Capital Factors actions, discovery has just begun,
few documents have been exchanged, no depositions have been taken, and the
Company has not answered either the Capital Factors complaint or the amended
International complaint. The Company intends to defend these lawsuits
vigorously.
The United States Attorney for the Eastern District of New York is
conducting a criminal investigation regarding matters that include those alleged
in the consolidated Capital Factors actions. The Company, among others, is a
subject of such criminal investigation and is cooperating fully with the United
States Attorney.
In addition, subsequent to the filing of the complaint by Capital Factors
and as previously disclosed, the SEC initiated an informal inquiry into matters
that are the subject of the consolidated Capital Factors actions. On November 3,
2003, the Company received a subpoena issued by the SEC as a part of a formal
investigation by the SEC with respect to such matters. In connection with this
formal investigation, the SEC has requested that the Company produce certain
additional documents relating to the matters that are the subject of the
consolidated Capital Factors actions. The Company is cooperating fully with the
SEC in connection with this formal investigation.
As previously announced, the Company is conducting an internal
investigation in connection with the consolidated Capital Factors actions and
the related investigations by the United States Attorney for the Eastern
District of New York and the SEC. As a result of this internal investigation, as
previously announced, the Company terminated the employment of its Chief
Financial Officer who had been on leave.
Because these matters are still in their early stages, the Company is
unable at this time to predict the outcome of this contingency or the potential
exposure associated with the consolidated Capital Factors actions or the United
States Attorney and SEC investigations or to estimate the impact of this
reasonably possible contingent liability on the Company's results of operations,
financial condition or liquidity. Given the amounts sought in the consolidated
Capital Factors actions, and the inherent unpredictability of litigation, an
adverse outcome in these actions could have a material adverse effect on the
Company's results of operations, financial condition or liquidity, as further
described below. Direct costs of approximately $0.7 million incurred as a result
of the consolidated Capital Factors actions, the United States Attorney and SEC
investigations, and the Company's internal investigation, have been expensed
through October 31, 2003.
On October 29, 2003, the Company entered into a letter agreement with its
lenders which clarified and supplements the existing provisions of the Credit
Agreement with respect to the consolidated Capital Factors actions, the SEC
investigation and the investigation by the United States Attorney. Pursuant to
the letter agreement, the lenders under the Credit Agreement have reserved their
rights to determine that the consolidated Capital Factors actions, the SEC
inquiry or the United States Attorney's investigation constitutes a breach of
the Credit Agreement. If the required lenders were to make such a determination,
they would have the right to declare an event of default and cease funding under
the revolving loan facility under the Credit Agreement, among other things. If
the existing lenders were to cease funding under the revolving loan facility,
the Company would be required to seek new financing. There is no assurance that
new financing would be available on acceptable terms or at all. If the existing
lenders were to cease funding under the revolving loan facility and if the
15
Company were not able to arrange new financing on acceptable terms, this would
have a material adverse effect on the Company, which could affect the underlying
valuation of assets and liabilities. The accompanying financial statements have
been prepared assuming that the Company will continue as a going concern and do
not include any adjustments that might result from the occurrence of the
previously mentioned uncertainties.
In the course of the Company's internal investigation, as previously
announced, the Company discovered that its Executive Vice President,
Merchandising, violated a Company policy with respect to Company documentation
regarding the age of certain store inventory. Following that discovery, the
Company placed the executive on leave pending further investigation. Since then,
the Company discovered additional irregularities with respect to the
classification of inventory for the year ending January 31, 2001 and for the
quarter ending April 30, 2001, and for certain prior periods. These
irregularities resulted in inventory and accounts payable being equally
understated by approximately $6,300,000 for the period ending January 31, 2001
and approximately $2,500,000 for the period ending April 30, 2001. Such
irregularities had no effect on the Company's balance sheet for any subsequent
periods, including the years ending January 31, 2002 and January 31, 2003. The
matters referred to above did not have any income statement effects. As a result
of these matters, the Company terminated the employment of its Executive Vice
President, Merchandising.
The Company is subject to other claims and litigation in the normal course
of business. It is the opinion of management that additional liabilities, if
any, resulting from these other claims and litigation are not expected to have a
material adverse effect on the Company's financial condition or results of
operations.
11. RELATED PARTY TRANSACTIONS
The Company operates a program under which executive officers and
directors are permitted to purchase most Company merchandise at approximately
ten percent above the Company's cost. For the first nine months of fiscal 2003,
such purchases by executive officers and directors totaled approximately
$150,000.
12. PRIOR PERIOD RESTATEMENTS
In December 2003, the Company restated previously issued financial
statements to record adjustments resulting from various accounting matters
described below. The Company restated financial statements for the three-month
periods ended April 30, 2003 and 2002, the three and six month periods ended
July 31, 2003 and 2002 and the three-month and nine-month period ended October
31, 2002. The impact of these restatements on net income has also been disclosed
on Form 8-K filed with the SEC on December 22, 2003, which also includes the
three previous years ended January 31, 2003.
Adjustments to restate the financial statements are summarized into the
following four categories:
A. Merchandise inventory valuation adjustments
16
In prior periods, the Company entered into certain contemporaneous
agreements to both purchase merchandise inventory and return substandard
merchandise inventory to vendors, outside of the normal contractual return
privileges. Additionally, in fiscal 2001, the Company entered into a
barter arrangement for approximately $250,000 of merchandise inventory
that involved the exchange of merchandise inventory for barter credits.
These arrangements involved receiving vendor allowances at an amount
greater than the merchandise inventory fair market value in exchange for
purchases of merchandise inventory at a date in the future. The company
has restated the financial statements to write-down the substandard
merchandise inventory to fair market value and record the consideration
received in excess of the fair market value of the substandard inventory
as a vendor allowance, which benefits cost of sales in the inventory
turn-over period.
In periods prior to February 1, 2000, the Company had written down
substandard inventory to fair market value and did not exchange such
inventory with vendors.
B. Software development costs and amortization
The financial statements have been restated to capitalize certain costs
associated with software development that were expensed in the six-months
ended July 31, 2003, in accordance with Statement of Position 98-1
"Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use". In addition, the Company amortized certain capitalized
software development costs prior to the project being placed in service
and has reversed such amortization in the restated financial statements.
C. Vendor advertising/promotion credits
Certain vendor consideration, primarily related to co-op advertising and
program sponsorships, was received in the six-months ended July 31, 2003,
which should have reduced the carrying value of merchandise inventory in
accordance with EITF 02-16. The adjustments reflected in the Statement of
Operations relate to reversing the reimbursements received and recording
the benefit as an adjustment of the inventory carrying value which
benefits cost of sales in the inventory turnover period.
D. Tax effect of the adjustments
As a result of the restatement adjustments, income tax provisions were
revised in the Statement of Operations.
