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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[XX] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR (52 WEEKS) ENDED JANUARY 31, 2004
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
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Commission file number 1-10876
SHOPKO STORES, INC.
(Exact name of registrant as specified in its Charter)
Wisconsin 41-0985054
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(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
700 Pilgrim Way, Green Bay, Wisconsin 54304
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (920) 429-2211
Securities registered pursuant to Section 12(b) of the Act:
Name of each exchange on
Title of each class which registered
---------------------------- ---------------------
Common Stock, par value $0.01 per share New York Stock Exchange
Series B Preferred Stock Purchase Rights New York Stock Exchange
Securities registered pursuant to Section 12 (g) of the Act: None.
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No [ ]
(Cover page 1 of 2 pages)
1
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K [ ].
Indicate by check mark whether the Registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act).
Yes [X] No [ ]
The aggregate market value of the voting stock held by non-affiliates
of the Registrant as of August 2, 2003 was approximately $388,818,693 (based
upon the closing price of Registrant's Common Stock on the New York Stock
Exchange on such date).
Number of shares of $0.01 par value Common Stock outstanding as of
April 2, 2004: 29,345,319.
DOCUMENTS INCORPORATED BY REFERENCE
Part III incorporates by reference portions of the definitive Proxy
Statement for the Registrant's Annual Meeting of Shareholders to be held on May
26, 2004.
(Cover page 2 of 2 pages)
2
PART I
ITEM 1. BUSINESS
GENERAL
ShopKo Stores, Inc. ("ShopKo" or the "Company"), a Wisconsin
corporation, was incorporated in 1961 and in 1971 became a wholly owned
subsidiary of Supervalu Inc. ("Supervalu"). On October 16, 1991, the Company
sold 17,250,000 common shares or 54% of equity ownership in an initial public
offering. On July 2, 1997, Supervalu exited its remaining 46% investment in the
Company through a stock buyback and secondary public offering. The Company's
principal executive offices are located at 700 Pilgrim Way, Green Bay, Wisconsin
54304, and its telephone number is (920) 429-2211. The Company's internet
website can be found at www.shopko.com. ShopKo's annual report on Form 10-K,
quarterly reports on Form 10-Q, current reports on Form 8-K and any amendments
to such reports are available on this website as soon as reasonably practicable
after they have been filed with the Securities and Exchange Commission. In
addition, the Company makes information about quarterly web casts and recent
press releases available on its website.
The Company has two business segments: a ShopKo Retail segment and a
Pamida Retail segment. The ShopKo Retail segment consists of a multi-department
retailer operating under the "ShopKo" name, located primarily in mid-size and
larger communities. The ShopKo retail stores are committed to offering quality
merchandise, services and value to meet customers' needs for home, family
basics, casual apparel and seasonal products along with a special emphasis on
retail health, operating in-store pharmacies and optical centers. As of January
31, 2004, the Company had 141 ShopKo retail stores operating in 15 Midwest,
Pacific Northwest and Western Mountain states.
The Pamida Retail segment is a general merchandise retailer,
headquartered in Omaha, Nebraska, which serves smaller and more rural
communities, offering a convenient, one-stop shopping format. The Pamida Retail
segment was acquired in fiscal 1999. As of January 31, 2004, the Company had 218
Pamida retail stores operating in 16 Midwest, North Central and Rocky Mountain
states. Financial information about these two business segments is included in
Note I of the Notes to Consolidated Financial Statements for fiscal year 2003.
SHOPKO RETAIL
MERCHANDISING PHILOSOPHY - SHOPKO RETAIL
ShopKo Retail is committed to offering quality merchandise, service and
value to meet customers' requirements for health, home, family basics, casual
apparel and seasonal needs in its stores with speed, friendliness and
simplicity. ShopKo Retail strives to differentiate itself from its competition
by meeting customer needs more quickly and conveniently, and by anticipating the
needs of its customers' changing lifestyles.
ShopKo's strategy is to focus on selected merchandise categories tied
to its customers' changing lifestyle needs.
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ShopKo aims to deliver a superior customer experience in its retail
stores by:
- being a merchant-driven organization, responding to the wants and needs
of its customers,
- exceeding customers' expectations in terms of merchandise assortment,
service and value,
- ensuring that merchandise, particularly advertised merchandise, is
available for purchase, and
- providing simplicity, speed and friendliness in the shopping
experience.
ShopKo provides quality trend-correct, casual lifestyle merchandise at value
prices in an attractive, customer-friendly shopping environment.
MERCHANDISING AND SERVICES - SHOPKO RETAIL
The ShopKo Retail store net sales mix for the last three fiscal years
was:
2003 2002 2001
---- ---- ----
Hardlines 52% 53% 55%
Softlines 19% 20% 21%
Retail Health 29% 27% 24%
ShopKo Retail stores carry a wide assortment of branded and private
label softline goods, including:
- women's, men's and children's apparel,
- shoes,
- jewelry,
- cosmetics, and
- accessories.
ShopKo also carries a wide assortment of seasonal and everyday basic
categories of hardline goods such as:
- housewares, - music/videos,
- home textiles, - toys,
- household supplies, - sporting goods,
- health and beauty aids, - greeting cards and gift wrap,
- home entertainment products, - candy,
- small appliances, - snack foods, and
- furniture, - lawn and garden.
ShopKo carries a broad assortment of merchandise to provide customers
with a convenient one-stop shopping source for everyday items. For example, in
2004 the Company is exploring expanding the beverage area to include beer and
wine. ShopKo's accommodating customer service policies provide customers with a
pleasant shopping experience.
ShopKo continually seeks to offer leading national brand names in its
merchandise lines. It concentrates on brands that have wide customer acceptance
and provide quality and value. In
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addition, ShopKo seeks to maintain the appropriate mix of private label goods
through its well-developed private label programs. In fiscal 2003, the Company
formed a strategic partnership with Daymon Worldwide Trading and with Topco
Associates, LLC to pursue private label development and procurement of
consumables, health and beauty aids and household commodities. ShopKo's in-house
quality assurance and technical design team analyzes and develops the quality of
its fashion offerings. This allows ShopKo to deliver a better and more
consistent product, with greater control and efficiency.
The Company also provides retail health services in most of its ShopKo
stores. Of the Company's 141 stores as of January 31, 2004, 140 include retail
pharmacies and optical centers. In addition to generating store traffic and
building customer loyalty, these services contribute significantly to the
Company's overall profitability and provide the opportunity for additional
growth. ShopKo's pharmacies filled over 12.7 million prescriptions in fiscal
2003 and fiscal 2002. ShopKo's optometrists perform in-store eye exams and
prescribe correctional lenses, most of which are fabricated in the Company's
centralized optical laboratory and in approximately 83 in-store finishing labs.
In fiscal 2003, ShopKo dispensed over 663,000 eyewear prescriptions, compared to
683,000 eyewear prescriptions in fiscal 2002. The in-store finishing labs
typically service other ShopKo stores in the vicinity and provide customers with
same day or next day optical service for single vision lenses.
MARKETING AND ADVERTISING - SHOPKO RETAIL
ShopKo markets its general merchandise and retail pharmacy and optical
services by using week-end and mid-week newspaper circulars, which enables
ShopKo to reach a broad-based group of customers consisting largely of
middle-income families. The four-color week-end circulars average 24 pages,
supplemented with smaller mid-week circulars. The circulars feature values in
all of the departments in ShopKo's stores and have a circulation of 4.4 million.
ShopKo uses direct mail advertisements selectively during key promotional
periods. These direct mail advertisements average 56 pages and have a
circulation of 5.8 million. All printed advertising materials are designed by
the Company's in-house design team and photographed in the Company's own
photography studios.
In general, ShopKo uses its frequent advertising of a large group of
high demand items to reinforce its competitive value image and to generate store
traffic, rather than attempting to meet the lowest available price on every
item.
SHOPKO RETAIL STORE LAYOUT AND DESIGN
ShopKo stores are designed for simplicity, speed and ease of the
shopping experience. The stores emphasize ShopKo's customers' lifestyles and
brand awareness. The stores feature competitive assortments of softlines, home
and hardlines products as well as pharmacy and optical centers. The pharmacy and
optical centers are located in the front of the store for added convenience.
Health and Beauty Aids and Over The Counter products have been positioned
adjacent to the pharmacy, in most stores, to provide a total health care
environment. ShopKo designs the remainder of the store in a "racetrack"
configuration that assists customers in navigating easily throughout the store.
5
The Company is testing various store layouts, display techniques and
merchandise mixes in defining its evolving model format for both existing and
new stores. The Company introduced a new ShopKo store design in fiscal 2003
through the remodeling of three ShopKo stores during the year. The store model
will be continually modified and updated as the Company continues to test and
modify various merchandise presentation styles and lay-outs through the planned
remodels of 10 stores in fiscal 2004. The Company's current average ShopKo store
size is over 90,000 square feet. Future store size may vary depending on changes
to the Company's store design, the community in which the store is located, and
the retail competition in the immediate area.