17
The following tables set forth the effects of the restatement adjustments
discussed above on the restated components of the Statement of Operations
for the three-month interim periods ended April 30, 2003 and 2002, the
three-month and six-month interim periods ended July 31, 2003 and 2002 and
the three-month and nine-month interim periods ended October 31, 2002
(unaudited, in thousands, except per share data):
Three months ended Three months ended
April 30, 2003 April 30, 2002
As previously As previously
reported Restated reported Restated
----------- -------- ----------- --------
Cost of sales (including buying $ 46,052 $ 46,038 $ 47,376 $ 47,494
and occupancy expenses)
Gross profit 23,097 23,111 27,212 27,094
Selling, general and
administrative expenses 26,692 26,770 25,627 25,627
Income (loss) from operations (3,595) (3,659) 1,585 1,467
Income (loss) before income taxes (4,503) (4,567) 573 455
Income tax expense (benefit) (1,755) (1,780) 204 162
Net income (loss) (2,748) (2,787) 369 293
Earnings per share:
Basic $ (0.19) $ (0.20) $0.03 $0.02
Diluted $ (0.19) $ (0.20) $0.02 $0.02
Three months ended Three months ended
July 31, 2003 July 31, 2002
As previously As previously
reported Restated reported Restated
----------- -------- ----------- --------
Cost of sales (including buying $ 48,623 $ 48,540 $ 49,703 $ 49,798
and occupancy expenses)
Gross profit 24,109 24,192 26,540 26,445
Selling, general and
administrative expenses 27,251 27,223 25,251 25,251
Income (loss) from operations (3,142) (3,031) 1,289 1,194
Income (loss) before income taxes (4,706) (4,595) 178 83
Income tax expense (benefit) (1,835) (1,792) 64 29
Net income (loss) (2,871) (2,803) 114 54
Earnings per share:
Basic $ (0.20) $ (0.20) $0.01 $0.00
Diluted $ (0.20) $ (0.20) $0.01 $0.00
Six months ended Six months ended
July 31, 2003 July 31, 2002
As previously As previously
reported Restated reported Restated
----------- -------- ----------- --------
Cost of sales (including buying $ 94,675 $ 94,578 $ 97,079 $ 97,292
and occupancy expenses)
Gross profit 47,206 47,303 53,752 53,539
Selling, general and
administrative expenses 53,943 53,993 50,878 50,878
Income (loss) from operations (6,737) (6,690) 2,874 2,661
Income (loss) before income taxes (9,209) (9,162) 751 538
Income tax expense (benefit) (3,590) (3,572) 268 191
Net income (loss) (5,619) (5,590) 483 347
Earnings per share:
Basic $ (0.40) $ (0.39) $0.03 $0.02
Diluted $ (0.40) $ (0.39) $0.03 $0.02
Three months ended Nine months ended
October 31, 2002 October 31, 2002
As previously As previously
reported Restated reported Restated
----------- -------- ----------- --------
Cost of sales (including $ 42,959 $ 43,069 $140,038 $140,361
buying and occupancy
expenses)
Gross profit 18,872 18,762 72,624 72,301
Selling, general and
administrative expenses 25,553 25,553 76,431 76,431
Loss from operations (6,681) (6,791) (3,807) (4,130)
Loss before income taxes (7,849) (7,959) (7,098) (7,421)
Income tax benefit (2,810) (2,849) (2,542) (2,658)
Net loss (5,039) (5,110) (4,556) (4,763)
Earnings per share:
Basic $ (0.35) $ (0.35) $ (0.31) $ (0.33)
Diluted $ (0.35) $ (0.35) $ (0.31) $ (0.33)
18
The following table sets forth the effects of the restatement adjustments
discussed above on the restated components of the Balance Sheets at January 31,
2003 and October 31, 2002 (unaudited, in thousands):
Balance Sheets
------------------------------------------------------
January 31, 2003 October 31, 2002
As previously As previously
reported Restated reported Restated
----------- -------- ----------- --------
Merchandise inventories $197,859 $196,694 $220,342 $219,186
Current income tax benefit 3,690 3,649
Deferred income taxes, net 2,172 2,627 2,223 2,674
Total current assets 205,680 204,970 231,830 231,084
Total assets 273,189 272,479 300,519 299,773
Income taxes payable 3,261 3,303
Total current liabilities 147,151 147,193
Total liabilities 154,536 154,578
Accumulated earnings 48,777 48,025 34,314 33,568
Total stockholders' equity, net 118,653 117,901 106,384 105,638
Total liabilities and stockholders'
equity 273,189 272,479 300,519 299,773
The balance sheet for the period ended January 31, 2001 and interim period
ended April 31, 2001 will also include restatement entries of approximately $6.3
million and $2.5 million respectively, related to Company merchandise inventory
that was incorrectly recorded as consigned inventory. The restatement entries
will increase inventory and accounts payable by comparable amounts.
The following table sets forth the effects of the restatement adjustments
discussed above on the restated components of the Balance Sheets at April 30,
2001 and January 31, 2001 (unaudited, in thousands).
Balance Sheets
----------------------------------------------------
April 30, 2001 January 31, 2001
------------------------ ------------------------
As previously As previously
reported Restated reported Restated
----------- -------- ----------- --------
Merchandise inventories $186,698 $189,194 $178,053 $184,365
Total current assets 199,308 201,804 186,292 192,604
Total assets 271,490 273,986 255,794 262,106
Accounts payable 51,390 53,886 57,982 64,294
Total current liabilities 158,352 160,848 140,105 146,417
Total liabilities 169,742 172,238 152,623 158,935
Total liabilities and stockholders' equity 271,490 273,986 255,794 262,106
The following table sets forth the effects of the restatement adjustments
discussed above on the Statement of Operations for the three months ended April
30, 2003, the three months ended July 31, 2003 and the six months ended July 31,
2003 (unaudited, in thousands, except per share data):
Three months Three months Six months
ended ended ended
April 30, 2003 July 31, 2003 July 31, 2003
-------------- ------------- -------------
Net loss
As previously reported $ (2,748) $ (2,871) $ (5,619)
Reduced/(additional) expense:
Merchandise inventory
valuation adjustments (4) 6 2
Software development costs
and amortization 27 78 105
Vendor advertising/promotion
credits (87) 27 (60)
Tax effects of items above 25 (43) (14)
-------- -------- --------
As restated $ (2,787) $ (2,803) $ (5,590)
======== ======== ========
Basic loss per share
As previously reported $ (0.19) $ (0.20) $ (0.40)
As restated $ (0.20) $ (0.20) $ (0.39)
Weighted average common
shares 14,206 14,215 14,210
Diluted loss per share
As previously reported $ (0.19) $ (0.20) $ (0.40)
As restated $ (0.20) $ (0.20) $ (0.39)
Weighted average common
shares and common share
equivalents 14,206 14,215 14,210
19
The following table sets forth the effects of the restatement adjustments
discussed above on the Statements of Operations for each of the three months
ended April 30, 2002, July 31, 2002 and October 31, 2002 and the six months
ended July 31, 2002 and the nine months ended October 31, 2002, respectively
(unaudited, in thousands, except per share data):
Three months Six months Three months Nine months
ended ended ended ended
-------------------------------------------------------------
April 30, July 31, July 31, October 31, October 31,
2002 2002 2002 2002 2002
-------------------------------------------------------------
Net income (loss)
As previously reported $ 369 $ 114 $ 483 $(5,039) $(4,556)
Reduced/(additional)
expense:
Merchandise inventory
valuation adjustments (118) (95) (213) (110) (323)
Tax effects of items
above 42 35 77 39 116
------ ------ ------ ------- -------
As restated $ 293 $ 54 $ 347 $(5,110) $(4,763)
====== ====== ====== ======= =======
Basic earnings (loss) per share:
As previously reported $ 0.03 $ 0.01 $ 0.03 $(0.35) $(0.31)
As restated $ 0.02 $ 0.00 $ 0.02 $(0.35) $(0.33)
Weighted average common
shares 14,667 14,807 14,719 14,475 14,637
Diluted earnings (loss) per share:
As previously reported $ 0.02 $ 0.01 $ 0.03 $(0.35) $(0.31)
As restated $ 0.02 $ 0.00 $ 0.02 $(0.35) $(0.33)
Weighted average common
shares and common share
equivalents 15,382 15,594 15,476 14,475 14,637
20
The following table sets forth the effects of the restatement adjustments
discussed above on the Statements of Operations for each of the three years
ended January 31, 2003 (unaudited, in thousands, except per share data):
Statement of Operations for the
Years ended January 31
-------------------------------
2003 2002 2001
-------------------------------
Net income
As previously reported $ 9,907 $10,080 $ 7,306
Reduced/(additional) expense:
Merchandise inventory valuation
adjustments
(332) (653) (180)
Tax adjustments for effects of items
above 119 227 67
------- ------- -------
As restated $ 9,694 $ 9,654 $ 7,193
======= ======= =======
Basic earnings per share:
As previously reported $ 0.68 $ 0.69 $ 0.47
As restated $ 0.67 $ 0.66 $ 0.46
Weighted average common shares
14,545 14,584 15,617
Diluted earnings per share:
As previously reported $ 0.66 $ 0.69 $ 0.46
As restated $ 0.64 $ 0.66 $ 0.45
Weighted average common shares and
common share equivalents
15,038 14,685 15,964
21
PART I - FINANCIAL INFORMATION
Item 2 - Management's Discussion and Analysis of Financial Condition and Results
of Operations
Restatements of Prior Results
In December 2003, the Company determined that it was appropriate to
restate previously issued financial statements to record adjustments resulting
from various accounting matters described in Note 12 to the financial
statements. In connection with the process, the Company restated its financial
statements for the three-month period ended April 30, 2003 and 2002, the three
and six month periods ended July 31, 2003 and the three month and nine-month
period ended October 31, 2002. The Company also reported the net impact of the
restatements on net income for the previously mentioned periods and the three
previous years ended January 31, 2003 on Form 8-K filed with the Securities and
Exchange Commission (the "SEC") on December 22, 2003. Accordingly, the financial
statements included in this section are discussed as adjusted by the restatement
of prior period interim and annual periods. The Company expects to file amended
Form 10-K and Form 10-Q reports with respect to the restatements discussed above
as soon as practicable.
Results of Operations for the Three Months Ended October 31, 2003
Net sales for the third quarter of fiscal 2003 increased $4.4 million, or
7.0%, to $66.2 million from $61.8 million in the third quarter of fiscal 2002.
Comparable store sales increased $2.4 million, or 3.9%, in the third quarter of
fiscal 2003 from the third quarter of fiscal 2002. Additionally, sales from new
stores increased $3.0 million, which were partially offset by a sales decrease
of $1.0 million related to closed stores. The total number of merchandise units
sold increased by approximately 16.4% in the third quarter of fiscal 2003 from
the third quarter of fiscal 2002 while the average price per merchandise sale
declined to $319 in the third quarter of fiscal 2003 from $347 in the third
quarter of fiscal 2002. Marketing promotions run throughout the third quarter
and the expansion of watch lines contributed to the increase in sales. Credit
sales as a percentage of net sales remained about the same in the third quarter
of fiscal 2003 compared to the third quarter of fiscal 2002. The Company opened
two new stores and closed one in the third quarter of fiscal 2003, increasing
the number of stores open to 384 as of October 31, 2003 compared to 375, as of
October 31, 2002.
Gross profit for the third quarter of fiscal 2003 increased $2.1 million,
or 11.3%, to $20.9 million from $18.8 million in the same period in fiscal 2002.
Gross profit as a percentage of net sales increased to 31.6% in the third
quarter of fiscal 2003 from 30.3% in the third quarter of fiscal 2002. Gross
profit rate increased primarily due to lower merchandise inventory cost
associated with higher vendor discounts and allowances as compared to the prior
year period. This increase was somewhat offset by an increased mix of watch
sales which carry a lower margin than certain other merchandise categories, the
increase in the price of gold and the competitive pricing environment.
Selling, general and administrative expenses for the third quarter of
fiscal 2003 increased $4.9 million, or 19.5%, to $30.5 million from $25.6
million in the third quarter of fiscal 2002. As a percentage of net sales,
selling, general and administrative expenses increased to 46.1% in the third
quarter of fiscal 2003 from 41.3% in the third quarter of fiscal 2002. The
dollar increase was primarily related to higher other expense ($2.9 million),
higher personnel expense ($1.3 million) and higher advertising expense ($0.5
million). The increase in other expenses is primarily due to the increase in the
number of stores, increases in professional fees ($0.8 million) primarily
22
associated with the investigations described in Note 10 to the financial
statements, increases in insurance costs ($0.7 million) and increases in
accruals for state and local taxes ($0.6 million). Payroll costs increased
primarily due to the increased number of stores. Advertising expense increased
due to new promotional initiatives in 2003 and the impact of the adoption of
ETIF 02-16 as of the beginning of this fiscal year. Prior to the adoption of
EITF 02-16, management had expected that the impact of the promotional
initiatives would be substantially offset by advertising co-op allowances which
are now recorded in cost of sales.
Interest expense decreased $0.3 million to $0.9 million in the third
quarter of fiscal 2003 from $1.2 million in the third quarter of fiscal 2002,
resulting from lower average interest rates and decreased amortization of
financing fees related to the refinancing of the prior credit facility partially
offset by higher average borrowings.