SHOPKO RETAIL STORE OPERATIONS AND MANAGEMENT
ShopKo's store operations organization focuses on:
- Delivering a great customer experience
- Consistent, timely execution of merchandising plans
- Maximizing profitability of stores for today and in the future
ShopKo store operations group strives to drive profitable sales through
execution of the merchandising plans that will satisfy customers by having the
right item in stock at the right time. ShopKo's operating philosophy encourages
trust and empowerment of teammates to do what's right for the customer while
holding each other accountable for the results. The store operations
organization framework is based on three key components: customers, financial
performance and teammates.
Customers. The Company has focused on serving our customers at a level
that will exceed their expectations. ShopKo has developed and implemented a
customer service program that rewards our teammates for the great service they
provide. This program is monitored by an outside company to ensure that ShopKo
is meeting the ever changing needs of the customer.
Financial performance. The Company is committed to maximizing its
financial performance by improving productivity through use of technology,
training and by developing best practices.
Teammates. The Company believes in providing all teammates with the
training necessary for them to perform their jobs with excellence. ShopKo
encourages individual thinking while rewarding teammates for high performance
and serving its customers with excellence.
ShopKo holds its store operations management teams accountable for
execution of merchants' plans, operational objectives and achievement of
financial goals. ShopKo emphasizes ongoing development of its management teams
to ensure that they have the skills necessary to meet these objectives. In
fiscal 2003, ShopKo reorganized the store operations functions at the general
office and in the field level store operations resulting in expense savings and
focus on achievement of financial goals.
6
PURCHASING AND DISTRIBUTION - SHOPKO RETAIL
ShopKo purchases merchandise from more than 1,800 vendors. ShopKo's ten
largest vendors accounted for approximately 39.8% of ShopKo's purchases during
fiscal 2003. ShopKo believes that most merchandise, other than branded goods, is
available from a variety of sources. ShopKo is working with its entire supply
chain to link its vendors into ShopKo's general merchandise business planning
process to reduce costs and to replenish its inventory more efficiently. The
majority of ShopKo's vendors are linked to its electronic data interchange
purchase order systems. Select vendors electronically receive point-of-sale
information from ShopKo, which allows them to respond to changing inventory
levels in the stores. In addition, the majority of ShopKo's vendors are
electronically transmitting invoices directly into the Company's automated
invoice matching system.
Purchasing and distribution of merchandise is a critical aspect of
ShopKo's business. The Company controls the flow of main store and optical
merchandise through the use of centralized purchasing, replenishment and
allocation processes and information systems. Allocation and distribution
management is closely tied to the merchandise buying organization to effectively
control and plan merchandise logistics. ShopKo's pharmacy merchandise is
replenished primarily through the use of a distributor. Pharmacies are
electronically linked to the distributor and place orders as product is needed.
Direct imports accounted for approximately 6.7% of ShopKo's purchases,
based upon cost of goods, during fiscal 2003. ShopKo buys its imported goods
principally in the Far East and ships the goods to its distribution centers for
distribution to the stores.
ShopKo has three distribution centers strategically located throughout
the United States to efficiently support its retail operations. Utilization of
distribution centers has enabled ShopKo to:
- purchase the majority of its merchandise directly from manufacturers,
which reduces its cost of goods,
- reduce direct vendor-to-store deliveries, which reduces freight expense
and cost of goods through consolidated volume purchasing, and
- increase its pick and pull capabilities, enhancing the effectiveness
and efficiency of its store replenishment process.
ShopKo believes that these cost reductions help it remain
price-competitive. During fiscal 2003, approximately 90% of the merchandise sold
by ShopKo, excluding optical and pharmaceutical products, flowed through its
distribution centers.
The Company operates a fleet of tractors and trailers to transport
merchandise from the distribution centers to the ShopKo stores. This provides
control over the timing of inventory deliveries, resulting in store labor
savings. Third party transportation companies are utilized as needed.
Expansion of the ShopKo distribution center in Omaha, Nebraska is
scheduled for completion in July 2004. The expansion of the current ShopKo
facility will add 135,000 square feet and accommodate the consolidation of the
Pamida distribution operations located in Omaha into the automated ShopKo
facility, through investments in conveyors, fixtures, and systems. The
operations of ShopKo's other distribution centers are not expected to be
affected by this project.
7
In fiscal 2003, ShopKo's reverse logistics operations, consisting of
vendor returns and non-saleable salvage returns from stores, were consolidated
into its distribution centers in an effort to provide more efficient reverse
logistics processing. The vacant returns processing facility is for sale.
Pursuant to a license agreement, Payless ShoeSource, Inc. operates a
shoe department (other than certain nationally-branded athletic shoes) in every
ShopKo store. ShopKo retains a percentage of the gross proceeds collected as
rent.
MANAGEMENT INFORMATION SYSTEMS - SHOPKO RETAIL
ShopKo uses information technology to improve customer service, reduce
operating costs and provide useful information to help ShopKo make timely
decisions regarding merchandising. In order to support these objectives, the
Company expects to make significant investments over the next several years to
enhance, replace or add new management information systems.
ShopKo uses point-of-sale terminal systems for electronic price lookup
and tracking sales information at store and Stock Keeping Unit (SKU) level.
ShopKo uses a high-speed, private, frame relay communications network to provide
real-time, on-line credit card and check authorization as well as pharmacy
adjudication. ShopKo uses portable radio-frequency terminals extensively in its
stores for merchandise receiving, stocking, replenishment, pricing and label
printing. ShopKo operates self checkout units in ten stores, with additional
installations under consideration for 2004.
ShopKo's merchandising systems provide for integrated perpetual
inventory management, automated replenishment, promotional planning, space
planning, merchandise financial planning and assortment planning. ShopKo
assimilates daily customer sales transactions into actionable information and
decision support tools for the Company's management. The Company expects that a
substantial portion of future information technology investments, particularly
in fiscal 2004, will be made in support of these systems.
ShopKo's pharmacy and optical businesses are supported by integrated
systems built to support customer prescription and eye care needs. These systems
provide automation for prescription fulfillment, insurance claims processing,
and the manufacture and delivery of prescription eyeglasses.
ShopKo's warehouse management system provides complete warehouse
functionality such as conveyor control and direction of picking and put-away
processes by using portable radio-frequency terminals. In addition, this system
is integrated with the Company's central information systems through its data
communications network, thereby ensuring up-to-date perpetual inventory records,
as well as facilitating merchandise allocation and distribution decisions.
ShopKo uses electronic commerce technology to support supply chain
management. This includes integrated replenishment systems, vendor-managed
inventories, scan-based-trading, and electronic data interchange.
EXPANSION - SHOPKO RETAIL
The Company's growth plans include the previously announced test of
three new freestanding drug stores during fiscal 2004, along with the planned
remodels of 10 existing ShopKo stores. Pending the evaluation of the fiscal 2003
and fiscal 2004 remodels, the Company expects to
8
increase the number of remodels to approximately 20 per year, beginning in
fiscal 2005. In addition to the remodels, the Company plans to invest in
merchandise initiatives in key categories, based on customer acceptance of the
fiscal 2003 remodels. The Company does not currently anticipate the addition of
any new full-size ShopKo stores in the upcoming fiscal year. See Item 7-
Management's Discussion and Analysis of Financial Condition and Results of
Operations-Liquidity and Capital Resources. Costs for conversion of existing
stores to a remodeled design concept, as well as the timing of renovations of
existing stores, will depend on a variety of factors, including the success of
the stores remodeled in the 2003 fiscal year. The Company's plans with respect
to new store growth are subject to change, and there can be no assurances that
the Company will achieve its plans.
COMPETITION - SHOPKO RETAIL
The discount general merchandise business is very competitive. ShopKo
competes in most of its markets with a variety of national, regional and local
discount stores, national category killers, specialty niche retailers, catalog
merchants and Internet retailers. In addition, department stores compete with
some branded merchandise lines, discount specialty retail chains compete with
some merchandise lines such as health and beauty aids, household and cleaning
supplies, electronics, bed and bath, housewares, casual furniture and toys, and
pharmaceutical and optical operations compete with some of ShopKo's pharmacy and
optical centers. ShopKo believes that the principal competitive factors in its
markets include:
- store location;
- differentiated merchandising;
- competitive pricing;
- quality of product selection;
- attractiveness and cleanliness of the stores;
- responsiveness to changing lifestyle needs and regional and local
trends;
- customer service;
- in-stock availability of merchandise; and
- advertising.
ShopKo's principal national general merchandise discount chain
competitors are Wal-Mart, Kmart and Target, each of which is substantially
larger than, and has greater resources than, the Company.
The percentage of ShopKo stores where these competitors are present
within the applicable market is as follows:
- - Wal-Mart 96%
- - Kmart 72%
- - Target 74%
ShopKo also competes with regional chains in some markets in the Midwest and the
Pacific Northwest. These competitors continue to open new stores in ShopKo's
markets.
9
Historically, the entry of one of these chains into an area served by a
ShopKo store generally has had an adverse effect on the affected store's sales
growth for approximately 12 months. After the 12 month time period, the ShopKo
store generally has resumed a positive growth trend, although not necessarily to
previous levels. Entry by one of these competitors into a ShopKo market often
has resulted in permanently intensified price competition. In addition, ShopKo
store sales are generally negatively affected by a competitor's increased
saturation through expansion, relocation and additional stores in an existing
market.
SEASONALITY - SHOPKO RETAIL
ShopKo's retail general merchandise operations are highly seasonal.
Historically, ShopKo's second and fourth fiscal quarters have contributed a
significant part of the Company's earnings, with the latter due to the Christmas
selling season.
PAMIDA RETAIL
MERCHANDISING PHILOSOPHY - PAMIDA RETAIL
Pamida's strategy is to offer consumers in small, rural communities a
convenient one-stop shopping format. A typical store carries a broad assortment
of value-priced softlines and hardlines merchandise, including consumables, and
in 2003 Pamida began to expand the beverage area to include alcohol. Pamida also
has retail pharmacies in 103 of its 218 stores.
Pamida stores generally are located in small towns where there often is
less competition from another major general merchandise retailer and which
Pamida considers to be either too small to support more than one major general
merchandise retailer (thereby creating a potential barrier to entry by a major
competitor) or too small to attract competitors whose stores generally are
designed to serve larger populations.
Pamida's merchandising strategy is to provide customers with a reliable
and convenient family shopping experience featuring nationally advertised
brand-name products as well as select private-label merchandise at competitive
prices. Pamida stores are self-service. Advertising circulars are run weekly.
Pamida places special emphasis on maintaining a strong in-stock position in all
merchandise categories.
MERCHANDISING AND SERVICES - PAMIDA RETAIL
The Pamida Retail store net sales mix for the last three fiscal years
was:
2003 2002 2001
---- ---- ----
Hardlines 65% 67% 69%
Softlines 16% 17% 18%
Pharmacy 19% 16% 13%
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Pamida's softlines division includes:
- men's, women's, children's and infant's clothing,
- men's and women's footwear,
- jewelry and accessories, and
- cosmetics.
Pamida's hardlines division includes categories such as:
- home furnishings, - seasonal,
- hardware, - consumables,
- domestics, - health and beauty aids,
- electronics, - automotive, and
- lawn and garden, - toys.
Pamida added 16 new pharmacies in fiscal 2003. The pharmacies have
proven to be effective in building customer loyalty and attracting customers who
are likely to purchase other items in addition to prescription drugs. Pamida
intends to continue its aggressive growth of its pharmacy base for at least the
next couple of years.
MARKETING AND ADVERTISING - PAMIDA RETAIL
Pamida's advertising primarily utilizes four-color weekly circulars
coordinated by an internal advertising staff. Circulars advertise brand-name and
other merchandise at competitive prices.
PAMIDA RETAIL STORE LAYOUT AND DESIGN
Pamida remodeled 17 stores in 2003 after the completion of concept
tests using various layouts and merchandising mixes, as well as 17 smaller
remodeling projects in low sales volume and smaller sized stores. Customer
response to the remodels which emphasize convenience, value and selection, has
been positive. The Company intends to remodel approximately 50 stores in the
next fiscal year, using both the larger and smaller scale remodeling concepts.
Pamida's stores average approximately 33,500 gross square feet and
range in size from approximately 8,000 to 50,000 square feet of sales area.
Pamida continues to make adjustments to its model as it identifies new
strategies and trends.
PAMIDA RETAIL STORE OPERATIONS AND MANAGEMENT
The methods Pamida employs to build customer loyalty and satisfaction
are weekly advertised specials, competitive pricing, clean and orderly stores
and friendly, well-trained personnel.
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PURCHASING AND DISTRIBUTION - PAMIDA RETAIL
Pamida maintains a centralized purchasing, merchandise allocation and
space planning staff at its central offices. Pamida's point-of-sale data
equipment provides current information to Pamida's buyers and inventory
management specialists to assist them in managing inventories, effecting prompt
reorders of popular items, eliminating slow-selling merchandise and reducing
markdowns.
Centralized purchasing enables Pamida to more effectively control the
cost of merchandise and to take advantage of promotional programs and volume
discounts offered by certain vendors. Pamida continuously seeks to control
merchandise costs.
Pamida purchases merchandise from more than 1,600 vendors. Pamida's ten
largest vendors accounted for approximately 33.9% of Pamida's purchases during
fiscal 2003. Pamida believes that most merchandise, other than branded goods, is
available from a variety of sources. Pamida is working with its entire supply
chain to link its vendors into Pamida's general merchandise business planning
process to reduce costs and to replenish its inventory more efficiently. The
majority of Pamida's vendors are linked to its electronic data interchange
purchase order systems. Select vendors electronically receive point-of-sale
information from Pamida, which allows them to respond to changing inventory
levels in the stores. In addition, the majority of Pamida's vendors are
electronically transmitting invoices directly into the Company's automated
invoice matching system.
Pamida has an agreement with Payless ShoeSource, Inc. to be the primary
vendor within the shoe category.
Purchasing and distribution of merchandise is a critical aspect of
Pamida's business. The Company controls the flow of main store merchandise
through the use of centralized computerized purchasing, replenishment and
allocation processes. Allocation and distribution management is closely tied to
the merchandise buying organization to effectively control and plan merchandise
logistics. Pamida's pharmacy merchandise is replenished primarily through the
use of a distributor. Pharmacies are electronically linked to the distributor
and place orders, as product is needed.
Direct imports accounted for approximately 5.3% of Pamida's purchases,
based upon cost of goods, during fiscal 2003. Pamida buys its imported goods
principally in the Far East and ships the goods to its distribution centers for
distribution to the stores.
Pamida operates distribution facilities in Omaha, Nebraska and Lebanon,
Indiana; both of which serve primarily as distribution centers for bulk
shipments and promotional and replenishment merchandise on which cost savings
can be realized through quantity purchasing. During fiscal 2003, approximately
84% of Pamida's merchandise, excluding pharmaceutical products, was distributed
to the stores through these distribution centers, while the remaining
merchandise was supplied directly to the stores by manufacturers or
distributors.
The Pamida Omaha distribution facility is 336,000 square feet. The
Lebanon distribution center is 418,000 square feet and is used as a full-service
operation providing both full-case and less-than-case merchandise distribution,
similar to the primary Omaha facility.
Expansion of the ShopKo distribution center in Omaha, Nebraska is
scheduled for completion in July 2004. The expansion of the current ShopKo
facility will add 135,000 square feet and accommodate the consolidation of the
Pamida distribution operations located in Omaha into the automated ShopKo
facility. This move will include investment in expanding conveyors, fixtures,
and
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systems. Most importantly, however, the move will help the company better serve
its customers in a much more efficient manner. After the transfer of
distribution activities to the newly expanded distribution facility the Company
plans to close the Pamida Omaha facility and offer it for sale. The operation of
Pamida's Lebanon, Indiana distribution center is not expected to be affected by
this project.
Pamida's reverse logistics operations, consisting of vendor returns and
non-saleable salvage returns from stores, were consolidated into the Pamida
distribution centers to provide more efficient reverse logistics processing. The
vacant returns processing facility is for sale.
MANAGEMENT INFORMATION SYSTEMS - PAMIDA RETAIL
Similar to ShopKo, Pamida employs integrated retail information
systems, including merchandise procurement, inventory management, automated
replenishment, merchandise and space planning, warehouse management, pharmacy
management and point of sale.
In fiscal 2002, the Company consolidated Pamida's data center and
selected information technology support functions into the corporate
headquarters in Green Bay, Wisconsin. In addition, during fiscal 2002, Pamida
completed a major upgrade of its core buying system and is in the process of
implementing a centralized pharmacy claims management system. Pamida will
continue to upgrade and enhance its existing information systems, while seeking
opportunities to leverage future technology investments in conjunction with the
ShopKo division.
EXPANSION - PAMIDA RETAIL
On June 29, 2000, the Company acquired the retail chain, P.M. Place
Stores Company ("Places"), which operated 49 discount stores in Missouri, Iowa,
Kansas, and Illinois. Forty-eight of these stores were reopened as Pamida
stores, and one Places store, located in an existing Pamida location, was
closed. During fiscal 2000, Pamida opened 76 new stores, including the 48
converted Places stores, and closed four stores. Between fiscal 2001 and fiscal
2003, the Company opened two new stores and closed 13 stores, decreasing the
total number of Pamida stores to 218 as of January 31, 2004.