Income taxes decreased $0.3 million, resulting in a benefit of $3.1
million in the third quarter of fiscal 2003 compared to a benefit of $2.8
million in the third quarter of fiscal 2002, reflecting an effective tax rate of
29.6% and 35.8% in the third quarter of fiscal 2003 and 2002, respectively. The
third quarter income tax benefit was impacted by a change in the Company's
estimated effective annual tax rate for fiscal year 2003 to 34.0%, considering
the significant professional fees being incurred with respect to the
contingencies described in Note 10 of the financial statements which will
continue into the fourth quarter. For the six months ended July 31, 2003, the
Company had recorded the income tax benefit based upon an effective annual tax
rate of 39.0%. The Company's annual effective tax rate was 38.1% for fiscal
2002.
Net loss of $7.4 million in the third fiscal quarter of 2003, compared to
net loss of $5.1 million in the third quarter of fiscal 2002, primarily resulted
from the factors discussed individually above.
Results of Operations for the Nine Months Ended October 31, 2003
Net sales for the nine months ended October 31, 2003 decreased $4.6
million, or 2.2%, to $208.1 million from $212.7 million in the nine months ended
October 31, 2002. Comparable store sales decreased $9.3 million, or 4.5%, in the
first nine months of fiscal 2003 from the same period in fiscal 2002. These
decreases were partially offset by sales from new stores of $8.5 million.
Additionally, there were sales decreases of $3.8 million primarily related to
closed stores. The total number of merchandise units sold increased 4.5% in the
first nine months of fiscal 2003 from the first nine months of fiscal 2002 and
the average price per merchandise sale declined to $292 in fiscal 2003 from $312
in fiscal 2002. The decline in the average price per merchandise sale and the
increase in the total number of merchandise units sold was primarily due to
lower price-point items sold during promotional events throughout the first nine
months of fiscal 2003 as compared to the prior year period. The slower economy
and lower consumer confidence had a negative impact on sales which was partially
offset by increased sales generated from new promotional initiatives and the
expansion of the watch lines carried in inventory. Credit sales as a percentage
of net sales increased slightly in the first nine months of fiscal 2003 compared
to the first nine months of fiscal 2002. The Company opened 21 new stores and
closed seven stores in the first nine months of fiscal 2003, increasing the
number of stores open to 384 as of October 31, 2003 compared to 375 as of
October 31, 2002.
Gross profit for the first nine months of fiscal 2003 decreased $4.1
million, or 5.7%, to $68.2 million from $72.3 million compared to the same
period in fiscal 2002. Gross profit as a percentage of sales decreased to 32.8%
from 34.0% in the same period of fiscal 2002. The reduction in gross profit
margin was impacted by an increase in store occupancy expense and store-closing
23
costs ($0.5 million). Gross profit rate was also negatively impacted by an
increased mix of watch sales which carry a lower margin than certain other
merchandise categories, the increase in the price of gold as well as the
competitive pricing environment. These declines in gross margin were partially
offset by lower merchandise inventory cost associated with higher vendor
discounts and allowances as compared to the same period in the prior year.
Selling, general and administrative expenses for the first nine months of
fiscal 2003 increased $8.1 million, or 10.6%, to $84.5 million from $76.4
million for the first nine months of fiscal 2002. As a percentage of net sales,
selling, general and administrative expenses increased to 40.6% in the first
nine months of fiscal 2003 from 35.9% in the first nine months of fiscal 2002.
The dollar increase was primarily related to higher other expense ($5.0
million), higher personnel expense ($2.1 million), and higher advertising
expense ($1.3 million) which were partially offset by lower credit expense ($0.4
million). The increase in other expenses is primarily due to the increase in the
number of stores, increases in professional fees ($1.7 million) primarily
associated with the investigations described in Note 10 to the financial
statements, increases in insurance expense ($0.8 million) and increases in
accruals for state and local taxes ($0.6 million). Advertising expense increased
due to new promotional initiatives in 2003 and the impact of the adoption of
ETIF 02-16 as of the beginning of this fiscal year. Prior to the adoption of
EITF 02-16, management had expected that the impact of the promotional
initiatives would be substantially offset by advertising co-op allowances, which
are now recorded in cost of sales. Payroll costs increased primarily due to the
increased number of stores.
Interest expense was $3.3 million in both the first nine months of fiscal
2003 and 2002. The benefit of lower interest rates in the first nine months of
fiscal 2003 was offset by the write-off of $516,000 of deferred financing fees
related to the refinancing of the prior credit facility and higher average
borrowings.
Income tax benefit increased $4.0 million to $6.7 million in the first
nine months of fiscal 2003 compared to a benefit of $2.7 million in the prior
period, reflecting an effective annual tax rate of 34.0%. This effective tax
rate is currently management's best estimate considering the significant
professional fees being incurred with respect to the contingencies described in
Note 10 of the financial statements which will continue into the fourth quarter.
To the extent that income is significantly more or less than expected, the
Company's effective income tax rate for the fourth quarter and the full year
could vary significantly from that of the previous quarters. The Company's
annual effective tax rate was 38.1% for fiscal 2002.
Net loss of $13.0 million in the nine months ended October 31, 2003,
compared to net loss of $4.8 million in the nine months ended October 31, 2002,
primarily resulted from the factors discussed individually above.
Liquidity and Capital Resources
The Company's cash requirements consist principally of funding inventory
for existing stores, capital expenditures and working capital associated with
the Company's new stores. The Company's primary sources of liquidity have been
cash flow from operations and bank borrowings under the Company's revolver.
The Company's inventory levels and working capital requirements have
historically been highest in advance of the Christmas season. The Company has
funded these seasonal working capital needs through borrowings under the
Company's revolver and increases in trade payables and accrued expenses. As of
October 31, 2003, the calculated revolver availability, pursuant to the Credit
Agreement, exceeded the maximum availability of $125.0 million. The
24
Company had $107.1 million of outstanding borrowings under the revolving loan
facility as of October 31, 2003.
The Company's cash flow provided by operating activities was $3.6 million
in the first nine months of 2003 compared to $29.4 million used in operating
activities in the first nine months of fiscal 2002. Depreciation and
amortization ($9.0 million) and increases in accounts payable ($42.8 million),
accrued liabilities ($2.9 million), accrued payroll ($1.5 million) and customer
deposits ($1.3 million) and decreases in accounts receivable ($1.1 million) were
partially offset by increases in merchandise inventories ($32.7 million) and
current income tax benefit ($7.1 million), decreases in current income taxes
payable ($3.3 million), and loss from operations ($13.0 million). The increase
in accounts payable in fiscal 2003 reflects the impact of timing of vendor
payments resulting from the Company's strategy to pay certain accounts payable
in advance in fiscal 2002 in order to earn additional cash discounts. The
increase in merchandise inventories primarily related to seasonal purchasing
patterns, the expansion of the watch lines carried in inventory which resulted
in higher watch inventories of $10.4 million compared to the prior year-end and
inventory for additional stores operated during the first nine months of fiscal
2003 compared to the same period in the prior year.
The Company utilized cash in the first nine months of 2003 primarily to
fund capital expenditures ($9.5 million) related to the opening of 21 new stores
in the first nine months of 2003, to repay the term loan ($4.5 million), to
purchase 321,400 shares of Company stock during the third quarter at an average
price of $11.92 per share under the Stock Repurchase Program ($3.8 million) and
to pay financing costs ($1.0 million) associated with the second amended and
restated credit facility. These expenditures were funded through increased
revolver borrowings ($12.6 million) and an increase in outstanding checks ($1.6
million).
Subject to the contingencies identified in Note 10 to the October 31, 2003
financial statements and other risks, including those identified in
Forward-Looking Statements in Part II, Item 5, management expects that cash flow
from operating activities and funds available under the Company's revolving
credit facilities should be sufficient to support the Company's current new
store expansion program and seasonal working capital needs. In the near term,
the Company expects to incur significant professional fees associated with the
matters discussed in Note 10 to the financial statements which will impact
earnings for the remainder of the year and in the next fiscal year.
On October 29, 2003, the Company entered into a letter agreement with its
lenders which clarified and supplements the existing provisions of the Credit
Agreement with respect to the consolidated Capital Factors actions, the SEC
investigation and the investigation by the United States Attorney. Pursuant to
the letter agreement, the lenders under the Credit Amendment have reserved their
rights to determine that the consolidated Capital Factors actions, the SEC
inquiry or the United States Attorney's investigation constitutes a breach of
the Credit Agreement. If the required lenders were to make such a determination,
they would have the right to declare an event of default and cease funding under
the revolving loan facility under the Credit Agreement, among other things. If
the existing lenders were to cease funding under the revolving loan facility,
the Company would be required to seek new financing. There is no assurance that
new financing would be available on acceptable terms or at all. If the existing
lenders were to cease funding under the revolving loan facility and if the
Company were not able to arrange new financing on acceptable terms, this would
have a material adverse effect on the Company, which could affect the underlying
25
valuation of assets and liabilities. The accompanying financial statements have
been prepared assuming that the Company will continue as a going concern and do
not include any adjustments that might result from the occurrence of the
previously mentioned uncertainties.
On December 15, 2003, the Company entered into a second letter agreement
with respect to the Credit Agreement, pursuant to which the lenders have
extended the date by which the Company is required to deliver its financial
statements for the third quarter of fiscal 2003 from December 15, 2003 to
December 31, 2003. In addition, as scheduled under the terms of the original
Credit Agreement, the interest rate at which London Interbank Offered Rates
("LIBOR") based borrowings are available under the Credit Agreement increased
from LIBOR plus 1.5% to LIBOR plus 2.0% as of December 15, 2003. Also, the
Company has agreed to provide a semi-monthly borrowing base certificate.
Contractual Obligations and Contingencies
The Company disclosed contractual obligations in the Management's
Discussion and Analysis of Financial Conditions and Results of Operations in the
Form 10-K filing for the fiscal year ended January 31, 2003.
Refer to Note 10 of the October 31, 2003 financial statements filed in
Form 10-Q with respect to commitments and contingencies.
Critical Accounting Policies and Estimates
The Company's critical accounting policies and estimates, including the
assumptions and judgments underlying them, are disclosed in the notes to the
Financial Statements and Managements Discussion and Analysis of Financial
Condition and Results of Operations in the Form 10-K filing for the year ended
January 31, 2003. These policies have been consistently applied in all material
respects and address such matters as revenue recognition, inventory valuation,
depreciation methods and asset impairment recognition. While the estimates and
judgments associated with the application of these policies may be affected by
different assumptions or conditions, the Company believes the estimates and
judgments associated with the reported amounts are appropriate in the
circumstances. Management has discussed the development and selection of these
critical accounting estimates with the audit committee of our Board of
Directors.
The Company reviewed goodwill for impairment as of October 31, 2003 and
determined that no impairment existed. This assessment is subject to change from
period to period because it requires Company management to make assumptions
about the future cash flows over several years in the future. The impact that
recognizing an impairment would have on assets reported on our balance sheet as
well as our results of operations could be material. Management's assumptions
about future cash flows requires significant judgment and actual cash flows in
the future may differ significantly from those forecasted today, particularly
when considering the uncertainties identified in Note 10 of the October 31, 2003
financial statements in this Form 10-Q.
Additionally, due to the seasonal nature of the business, the Company
tends to generate nearly all of its income in the fourth quarter. While the 34%
effective tax rate currently estimated for the year is management's best
estimate, to the extent that income is significantly more or less than expected,
the Company's effective income tax rate for the fourth quarter and the full year
could vary significantly from that of the previous quarters. The effective rate
of 29.6% for the three months ended October 31, 2003 includes the impact of
reducing the estimated annual effective rate from 39% to 34% in the third
quarter. In addition, the Company tends to generate tax benefits in
26
early quarters, which are expected to be realized in later quarters or through
carry back to prior fiscal years.
Merchandise inventories are stated principally at the lower of weighted
average cost or market. Cost is reduced to reflect certain allowances and
discounts received from vendors. Periodic payments from vendors in the form of
buydowns, volume or other purchase discounts that are evidenced by signed
agreements are reflected in the carrying value of the inventory when earned and
as a component of cost of sales, buying and occupancy as the merchandise is
sold. Additionally, to the extent it is not addressed by established vendor
return privileges, and if the amount of cash consideration received from the
vendor exceeds the estimated fair value of the goods returned, that excess
amount is reflected as a reduction in the purchase cost of the inventory
acquired. To the extent the Company's agreements with vendors specify co-op
advertising, the Company has historically classified such credits as a reduction
to advertising expense in selling, general and administrative expenses. Emerging
Issues Task Force ("EITF") Issue No. 02-16, "Accounting by a Customer (Including
a Reseller) for Certain Consideration Received from a Vendor" ("EITF 02-16"),
which was effective for all arrangements entered into after December 31, 2002,
requires vendor allowances to be classified as a reduction to cost of sales
unless evidence exists supporting an alternative classification.
The Company also obtains merchandise from vendors under various
consignment agreements. The consigned inventory and related contingent
obligations associated with holding and safekeeping such consigned inventory are
not reflected in the Company's financial statements. At the time of sale of
consigned merchandise to customers, the Company records the purchase liability
and the related consignor cost of such merchandise in cost of sales.
Transactions with Affiliates and Related Parties
The Company operates a program under which executive officers and
directors are permitted to purchase most Company merchandise at approximately
ten percent above the Company's cost. For the first nine months of fiscal 2003,
such purchases by executive officers and directors totaled approximately
$150,000.