The Company has announced plans to open three new Pamida stores and
relocate an existing Pamida store in fiscal 2004. In addition, the Company plans
to acquire pharmacy customer lists to expand its retail pharmacy business or may
acquire pharmacy locations to expand the Pamida store base. Pamida is using an
inexpensive alternative of leasing existing vacant retail locations for
expansion and growth. The risks associated with this alternative will be
minimized through the negotiation of shorter lease terms and options for lease
extensions.
The Company has identified certain communities as potential sites for
Pamida stores and in which it believes it can achieve an attractive market
position. There is, however, no assurance that the Company will open stores in
such communities or on any particular time schedule. Pamida will also continue
to evaluate other merchandise mix and store formats.
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COMPETITION - PAMIDA RETAIL
The general merchandise retail business is highly competitive. Pamida's
stores generally compete with other general merchandise retailers, supermarkets,
drug and specialty stores, mail order and catalog merchants, Internet retailers
and, in some communities, department stores. The type and degree of competition
and the number of competitors with which Pamida's stores compete vary by market.
Pamida stores generally are located in small towns where there is
little direct local competition from another major general merchandise retailer
in the town, and which may be either too small to support more than one major
general merchandise retailer (thereby creating a potential barrier to entry by a
major competitor) or too small to attract competitors whose stores generally are
designed to serve larger populations.
The percentage of Pamida stores where national general merchandise
discount chains are present (within 10 miles) is as follows:
- - Wal-Mart 13%
- - Kmart 7%
- - Target 3%
In recent years Pamida's business strategy has been to focus its store
expansion program on communities with less likelihood of the entry of a new
major competitor, but there can be no assurance that in the future major
competitors will not open additional stores in Pamida's markets.
SEASONALITY - PAMIDA RETAIL
Pamida's business, like that of most other general merchandise
retailers, is seasonal. First quarter sales are lower than sales during the
other three fiscal quarters, while second and fourth quarter sales have
contributed a significant part of the segment's earnings, with the latter due to
the Christmas selling season.
CONSOLIDATED
EMPLOYEES
The Company employs approximately 19,000 persons in its ShopKo
division, of whom approximately 7,800 are full-time employees and 11,200 are
part-time employees and approximately 6,500 persons in its Pamida division, of
whom approximately 3,200 are full-time employees and 3,300 are part-time
employees. During the Christmas shopping season, the Company typically employs
additional persons on a temporary basis. No employees of the Company are covered
by collective bargaining agreements.
14
GOVERNMENT REGULATION
The Company's pharmacy and optical services businesses are subject to
extensive federal and state laws and regulations governing, among other things:
Licensure and Regulation of Retail Pharmacies and Optical Centers
There are extensive federal and state regulations applicable to the
practice of pharmacy and optometry at the retail level. Most states have laws
and regulations governing the operation and licensing of pharmacies and optical
centers, and regulate standards of professional practice by pharmacy and optical
service providers. These regulations are issued by an administrative body in
each state, typically a pharmacy board or board of optometry, which is empowered
to impose sanctions for non-compliance.
Future Legislative Initiatives
Legislative and regulatory initiatives pertaining to such healthcare
related issues as reimbursement policies, payment practices, therapeutic
substitution programs, and other healthcare cost containment issues are
frequently introduced at both the state and federal level. The Company is unable
to predict accurately whether or when legislation may be enacted or regulations
may be adopted relating to the Company's pharmacy and optical services
operations or what the effect of such legislation or regulations may be.
Substantial Compliance
The Company's management believes the Company is in substantial
compliance with, or is in the process of complying with, all existing statutes
and regulations material to the operation of the Company's pharmacy and optical
services businesses and, to date, no state or federal agency has taken
enforcement action against the Company for any material non-compliance, and to
the Company's knowledge, no such enforcement against the Company is presently
contemplated.
FORWARD-LOOKING STATEMENTS AND RISK FACTORS
In accordance with the Private Securities Litigation Reform Act of
1995, the Company can obtain a "safe-harbor" for forward-looking statements by
identifying those statements and by accompanying those statements with
cautionary statements which identify factors that could cause actual results to
differ from those in the forward-looking statements. Accordingly, the following
information contains or may contain forward-looking statements: (1) information
included or incorporated by reference in this Annual Report on Form 10-K,
including, without limitation, statements made under Item 1, Business, and under
Item 7, Management's Discussion and Analysis of Financial Condition and Results
of Operations, (2) information included or incorporated by reference in future
filings by the Company with the Securities and Exchange Commission ("SEC")
including, without limitation, statements with respect to growth, acquisition
and expansion plans, store layouts and evolving prototypes, financing plans and
projected sales, revenues, earnings, costs and capital expenditures, and (3)
information contained in written material, releases and oral statements issued
by, or on behalf of, the Company including, without limitation, statements with
respect to growth, acquisition and expansion plans, store layouts and evolving
prototypes, financing plans and projected sales, revenues, earnings, costs and
capital expenditures. The Company's actual results may differ materially from
those contained in the forward-looking statements identified
15
above. Factors which may cause such a difference to occur include, but are not
limited to, (i) the impact of recent accounting pronouncements as described
herein, (ii) the risk factors described below, and (iii) other risks described
from time to time in the Company's SEC filings.
An investment in ShopKo's Common Stock or other securities carries
certain risks. Investors should carefully consider the risks described below and
other risks, which may be disclosed from time to time in ShopKo's filings with
the SEC, before investing in ShopKo's Common Stock or other securities.
The Company has a significant amount of debt, which could adversely
affect its business and growth prospects. At January 31, 2004, the Company had
approximately $393.1 million of total debt and lease obligations, including
$82.3 million outstanding on an amended and restated senior secured revolving
credit facility (the "Amended Secured Credit Facility"). The restrictions and
limitations in the Amended Secured Credit Facility, as well as the significant
amount of debt in general, could have material adverse effects on the Company's
business. For example, it:
- makes it more difficult for the Company to obtain additional financing
on favorable terms,
- restricts capital expenditures,
- requires the Company to dedicate a substantial portion of its cash
flows from operations to the repayment of its debt and the interest on
its debt,
- limits the Company's ability to open new stores or to make
acquisitions,
- limits the Company's ability to capitalize on significant business
opportunities,
- makes the Company more vulnerable to economic downturns, adverse retail
industry conditions and competitive pressures, and subjects the Company
to certain covenants which restrict its ability to operate its
business.
The Company finances a significant portion of its operations through
vendor financing. The credit terms provided by the Company's vendors are an
important source of financing for the Company's operations. Future operating
performance could negatively impact the favorable credit terms the Company now
maintains with these vendors. If the credit terms provided to the Company by a
significant portion of its vendors were to deteriorate, the Company would be
materially adversely affected.
The Company may not achieve the expected benefits of current or future
reorganizations. During the fourth quarter of fiscal 2000, the Company announced
a strategic reorganization plan to improve the productivity of its assets and
reduce debt. The plan included store and distribution center closings and a
charge to earnings of approximately $125 million. The Company believes that
implementation of the plan has resulted in an increase in the Company's
profitability and efficiency. However, the analysis underlying this plan
involved many variables and uncertainties. Based on the overall softness in the
real estate market and an independent valuation analysis, the Company determined
that an additional $6.0 million should be added to the reserve in the fourth
quarter of 2002. The Company may not achieve all of the expected benefits of its
plan and additional charges may be necessary in the future. There can be no
assurances that additional reorganizations of this nature, together with related
charges to earnings, will not be required in the future to improve the
productivity and efficiency in the Company's ShopKo and Pamida segments. Such
reorganizations and charges to earnings could have a material adverse effect on
our financial position or results of operations.
16
The Company may be unable to execute its expansion plans, which may
have a significant adverse effect on its financial performance and its growth
strategy and prospects. The Company considers expansion in the number of its
retail stores, in one format or another, to be an integral part of its plan to
achieve projected operating results in future years. The Company expects that
any new stores will typically require an extended period of time to reach the
sales and profitability levels of its existing stores. The opening of any new
stores does not ensure that those stores will ever be as profitable as existing
stores, especially when those new stores are opened in highly competitive
markets. The failure to expand by opening new retail stores as planned and the
failure to generate anticipated sales and earnings growth in markets where new
stores are opened could have a material adverse effect on the Company's future
sales growth and profitability.
If the Company is not able to remodel its existing store base on
schedule or to carry out such plans in a cost-effective manner, then the
Company's results of operations and financial condition could be materially
adversely affected. The Company believes that the identification of new store
designs to fit its customers' changing lifestyles and preferences and the
remodeling of its stores is a necessary aspect of its growth plans. The failure
to upgrade the Company's existing retail stores could have a material adverse
effect on the Company's anticipated sales and profitability. To the extent the
Company is able to upgrade its existing stores, the associated expenses could
result in a significant impact on our net income in the future and there can be
no assurance that these upgrades will generate any of the anticipated benefits.