Inflation
Management believes that inflation generally has not had a material effect
on the Company's results of operations.
Accounting for Costs Associated with Exit or Disposal Activities
In June 2002, the Financial Accounting Standards Board issued Statement
No. 146 ("SFAS 146"), "Accounting for Costs Associated with Exit or Disposal
Activities." SFAS 146 requires that costs associated with disposal or exit
activities after December 31, 2002 be recorded at fair value in the period the
liability is incurred. The Company adopted SFAS 146 effective January 1, 2003,
which had no significant impact on its financial statements.
Accounting by a Customer for Certain Consideration Received from a Vendor
Merchandise inventories are stated principally at the lower of weighted
average cost or market. Purchase cost is reduced to reflect certain allowances
and discounts received from merchandise vendors. Periodic credits or payments
from merchandise vendors in the form of buy downs, volume or other purchase
discounts and other vendor consideration are reflected in the carrying value of
the inventory and recognized as a component of cost of sales as the merchandise
is sold. Additionally, to the extent it is not addressed by established vendor
return privileges, and if the amount of cash consideration received from the
vendor exceeds the estimated fair value of the goods returned, that excess
amount is reflected as a reduction in the purchase cost of the inventory
acquired.
To the extent the Company's agreements with vendors provide credits for
co-op advertising, the Company has historically classified such credits as a
reduction to advertising expense in selling, general and administrative
expenses. Emerging Issues Task Force Issue No. 02-16, "Accounting by a Customer
(Including a Reseller) for Certain Consideration Received from a Vendor" ("EITF
02-16"), which was effective for all arrangements entered into after December
31, 2002, requires certain merchandise vendor allowances to be classified as a
reduction to inventory cost unless evidence exists supporting an alternative
classification. The Company has recorded such merchandise vendor allowances as a
reduction of inventory cost. The total amount of these allowances and other
vendor consideration earned as of October 31, 2003, January 31, 2003, and
October 31, 2002 was approximately $3,327,000, $3,254,000 and $2,054,000,
respectively.
27
Accounting for Stock-Based Compensation
The Financial Accounting Standards Board issued Statement No. 148 ("SFAS
148"), "Accounting for Stock-Based Compensation-Transition and Disclosure,"
during 2002. SFAS 148 amends Statement No. 123, "Accounting for Stock-Based
Compensation," to provide alternative methods of transition for a voluntary
change to the fair value based method of accounting for stock-based employee
compensation and amends the disclosure requirements to require prominent
disclosures in both annual and interim financial statements about the method of
accounting for stock-based employee compensation and the effect of the method
used on reported results. The Company adopted the disclosure requirements of
SFAS 148 as of January 31, 2003.
Corporate Governance Initiatives
As part of its ongoing work in connection with the Sarbanes-Oxley Act and
the resulting rules and regulations promulgated by the SEC and listing standards
adopted by the New York Stock Exchange, the Board of Directors of the Company
has recently adopted corporate governance guidelines designed to formalize
existing Board practices, such as regular meetings of the non-executive
directors, and to address other governance matters, such as criteria for Board
membership. The Board also is considering additional measures designed to
enhance the continued independence of the Board.
In addition, as a result of the Company's internal investigation described
elsewhere in this Form 10-Q and the recent terminations of the Company's Chief
Financial Officer and Executive Vice President, Merchandising arising out of
that investigation, the Board and management are undertaking several changes in
the Company's management structure. In particular, the Company is in the process
of initiating a search for a Chief Operating Officer, who will have significant
responsibility for the day-to-day operations of the Company. In addition, the
Company plans to hire a new Executive Vice President, Merchandising. The Company
also plans to hire a General Counsel, who will oversee all legal matters and
serve as the Company's Chief Corporate Compliance Officer.
Accounting for Guarantees
In November 2002, the Financial Accounting Standards Board issued FASB
Interpretation No. 45 ("FIN 45"), "Guarantor's Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of
Others," an interpretation of FASB Statements No. 5, 57 and 107 and rescission
of FASB Interpretation No. 34. The Company has adopted the guidance of FIN 45
and has reflected the required disclosures in its financial statements
commencing with the financial statements for the year ended January 31, 2003.
Under its bylaws, the Company has agreed to indemnify its officer and
directors for certain events or occurrences while the officer or director is, or
was serving, at its request in such capacity. The maximum potential amount of
future payments the Company could be required to make pursuant to these
indemnification obligations is unlimited; however, the Company has a directors
and officer liability insurance policy that, under certain circumstances,
enables it to recover a portion of any future amounts paid. As a result of its
insurance policy coverage, the Company believes the estimated fair value of
these indemnification obligations is minimal. The Company has no liabilities
recorded for these obligations as of October 31, 2003.
28
Item 3 - Quantitative and Qualitative Disclosure About Market Risk
Interest Rate Risk
The Company's exposure to changes in interest rates relates primarily to
its borrowing activities to fund business operations. The Company principally
uses floating rate borrowings under its revolving credit and gold consignment
facilities. The Company's private label credit card provider charges the Company
varying discount rates for its customer's credit program purchases. These
discount rates are sensitive to significant changes in interest rates. The
Company currently does not use derivative financial instruments to protect
itself from fluctuations in interest rates.
Gold Price Risk
The Company does not hedge gold price changes. Current increases in gold
prices have had and may have a future negative impact on gross margin to the
extent sales prices do not increase commensurately.
Item 4. Controls and Procedures
In the course of performing its review of the interim financial statements
of the Company for the period ended October 31, 2003, PricewaterhouseCoopers
advised the Company's audit committee and management that the Company had
internal control deficiencies in its cash disbursements and merchandise areas
that PricewaterhouseCoopers considered collectively to be a "material weakness"
under standards established by the American Institute of Certified Public
Accountants. These deficiencies had no impact on the Company's results of
operations or financial condition for and as of the three and nine-month periods
ended October 31, 2003 and the fiscal year ended January 31, 2003. During the
third quarter the Company: (1) implemented a policy requiring that each check
disbursement be accompanied by a remittance advice identifying the invoices and
credit memos covered by such disbursement and (2) formally adopted and
internally promulgated a policy detailing procedures for accounts payable
disbursements. The Company's management, with the participation of our Chief
Executive Officer and our Chief Financial Officer, carried out an evaluation of
the effectiveness of the design and operation of the Company's disclosure
controls and procedures (as defined in Rule 13a-15(e) promulgated under the
Securities Exchange Act of 1934, as amended). Based upon this evaluation, the
Company's Chief Executive Officer and Chief Financial Officer concluded that the
Company's disclosure controls and procedures were effective as of October 31,
2003 to provide reasonable assurance that information required to be disclosed
by the Company in reports filed or submitted under the Securities Exchange Act
of 1934, as amended, is recorded, processed, summarized and reported, within the
time periods specified in the SEC's rules and forms. Other than the procedures
noted above, there have been no changes in the Company's internal control over
financial reporting that occurred during the Company's fiscal quarter ended
October 31, 2003 that has materially affected, or is reasonably likely to
materially affect, the Company's internal control over financial reporting.
In addition, following the end of the third quarter, the Company has
already or will shortly undertake a number of additional measures in respect of
its internal control over financial reporting. In particular, the Company: (1)
commenced a search for an internal audit director, who will report directly to
the audit committee of the Board of Directors; (2) is in the process of
instituting a compliance program, as part of which the Company has adopted a
Code of Business Conduct and Ethics and has appointed a Chief Corporate
Compliance Officer; (3) implemented improvements in the process by
29
which monthly statements from vendors of outstanding invoices and credits are
reconciled to the Company's records; and (4) implemented additional procedures
for approving purchases by the Company of items previously provided to the
Company on consignment.
30
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
On July 25, 2002, the Company was named a defendant in a wage hour class
action suit filed in California by three former store managers. The case was
based principally upon the allegation that store managers employed by the
Company in California should have been classified as non-exempt for overtime
purposes. In April 2003, the parties reached a preliminary agreement to settle
the matter resulting in a pre-tax charge of $1,000,000, inclusive of the
plaintiffs' attorneys' fees, interest, penalties, administrative costs and other
Company costs. This settlement covers the period from July 25, 1998 through the
date of final settlement approval by the court. The court granted final approval
to the settlement on December 11, 2003.
The Company was named a defendant in a wage hour suit filed in California
by a former employee on May 6, 2003. The case was based principally upon the
allegation that the amount of overtime paid to certain California employees was
less than the amount actually earned. The suit asserts a claim for $1,000,000.
The parties have reached a settlement of the suit for an amount that is not
significant in relation to the Company's financial statements.
The Company has been named as one of 14 defendants in a lawsuit originally
filed in the United States District Court for the Southern District of New York,
now pending in New York State Supreme Court, Commercial Division. The case is
brought by Capital Factors, Inc. ("Capital Factors"), which provided financing
to defendant Cosmopolitan Gem Corp. ("Cosmopolitan"), an entity with which the
Company has certain consignment and other commercial arrangements. The complaint
alleges that Cosmopolitan defrauded Capital Factors into advancing funds to
Cosmopolitan by misrepresenting Cosmopolitan's finances and the profitability of
its operations, and that the Company, along with other persons and entities,
including other jewelry retailers, aided and abetted or participated in the
alleged fraud. The complaint asserts against the defendants, including the
Company, claims under common law and the Racketeer Influenced and Corrupt
Organizations Act ("RICO"). Capital Factors seeks aggregate damages from all of
the defendants, including the Company, of $30,000,000, plus unspecified punitive
damages, interest and fees. Damages, excluding punitive damages, awarded
pursuant to claims asserted under RICO as well as interest on such damages are
subject to trebling, within the discretion of the court.
The Company has also been named as one of 13 defendants in an amended
complaint filed on December 2, 2003 by International Diamonds, L.L.C.
("International") and its affiliate, Astra Diamonds Manufacturers, Ltd.
("Astra"). Astra is an Israeli diamond wholesaler that supplied diamonds to
Cosmopolitan; International is a joint venture formed by Cosmopolitan and Astra
to sell high quality finished diamond jewelry in the United States. The amended
complaint, consolidated with the Capital Factors action described above (the
"consolidated Capital Factors actions"), alleges that the Company, along with
other jewelry retailers and business affiliates of Cosmopolitan, participated in
Cosmopolitan's fraudulent scheme to defraud Capital Factors, and thus injured
International and Astra. The complaint asserts claims under common law and RICO,
seeking aggregate damages from all of the defendants, including the Company, of
$6,800,000 plus interest and fees. Damages awarded pursuant to claims asserted
under RICO as well as interest on such damages are subject to trebling, within
the discretion of the court. In addition, the complaint alleges claims against
the Company for breach of contract for approximately $2,520,000 in goods
delivered and invoiced to the Company, for which International has not received
payment.
31
In connection with the consolidated Capital Factors actions in New York
state court, the Company has filed an interpleader action for declaratory
relief, asking the Court to determine the proper parties to whom the Company
must pay amounts and deliver goods that are not in dispute related to goods
received from Cosmopolitan and certain other entities. In its answer to the
interpleader, Capital Factors has asserted that Whitehall owes Cosmopolitan
$8,600,000 in accounts receivable on invoices assigned to Capital Factors. This
amount may be included in the $30,000,000 of losses that Capital Factors seeks
in its RICO claims, although the Company is not certain at this time. The
Company is not currently aware of any accounts payable due and owing to any of
the claimants in this action that are not already reflected in the Company's
accounts payable and accrued liabilities.
In these consolidated Capital Factors actions, discovery has just begun,
few documents have been exchanged, no depositions have been taken, and the
Company has not answered either the Capital Factors complaint or amended
International complaint. The Company intends to defend these lawsuits
vigorously.
The United States Attorney for the Eastern District of New York is
conducting a criminal investigation regarding matters that include those alleged
in the consolidated Capital Factors actions. The Company, among others, is a
subject of such criminal investigation and is cooperating fully with the United
States Attorney.
In addition, subsequent to the filing of the complaint by Capital Factors
and as previously disclosed, the SEC initiated an informal inquiry into matters
that are the subject of the consolidated Capital Factors actions. On November 3,
2003, the Company received a subpoena issued by the SEC as a part of a formal
investigation by the SEC with respect to such matters. In connection with this
formal investigation, the SEC has requested that the Company produce certain
additional documents relating to the matters that are the subject of the
consolidated Capital Factors actions. The Company is cooperating fully with the
SEC in connection with this formal investigation.
As previously announced, the Company is conducting an internal
investigation in connection with the consolidated Capital Factors actions and
the related investigations by the United States Attorney for the Eastern
District of New York and the SEC. As a result of this internal investigation, as
previously announced, the Company terminated the employment of its Chief
Financial Officer who had been on leave.
Because these matters are still in their early stages, the Company is
unable at this time to predict the outcome of this contingency or potential
exposure associated with the consolidated Capital Factors actions or the United
States Attorney and SEC investigations or to estimate the impact of this
reasonably possible contingent liability on the Company's results of operations,
financial condition or liquidity. Given the amounts sought in the consolidated
Capital Factors actions, and the inherent unpredictability of litigation, an
adverse outcome in these actions could have a material adverse effect on the
Company's results of operations, financial condition or liquidity. Direct costs
of approximately $0.7 million incurred as a result of the consolidated Capital
Factors actions, the United States Attorney and SEC investigations, and the
Company's internal investigation, have been expensed through October 31, 2003.