The Company's quarterly performance fluctuates, which may cause
volatility or a decline in the price of its securities. Fluctuations in the
Company's quarterly operating results have occurred in the past and may occur in
the future based on a variety of factors, including:
- seasonality in the Company's operations, especially during the
Christmas selling season which has historically contributed a
significant part of the Company's earnings and primarily impacts
the fourth fiscal quarter,
- inventory imbalances caused by unanticipated fluctuations in consumer
demand or inefficiencies in the Company's distribution centers and
methods,
- margin rate compression resulting from competitive pricing pressure,
- increases and decreases in advertising and promotional expenses,
- changes in the Company's product mix,
- the ability to manage operating expenses, and
- the competitive and general economic conditions discussed below.
These fluctuations could cause the Company's operating results to vary
considerably from quarter to quarter and could materially adversely affect the
market price of its securities.
Competition in the retail industry could limit ShopKo's growth
opportunities and reduce its profitability. The Company competes in the discount
retail merchandise business. This business is highly competitive. The
competitive environment subjects the Company to the risk of reduced
profitability. The Company competes with other discount retail merchants as well
as mass merchants, catalog merchants, internet retailers and other general
merchandise, apparel and
17
household merchandise retailers. The discount retail merchandise business is
subject to excess capacity and some of the Company's competitors are much larger
and have substantially greater resources than the Company. The competition for
customers and store locations has intensified in recent years as larger
competitors, such as Wal-Mart, Kmart and Target, have moved into the Company's
geographic markets. The Company expects a further increase in competition from
these national discount retailers. There can be no assurance the Company will be
able to continue to compete successfully.
The long-term economic effects of U.S. and international political
unrest and an extended economic slowdown could negatively affect the Company's
financial condition. The ongoing military operations in Iraq, terrorist attacks,
the national and international responses to terrorist attacks and other acts of
war or hostility have created many economic uncertainties. These events could
adversely affect the Company's business and operating results in ways that
presently cannot be predicted. If terrorist attacks, political unrest,
international conflict or other factors cause further overall economic decline,
the Company's financial condition and operating results could be materially
adversely affected.
General economic conditions and adverse weather could have a
significant adverse effect on the Company's business. The Company operates its
retail stores in limited regions of the country. To the extent adverse economic
conditions and weather have a regional impact on the regions in which the
Company operates, the Company may be disproportionately affected compared to
peers that have a larger, national base of operations. General economic factors
in the regions in which the Company operates that are beyond its control may
materially adversely affect its forecasts and actual performance. The factors
that may materially adversely affect its forecasts and actual performance
include energy prices, interest rates, recession, inflation, deflation, consumer
credit availability, consumer debt levels, tax rates and policy, unemployment
trends and other matters that influence consumer confidence and spending.
Increasing volatility in financial markets may cause these factors to change
with a greater degree of frequency and magnitude. Because the Company's business
is subject to adverse weather conditions in its retail markets, particularly in
the Midwest, Western Mountain and Pacific Northwest regions, its operating
results may be unexpectedly and materially adversely affected. Frequent or
unusually heavy snow, ice or rain storms in its markets could have a material
adverse effect on its sales and earnings.
The Company is dependent on the smooth functioning of its
distribution network. The Company relies upon the ability to replenish its
depleted inventory through deliveries to its distribution centers from vendors,
and from the distribution centers to its stores and, to a limited extent,
direct-to-store deliveries from vendors. Problems that cause delays or
interruptions in the distribution network could have a material adverse effect
on the Company's business and results of operations.
Labor conditions may have a material adverse impact on its performance.
If the Company cannot attract and retain quality employees, its business will
suffer. The Company depends on attracting and retaining quality employees. Many
of its employees are in entry level or part-time positions with historically
high rates of turnover. The Company may be unable to meet its labor needs while
controlling costs due to external factors such as unemployment levels, minimum
wage legislation and changing demographics.
Anti-takeover provisions in the Company's organizational documents and
statutes may inhibit premium offers for its common stock. Anti-takeover
provisions in its amended and restated articles of incorporation, by-laws and
Wisconsin law and its shareholder rights agreement (See Exhibit 4.2) may deter
unfriendly offers or other efforts to obtain control of the Company. This could
make the
18
Company less attractive to a potential acquirer and deprive its shareholders of
opportunities to sell their shares of common stock at a premium price.
Pending or future changes in federal, state or local laws or
regulations could negatively impact the Company. Various aspects of the
Company's operations are subject to federal, state and local laws, rules and
regulations. Any of these laws, rules or regulations could change at any time.
Such changes could have the effect of increasing the Company's exposure to
liabilities, increasing the cost of operations or restricting the ability to set
prices. This is especially true with respect to our pharmacy business, which
could be subject to any number of legislative proposals regarding prescription
drugs.
Pending or future litigation could subject the Company to significant
monetary damages. If the Company becomes subject to liability claims that are in
excess of its insurance coverage or are not covered by its insurance policies,
the Company may be liable for damages and other expenses which could have a
material adverse effect on its business, operating results and financial
condition. In addition, any claims against the Company, regardless of merit or
eventual outcome, may have a material adverse effect on its reputation and
business. The sale of retail merchandise and provision of in-store pharmacy and
optical services entail a risk of litigation and liability. The Company is
currently subject to a number of lawsuits, and expects that from time to time it
will be subject to similar suits in the ordinary course of business. The Company
currently maintains insurance intended to cover a majority of liability claims,
subject to a $250,000 deductible for general liability claims and for liability
claims arising from prescription dispensing errors. The Company believes that
its insurance coverage is adequate. The Company cannot assure that it will be
able to maintain appropriate types or levels of insurance in the future, that
adequate replacement policies will be available on acceptable terms, or that
insurance will cover all claims against the Company.
19
ITEM 2. PROPERTIES
As of January 31, 2004, the Company operated 141 ShopKo retail stores
in 15 Midwest, Western Mountain and Pacific Northwest states. The following
table sets forth the geographic distribution of these ShopKo stores as of the
indicated date:
# OF
STATE STORES
----- ------
California 1
Colorado 3
Idaho 9
Illinois 10
Iowa 5
Michigan 4
Minnesota 13
Montana 5
Nebraska 11
Nevada 3
Oregon 4
South Dakota 6
Utah 15
Washington 10
Wisconsin 42
TOTAL 141
===
As of January 31, 2004, the Company operated 218 Pamida retail stores
in 16 Midwest, North Central and Rocky Mountain states. The following table sets
forth the geographic distribution of the present Pamida stores:
# OF
STATE STORES
----- ------
Illinois 8
Indiana 10
Iowa 41
Kansas 5
Kentucky 9
Michigan 19
Minnesota 26
Missouri 23
Montana 6
Nebraska 14
North Dakota 7
Ohio 13
South Dakota 6
Tennessee 4
Wisconsin 18
Wyoming 9
TOTAL 218
===
Of the Company's 359 ShopKo and Pamida retail stores at January 31,
2004 the number of stores owned and leased are listed below:
OWNS BUILDING SUBJECT
OWNS LAND AND TO GROUND LEASES LAND
BUILDING OUTRIGHT LEASE AND BUILDING TOTAL
----------------- --------------------- ------------ -----
ShopKo Stores 113 * 7 21 141
Pamida Stores 63 1 154 218
Total 176 8 175 359
* Fifteen of which are subject to mortgages.
The ground leases expire at various dates ranging from 2006 through
2018 and the other leases expire at various dates ranging from 2004 through
2038.
20
As of January 31, 2004, the Company's other principal properties were
as follows:
SQ. FT OF
BUILDING
LOCATION USE SPACE TITLE
-------- --- ----- -----
Green Bay, WI ShopKo Corporate Headquarters 228,000 Owned
Lawrence, WI Vacant / Available for Sale 114,300 Owned
De Pere, WI ShopKo Distribution Center / Return Center 494,000 Owned
Boise, ID ShopKo Distribution Center 347,000 Owned
Omaha, NE ShopKo Distribution Center 394,000 Owned
Ashwaubenon, WI ShopKo Optical Lab 29,000 Owned
Omaha, NE Pamida Corporate Headquarters 215,000 Owned
Omaha, NE Pamida Distribution Center * 336,000 Owned
Lebanon, IN Pamida Distribution Center 418,000 Leased
Omaha, NE Vacant / Available for Sale 40,000 Owned
* After the consolidation of distribution activities to the newly expanded
ShopKo distribution facility in Omaha, the Company plans to close the
Pamida Omaha facility and offer it for sale.
21
ITEM 3. LEGAL PROCEEDINGS
In the normal course of business, the Company has been named as a
defendant in various lawsuits. Some of these lawsuits involve claims for
substantial amounts. Although the ultimate outcome of these lawsuits cannot be
ascertained at this time, it is the opinion of management, after consultation
with counsel, that the resolution of such suits will not have a material adverse
effect on the consolidated financial statements of the Company.
In addition, the Company has been involved in two purported class
action lawsuits. First, during fiscal 2000, the Company was added as a defendant
in a purported class action (the "ProVantage Action") filed May 8, 2000 in the
Circuit Court of the State of Wisconsin for Waukesha County by James Jorgensen
(Allen v. ProVantage Health Services; Case No. 00CV-938), an alleged stockholder
of ProVantage Health Services, Inc. ("ProVantage"). The original complaint in
the ProVantage Action (the "Original Complaint") named ProVantage and the
directors of ProVantage as defendants (the "Original Defendants") and alleged,
among other things, that (1) ProVantage's directors breached their fiduciary
duties in connection with the sale of ProVantage to Merck & Co., Inc. ("Merck"),
and (2) the proposed price for ProVantage's common stock did not represent the
true value of ProVantage.
On or about August 18, 2000, an amended complaint (the "Amended
Complaint") was filed in the ProVantage Action which, among other things, added
the Company as a defendant. This matter was settled by all parties and the Court
issued its Notice of Entry of Final Judgment and Order of Dismissal on January
26, 2004. Settlement of the matter was not material to the Company's results of
operations.
Second, during fiscal 2001, alleged shareholders of the Company filed
purported class action securities lawsuits against the Company and its then
chief executive officer containing substantially identical claims in the Federal
District Court for the Eastern District of Wisconsin. The suits were
consolidated into one action (In Re ShopKo's Securities Litigation No. 01-C-1034
(E.D. Wis.)). The action alleges that the Company and its former chief executive
officer, William Podany, made various misrepresentations and omissions in public
disclosures concerning the Company between March 9, 2000 and November 9, 2000.
Specifically, it is alleged that the Company failed to disclose that the Company
was experiencing significant shipping and inventory control problems at the
Pamida distribution facility in Lebanon, Indiana. The complaints request, among
other things, that the court declare the action is a proper class action and
award compensatory monetary damages, including reasonable attorneys' fees and
experts' fees. On or about February 5, 2003, the Court granted, in part, the
Company's motion to dismiss the action, ruling that all allegations are
dismissed except those based on statements made in connection with an earnings
warning on October 5, 2000. The plaintiffs' Third Amended Complaint seeks to
expand the class period from August 10 - November 9, 2000. Discovery in this
matter continues, following which the defendants will file motions in response
to the Third Amended Complaint and certain other matters. The Company believes
this matter to be without merit and the Company intends to contest all
allegations set forth. There can be no assurances, however, with regard to the
outcome of the matter.
22
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of the security holders of
Registrant during the fourth quarter of fiscal year 2003.
EXECUTIVE OFFICERS OF THE REGISTRANT
SERVED IN EMPLOYED
CURRENT BY THE
POSITION COMPANY
NAME AGE* POSITION** SINCE SINCE
---- ---- ---------- ----- -----
Sam K. Duncan 52 President and Chief Executive Officer 2002 2002
Jeffrey C. Girard 56 Vice Chairman, Finance and Administration 2002 2002
Steven R. Andrews 51 Senior Vice President, Law & Human 2003 2002
Resources, General Counsel
Brian W. Bender 55 Senior Vice President, Chief Financial Officer 2000 2000
Michael J. Bettiga 50 Senior Vice President, Retail Health Operations 2003 1977
Dan J. Bolstad 51 Senior Vice President, Store Operations and 2003 2003
Logistics
Michael J. Hopkins 53 President, Pamida Division 1999 1995
Rodney D. Lawrence 46 Senior Vice President, Property Development 1996 1996
Matthew J. Lynch 44 Senior Vice President, Chief Information Officer 2003 1998
Paul G. White 47 Senior Vice President, General Merchandise
Manager - Softlines 2003 2003
Douglas N. Wurl 42 Senior Vice President, General Merchandise
Manager - Hardlines and Home 2003 2000
* as of January 31, 2004
** as of March 28, 2004
There are no family relationships between or among any of the directors
or executive officers of the Company.
The term of office of each executive officer is from one annual meeting
of the directors until the next annual meeting of directors or until a successor
for each is selected.
There are no arrangements or understandings between any of the
executive officers of the Company and any other person (not an officer or
director of the Company acting as such) pursuant to which any of the executive
officers were selected as an officer of the Company.
23
Each of the executive officers of the Company has been in the employ of
the Company for more than five years, except for Sam K. Duncan, Steven R.
Andrews, Brian W. Bender, Dan J. Bolstad, Jeffrey C. Girard, Matthew J. Lynch,
Paul G. White and Douglas N. Wurl.
Mr. Duncan has been President, Chief Executive Officer since October
2002. Prior to joining ShopKo, Mr. Duncan most recently served as President of
Fred Meyer Corporation, a large general merchandise and food retailer and a
division of Kroger, Inc., from February 2001 to October 2002. From 1969 to 1991,
Mr. Duncan served in numerous roles for Albertson's, eventually being named
Albertson's director of operations in 1991. He joined Fred Meyer in 1992 as Vice
President Grocery department and was promoted through the executive
merchandising ranks. Mr. Duncan was named Executive Vice President of Fred
Meyer's food division in 1997. In 1998, Fred Meyer Corporation acquired Ralph's
Super Markets and Mr. Duncan was named President of Ralph's Super Markets,
serving in that position from 1998 to 2001.
Mr. Andrews was promoted to Senior Vice President, Law and Human
Resources and General Counsel in June 2003. He had been Senior Vice President,
General Counsel since joining the Company in October 2002. Prior to joining
ShopKo, Mr. Andrews was Senior Vice President, General Counsel and Secretary of
PepsiAmericas, Inc. (formerly Whitman Corporation) from May 1999 to August 2001.
Before joining Whitman, Mr. Andrews was the interim President and Chief
Executive Officer of Multigraphics, Inc. from February to May of 1999 and Vice
President, General Counsel and Secretary of Multigraphics from 1994 to 1999.
Multigraphics was a worldwide manufacturer and distributor of graphic arts and
printing products.
Mr. Bender has been Senior Vice President, Chief Financial Officer
since October 2000. Prior to joining ShopKo, Mr. Bender most recently served as
Vice President and Chief Financial Officer at Egghead.com from November 1996 to
December 1999. Mr. Bender also served in that role at Egghead.com from May 1995
to May 1996. Mr. Bender was Senior Vice President and Chief Financial Officer at
Proffitt's, Inc. in 1996 and Senior Vice President and Controller at Younkers,
Inc. from 1993 to 1995. From 1976 to 1993, Mr. Bender served in numerous roles
for May Department Stores and its divisions, including Corporate Vice President
for Capital Planning and Analysis at May from 1987 to 1989; and Senior Vice
President and Chief Financial Officer at Sibley's from 1989 to 1990 and at May
D&F from 1990 to 1993.
Mr. Bolstad joined ShopKo Stores in March 2003 as Senior Vice
President, Store Operations and Logistics. Prior to joining ShopKo, Mr. Bolstad
most recently served as Senior Vice President, Operations Group of Fred Meyer
Corporation, a large general merchandise and food retailer and a division of
Kroger, Inc., from October 2000 to February 2003. He joined Fred Meyer in 1976
as a store management trainee and was promoted to local, district, regional and
corporate store operations leadership positions. In 2000, he assumed
responsibility for logistics management of all Fred Meyer businesses.
Mr. Girard has been a director of the Company since June 1991.
Effective April 9, 2002, Mr. Girard became the Vice Chairman, Finance and
Administration and Interim Chief Executive Officer of the Company, a role he
held until Mr. Duncan joined the Company in October 2002. Mr. Girard continues
in the role of Vice Chairman, Finance and Administration. Prior to joining the
Company, Mr. Girard was the President of Girard & Co. of Minneapolis, Minnesota,
a private consulting company, from 1999 to 2002 and from 1997 to 1999 was an
Adjunct Professor at the Carlson School of Management, University of Minnesota.
He served as Executive Vice President and Chief Financial Officer of Supervalu,
Inc. from October 1992 through July 1997; prior thereto, he held the positions
of Executive Vice President, Chief Financial Officer and Treasurer of
Supermarkets
24
General Holdings Corporation and Senior Vice President and Chief Financial
Officer of Supervalu, Inc.
Mr. Lynch has been Senior Vice President, Chief Information Officer
since October, 2003. Mr. Lynch joined the Company in 1998 as Vice President,
Operations and Technology Services. From 1993 to 1998, Mr. Lynch served as Vice
President, Information and Technology Services for Runzheimer International.
Prior to that, Mr. Lynch held various information systems management positions
since 1985 with Air Wisconsin Airlines, America West Airlines and Honeywell,
Aerospace Electronics Systems.