In the course of the Company's internal investigation, as previously
announced, the Company discovered that its Executive Vice President,
Merchandising, violated a Company policy with respect to Company documentation
regarding the age of certain store inventory. Following that discovery, the
Company placed the executive on leave pending further investigation. Since
32
then, the Company discovered additional irregularities with respect to the
classification of inventory for the year ending January 31, 2001 and for the
quarter ending April 30, 2001, and for certain periods. These irregularities
resulted in inventory and accounts payable being equally understated by
approximately $6,300,000 for the period ending January 31, 2001 and
approximately $2,500,000 for the period ending April 30, 2001. Such
irregularities had no effect on the Company's balance sheet for any subsequent
periods, including the years ending January 31, 2002 and January 31, 2003. The
matters referred to above did not have any income statement effect. As a result
of these matters, the Company terminated the employment of its Executive Vice
President, Merchandising.
The Company is subject to other claims and litigation in the normal course
of business. It is the opinion of management that additional liabilities, if
any, resulting from these other claims and litigation are not expected to have a
material adverse effect on the Company's financial condition or results of
operations.
33
Item 5 - Other Information
Forward-Looking Statements
This report contains certain forward-looking statements (as such term is
defined in Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934) and information relating to the Company that
are based on the current beliefs of management of the Company as well as
assumptions made by and information currently available to management including
statements related to the markets for our products, general trends and trends in
our operations or financial results, plans, expectations, estimates and beliefs.
In addition, when used in this report, the words "anticipate," "believe,"
"estimate," "expect," "intend," "plan," "predict" and similar expressions and
their variants, as they relate to the Company or our management, may identify
forward-looking statements. Such statements reflect our judgment as of the date
of this report with respect to future events, the outcome of which is subject to
certain risks, including the factors described below, which may have a
significant impact on our business, operating results or financial condition.
Investors are cautioned that these forward-looking statements are inherently
uncertain. Should one or more of these risks or uncertainties materialize, or
should underlying assumptions prove incorrect, actual results or outcomes may
vary materially from those described herein. Whitehall Jewellers undertakes no
obligation to update forward-looking statements. The following factors, among
others, may impact forward-looking statements contained in this report: (1) a
change in economic conditions or the financial markets which negatively impacts
the retail sales environment and reduces discretionary spending on goods such as
jewelry; (2) reduced levels of mall traffic caused by economic or other factors;
(3) our ability to execute our business strategy and the related effects on
comparable store sales and other results; (4) the extent and results of our
store expansion strategy and associated occupancy costs, and access to funds for
new store openings; (5) the high degree of fourth quarter seasonality of our
business; (6) the extent and success of our marketing and promotional programs;
(7) personnel costs and the extent to which we are able to retain and attract
key personnel; (8) the effects of competition; (9) the availability and cost of
consumer credit; (10) relationships with suppliers; (11) our ability to maintain
adequate information systems capacity and infrastructure; (12) our leverage and
cost of funds and changes in interest rates that may increase such costs; (13)
our ability to maintain adequate loss prevention measures; (14) fluctuations in
raw material prices, including diamond, gem and gold prices; (15) developments
relating to the consolidated Capital Factors actions and the related SEC and
U.S. Attorney's office investigations, including the impact of such developments
on our results of operations and financial condition and relationship with our
lenders or with our vendors; (16) regulation affecting the industry generally,
including regulation of marketing practices; (17) the successful integration of
acquired locations and assets into our existing operations; and (18) the risk
factors identified from time to time in our filings with the SEC.
34
Item 6 - Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit Number Description
-------------- -----------
10.1 Letter Agreement dated October 29, 2003 relating to the
Second Amended and Restated Revolving Credit and Gold
Consignment Agreement dated as of July 29, 2003 by and
among the Company, LaSalle Bank National Association, as
administrative agent for the banks ("Banks") party
thereto, the Banks, ABN AMRO Bank N.V., as syndication
agent, and JP Morgan Chase Bank, as documentation agent.
Incorporated by reference to Exhibit 99.1 of the Company's
Current Report on Form 8-K for November 6, 2003, file No.
0-028176.
10.2 Letter Agreement dated December 15, 2003 relating to the
Second Amended and Restated Revolving Credit and Gold
Consignment Agreement dated as of July 29, 2003 by and
among the Company, LaSalle Bank National Association, as
administrative agent for the Banks, the Banks, ABN AMRO
Bank N.V., as syndication agent, and JP Morgan Chase Bank,
as documentation agent.
31.1 Certification of the Chief Executive Officer pursuant to
Rule 13a-14(a) of the Securities Exchange Act of 1934
31.2 Certification of the Chief Financial Officer pursuant to
Rule 13a-14(a) of the Securities Exchange Act of 1934
32.1 Certification of Chief Executive Officer pursuant to 18
United States Code Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002
32.2 Certification of Chief Financial Officer pursuant to 18
United States Code Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002
(b) Reports on Form 8-K
On August 7, 2003, the Company filed a Current Report on Form
8-K with the SEC, to furnish a press release announcing sales for
the second quarter ended July 31, 2003.
On August 27, 2003, the Company filed a Current Report on Form
8-K with the SEC to disclose that the Company had been named a
defendant in a lawsuit filed by Capital Factors, Inc. in the United
States District Court for the Southern District of New York.
On August 28, 2003, the Company filed a Current Report on Form
8-K with the SEC, to furnish a press release regarding financial
results for the second quarter ended July 31, 2003.
On October 1, 2003, the Company filed a Current Report on Form
8-K with the SEC to disclose information regarding a criminal
investigation by the office of the United States Attorney for the
Eastern District of New York.
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On November 6, 2003, the Company filed a Current Report on
Form 8-K with the SEC to disclose information regarding a formal
inquiry by the Securities and Exchange Commission.
On November 10, 2003, the Company filed a Current Report on
Form 8-K with the SEC, to furnish a press release announcing sales
for the third quarter ended October 31, 2003.
On November 21, 2003, the Company filed a Current Report on
Form 8-K with the SEC, to disclose a press release announcing that
it has placed its Executive Vice President, Merchandising, on leave.
On December 11, 2003, the Company filed a Current Report on
Form 8-K with the SEC, to disclose a press release announcing the
termination of its Chief Financial Officer and commenting on the
release of financial results.
On December 22, 2003, the Company filed a Current Report on
Form 8-K with the SEC, to furnish a press release regarding
financial results for the third quarter ended October 31, 2003,
comparative store sales for November, 2003 and a portion of
December, 2003 and a restatement of its results for certain previous
periods primarily to reflect non-cash inventory valuation
adjustments.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
WHITEHALL JEWELLERS, INC.
(Registrant)
Date: December 22, 2003 By: /s/ John R. Desjardins
----------------------
John R. Desjardins
Executive Vice President -
Chief Financial Officer and Treasurer
(duly authorized officer and principal
financial officer)
37