Mr. White has been Senior Vice President, General Merchandise Manager -
Softlines since October, 2003. Prior to joining the Company, Mr. White was with
the Famous-Barr division of May Department Stores from 1995 to 2003. Most
recently he was Senior Vice President, Advertising and Sales Promotion from
August, 1998 to June, 2003. Prior to that, Mr. White held several senior
management and merchandising positions since 1985 with The May Department
Stores, Federated Department Stores and Elder Beerman Department Stores.
Mr. Wurl is currently Senior Vice President, General Merchandise
Manager - Hardlines and Home. He has had responsibility for the Home segment
since December 2001, and in January 2003, he assumed responsibility for the
Hardlines segment as well. He was Vice President, Division Merchandise Manager
since he joined the Company in May 2000. From 1998 to May 2000, Mr. Wurl served
as Vice President Merchandise Manager for Rich's Department Store, a division of
Federated Department Stores. Prior to that, Mr. Wurl was Director of Merchandise
and Product Development for Home Textiles for Federated Merchandising Group, a
division of Federated Department Stores from 1993-1998. From 1983 to 1993, Mr.
Wurl held various positions with divisions of May Department Stores.
25
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER
MATTERS
ShopKo Stores, Inc. common shares are listed on the New York Stock
Exchange under the symbol "SKO" and in the newspapers as "ShopKo." As of April
02, 2004, ShopKo's common shares were held by 2,472 record owners.
The following table sets forth the high and low reported closing sales
prices for the Common Stock for the last two fiscal years as reported on the New
York Stock Exchange Composite Tape.
HIGH LOW
--------- ---------
FISCAL YEAR 2002
First Quarter (ended May 4, 2002) $ 22.4800 $ 12.5100
Second Quarter (ended August 3, 2002) $ 21.4600 $ 15.1500
Third Quarter (ended November 2, 2002) $ 17.0000 $ 11.0000
Fourth Quarter (ended February 1, 2003) $ 16.2100 $ 10.7600
FISCAL YEAR 2003
First Quarter (ended May 3, 2003) $ 12.2000 $ 10.0800
Second Quarter (ended August 2, 2003) $ 14.2300 $ 11.0800
Third Quarter (ended November 1, 2003) $ 16.6700 $ 12.1900
Fourth Quarter (ended January 31, 2004) $ 17.0100 $ 14.0000
The closing sales price of the Common Stock on the New York Stock
Exchange on April 02, 2004 was $14.58 per share.
The Company's Amended Secured Credit Facility (see Note D of the Notes
to the Consolidated Financial Statements) has a restrictive covenant that limits
the payment of dividends. The Company has not paid any cash dividends in the
last two years. The Company currently intends to retain earnings for future
growth and expansion of its business and the payment of debt, and not to declare
or pay any cash dividends. Management will continue to evaluate the use of
dividends and stock repurchase practices.
Equity Compensation Plan Information
------------------------------------------------------------------------------
(a) (b) (c)
--- --- ---
Number of securities Number of securities remaining
to be issued upon Weighted-average available for future issuance
exercise of exercise price of under equity compensation
outstanding options, outstanding options, plans (excluding securities
Plan Category warrants and rights warrants and rights reflected in column (a))
- ---------------------------------- -------------------- -------------------- ------------------------------
Equity compensation plans approved
by security holders 2,511,869 $16.29 861,305
Equity compensation plans not
approved by security holders - 0 - - 0 - - 0 -
-------------------- -------------------- ------------------------------
Total 2,511,869 $16.29 861,305
==================== ==================== ==============================
26
ITEM 6. SELECTED FINANCIAL DATA
FISCAL YEARS ENDED
-----------------------------------------------------------------
Jan. 31 Feb. 1, Feb. 2, Feb. 3, Jan. 29,
2004 2003 2002 2001 2000
(52 Wks) (52 Wks) (52 Wks) (53 Wks) (2) (52 Wks) (1)
-------- -------- -------- ------------ ------------
Summary of Operations (Millions)
Net sales $ 3,184 $ 3,240 $ 3,374 $ 3,517 $ 3,048
Licensed department rentals and other income 13 13 13 13 14
Gross margin 818(10) 833 806 865(3) 790
Selling, general and administrative expenses 645(10) 636 612 674 568
Special charges -0- -0- -0- 9(4) 8(4)
Restructuring charge -0- 6 -0- 115(3) -0-
Depreciation and amortization expenses 83 83 92 94 75
Interest expense - net 38 52 66 66 54(5)
Earnings (loss) from continuing operations before
income taxes 64 68 50 (79) 98
Earnings (loss) from continuing operations 39 41 28 (50) 59
Discontinued operations - net -0- -0- -0- 34 43
Earnings (loss) before accounting change 39 41 28 (16) 102
Net earnings (loss) 39 (145)(6) 28 (16) 102
Per Share Data (Dollars)
Basic earnings (loss) per common share from
continuing operations $ 1.35 $ 1.43 $ 0.98 $ (1.72) $ 2.22
Basic net earnings (loss) per common share 1.35 (5.03) 0.98 (0.55) 3.62
Diluted earnings (loss) per common share from
continuing operations 1.33 1.41 0.98 (1.72) 2.19
Diluted net earnings (loss) per common share 1.33 (4.95) 0.98 (0.55) 3.57
Cash dividends declared per common share (7) -0- -0- -0- -0- -0-
Financial Data (Millions)
Working capital $ 73 $ 69 $ 121 $ 182 $ 95
Property and equipment-net 781 812 892 974 878
Total assets 1,478 1,505 1,820 2,027 1,953
Long-term debt & capital lease obligations 311 415 585 665 454
Total debt (8) 393 455 633 836 699
Total shareholders' equity 591 548 690 662 695
Capital expenditures 61 31 17 196 133
Financial Ratios
Current ratio 1.1 1.1 1.2 1.3 1.1
Return on beginning assets 2.6% -8.0% 1.4% (0.8)% 7.7%
Return on beginning shareholders' equity 7.1% -21.0% 4.3% (2.3)% 22.2%
Total debt as % of total capitalization (9) 39.0% 44.5% 47.0% 55.0% 48.6%
Other Year End Data
ShopKo stores open at year end 141 141 141 164 160
Average ShopKo store size-square feet 91,009 91,009 91,009 90,175 89,545
Pamida stores open at year end 218 223 225 229 157
Average Pamida store size-square feet 33,468 33,311 33,282 33,232 36,055
(1) Includes the results of the Pamida retail store chain acquired in July,
1999.
(2) Includes the results of P.M. Place stores acquired in June, 2000.
(3) The total restructuring charge of $125 million was recorded as inventory
liquidation charges of $10.4 million shown in the Gross margin line and
Restructuring charge of $115 million shown separately.
(4) Special charges relates to various costs incurred in connection with
business acquisitions, including process and system integration, employee
retention and store conversions.
(5) Includes loss on retirement of debt of $6.2 million.
(6) Includes cumulative effect of accounting change of $186.1 million ($6.36
per dilutive share).
(7) The terms of the Company's Amended Secured Credit Facility limit the
Company's ability to pay dividends, based on availability.
(8) Total debt includes short-term debt, total long-term debt obligations and
capital leases.
(9) Total capitalization includes shareholders' equity, total debt and
non-current deferred income taxes.
(10) Includes effect of adoption of EITF No. 02-16, which resulted in an
increase to gross margin of $14.4 million, an increase to selling, general
& administrative expense of $19.2 million, and a decrease to pre-tax
earnings of $4.8 million.
27
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
EXECUTIVE SUMMARY
For fiscal 2003, diluted earnings per share were $1.33 compared with
earnings per share in fiscal 2002 of $1.41, before cumulative effect of an
accounting change related to the adoption of SFAS No. 142. In fiscal year 2003,
the adoption of Emerging Issues Task Force ("EITF") Issue No. 02-16, "Accounting
By a Customer (Including a Reseller) for Certain Consideration Received From a
Vendor" had a $2.9 million, or $0.10 per share, unfavorable impact on full year
net earnings.
Consolidated sales were $3,184.1 million compared with $3,240.2 million
last year. Consolidated comparable store sales decreased 1.6% from the prior
year. While the financial results were below last year, the Company made
important progress in several areas, including the implementation of store
remodeling programs, increased investment in technology and a reduction in debt
of $62.1 million, or 13.6%. The decline in debt resulted in $14.3 million lower
interest expense. For the year, consolidated gross margin as a percent of sales
was 25.7%, the same as last year and selling, general and administrative (SG&A)
expense as a percent of sales was 20.3% compared with 19.6% last year. The
capital expenditures for the year were $60.4 million compared with $30.9 million
last year.
The retail industry is highly competitive and the ShopKo division
competes in most of its markets with a variety of national and regional
retailers. Pamida's competition varies by market. The Retail Health category has
become an increasing percentage of the Company's sales. In fiscal 2003, retail
health sales made up 29.0% and 18.8% of ShopKo retail segment sales and Pamida
retail segment sales, respectively.
Generating sales growth is a Company priority. However, the Company
expects to be challenged by competitor store openings for the foreseeable
future. To address sales growth, the Company has initiated investments in the
Company's organizational and technological infrastructure as well as store
remodeling plans and is continuing store development plans to focus on our
strong Retail Health category and to strengthen performance in Hardlines/Home
and Softlines. Store remodeling and development plans include the addition of
pharmacies to certain existing Pamida stores, the opening of new Pamida stores,
and the development and opening of freestanding drug stores. Moreover, the
Company will continue to refine and adjust merchandising and advertising
strategies. There can be no assurance that such efforts will succeed.
Notwithstanding margin management and expense controls, operating profit has
been adversely affected by the decline in sales in recent years, making
continued focus on margin and expenses a management priority as well.
28
RESULTS OF OPERATIONS
The following table sets forth items from our Consolidated Statements
of Operations as percentages of consolidated net sales:
FISCAL YEARS ENDED
---------------------------------------------
JAN. 31, 2004 FEB. 1, 2003 FEB. 2, 2002
(52 WEEKS) (52 WEEKS) (52 WEEKS)
------------- ------------ ------------
Revenues:
Net sales 100.0% 100.0% 100.0%
Licensed department rentals and other income 0.4 0.4 0.4
------------- ------------ ------------
100.4 100.4 100.4
Costs and Expenses:
Cost of sales 74.3 74.3 76.1
Selling, general and administrative expenses 20.3 19.6 18.2
Restructuring charge 0.0 0.2 0.0
Depreciation and amortization expenses 2.6 2.6 2.7
------------- ------------ ------------
97.2 96.7 97.0
------------- ------------ ------------
Earnings from operations 3.2 3.7 3.4
Interest expense - net 1.2 1.6 1.9
------------- ------------ ------------
Earnings before income taxes 2.0 2.1 1.5
Provision for income taxes 0.8 0.8 0.7
------------- ------------ ------------
Earnings before accounting change 1.2% 1.3% 0.8%
============= ============ ============
The Company's reportable segments are based on the Company's strategic
business operating units and include a ShopKo Retail segment and a Pamida Retail
segment, each of which includes the following product categories:
hardlines/home, softlines and retail health/pharmacy.
The following tables set forth items from the Company's business
segments as percentages of net sales:
SHOPKO RETAIL SEGMENT
FISCAL YEARS ENDED
---------------------------------------------
JAN. 31, 2004 FEB. 1, 2003 FEB. 2, 2002
(52 WEEKS) (52 WEEKS) (52 WEEKS)
------------- ------------ ------------
Revenues:
Net sales 100.0% 100.0% 100.0%
Licensed department rentals and other income 0.5 0.4 0.4
------------- ------------ ------------
100.5 100.4 100.4
Costs and Expenses:
Cost of sales 74.4 74.3 75.3
Selling, general and administrative expenses 18.9 17.7 16.6
Depreciation and amortization expenses 2.5 2.4 2.5
------------- ------------ ------------
95.8 94.4 94.4
Earnings from operations 4.7% 6.0% 6.0%
============= ============ ============
29
PAMIDA RETAIL SEGMENT
FISCAL YEARS ENDED
--------------------------------------
JAN. 31, FEB. 1, FEB. 2,
2004 2003 2002
(52 WEEKS) (52 WEEKS) (52 WEEKS)
---------- ---------- ----------
Revenues:
Net sales 100.0% 100.0% 100.0%
Licensed department rentals and other income 0.2 0.2 0.2
---------- ---------- ----------
100.2 100.2 100.2
Costs and Expenses:
Cost of sales 74.2 74.2 78.5
Selling, general and administrative expenses 21.6 21.7 20.0
Depreciation and amortization expenses 2.9 2.9 3.2
---------- ---------- ----------
98.7 98.8 101.7
Earnings (loss) from operations 1.5% 1.4% (1.5)%
========== ========== ==========
FISCAL 2003 COMPARED TO FISCAL 2002
NET SALES
---------------------------------------------
% INCREASE/
FISCAL YEAR (DECREASE)
---------------------- -------------------
2003 2002 TOTAL ** COMP *
--------- --------- -------- -------
ShopKo Retail $ 2,383.5 $ 2,456.1 (3.0%) (3.0%)
Pamida Retail 800.6 784.1 2.1% 2.8%
--------- --------- -------- -------
Consolidated $ 3,184.1 $ 3,240.2 (1.7%) (1.6%)
========= ========= ======== =======
* Comparable store sales represent sales of those stores open during both fiscal
years.
** Pamida division total sales variance reflects sales in the prior year periods
from nine locations, which have been closed and not replaced, and two new Pamida
locations opened in September 2003.
The 3.0 percent decrease in ShopKo comparable store sales during fiscal
2003 was primarily related to the decreased general merchandise sales, as a
result of lower promotional sales and competitive store openings, partially
offset by increased sales in retail health services. Changes in ShopKo
comparable store sales in fiscal 2003 by category were as follows: Retail
Health, 4.5%; Hardlines, (7.5)%; and Softlines, (6.0)%. The 2.8 percent increase
in Pamida comparable store sales during fiscal 2003 was driven by increased
pharmacy and advertised sales, as a result of new convenience and value
merchandising and marketing efforts. Changes in Pamida comparable store sales in
fiscal 2003 by category were as follows: Pharmacy, 21.7%; Hardlines, (0.1)%; and
Softlines, (4.6)%. The increase in Pharmacy sales for the Pamida division is
inclusive of new pharmacy openings in existing stores and the purchase of
pharmacy customer lists in existing pharmacies.
30
EFFECT OF THE ADOPTION OF EITF NO. 02-16
EITF No. 02-16, as it applies to the Company, addresses the recognition
of certain vendor allowances and requires these allowances to be treated as a
reduction of inventory cost unless specifically identified as reimbursement for
services or other costs incurred. The adoption of EITF No. 02-16 by the Company
resulted in a reclassification of certain vendor allowances that increased net
advertising expense included in Selling, General and Administrative expenses
and, correspondingly, decreased Cost of Sales, resulting in increased gross
margin. In addition, the adoption of EITF No. 02-16 resulted in the deferral of
certain vendor allowances into inventory cost that cannot be recognized until
the merchandise is sold, which resulted in a negative effect on earnings.
The following table presents the effects of adopting EITF No. 02-16 for
fiscal 2003 (dollars in millions):
FISCAL YEAR ENDED
JANUARY 31, 2004
--------------------------
$ INCREASE / PERCENT OF
GROSS MARGIN (DECREASE) NET SALES*
- ------------- ------------ ----------
ShopKo Retail 17.8 .75
Pamida Retail (3.4) (.42)
------------
Consolidated 14.4 .45
============
SELLING, GENERAL &
ADMINISTRATIVE $ INCREASE / PERCENT OF
EXPENSES (DECREASE) NET SALES*
- ------------------ ------------ ----------
ShopKo Retail 22.1 .93
Pamida Retail (2.9) (.35)
------------
Consolidated 19.2 .61
============
$ INCREASE /
PRE-TAX EARNINGS (DECREASE)
- ---------------- ------------
ShopKo Retail (4.3)
Pamida Retail (0.5)
------------
Consolidated (4.8)
============
* Percent of net sales represent the dollar amount shown as a percent of ShopKo
Retail and Pamida Retail business segments or consolidated net sales,
respectively. Thus, the percents are not cumulative.
Consolidated gross margin as a percent of net sales was 25.7 percent
for both fiscal 2003 and fiscal 2002. Aside from the effect of EITF No. 02-16,
the Company's gross margin, as a percent of net sales, declined primarily due to
lower merchandise and pharmacy margins (77 basis points) and higher distribution
expense (17 basis points), offset by reduced shrink expense (48 basis points).
Consolidated gross margin dollars decreased 1.9 percent to $817.6 million for
the same period.
ShopKo's gross margin as a percent of net sales was 25.6 percent for
fiscal 2003 compared with 25.7 percent for fiscal 2002. Aside from the effect of
EITF No. 02-16, ShopKo's gross margin, as a percent of net sales, declined
primarily due to lower merchandise and pharmacy margins (90 basis points) and
increased distribution expense (23 basis points), offset by reduced
31
shrink expense. ShopKo's gross margin dollars decreased 3.2 percent to $610.8
million for the same period. Pamida's gross margin as a percent of net sales was
25.8 percent in fiscal 2003 and fiscal 2002. The gross margin rate was primarily
impacted by the negative effect of EITF No. 02-16 (42 basis points) and lower
merchandise and pharmacy margins (46 basis points), offset by reduced shrink
expense (101 basis points). Pamida's gross margin dollars increased 2.1 percent
to $206.7 million for the same period.
The Company uses the last-in, first-out (LIFO) method for substantially
all inventories. There was no LIFO charge or credit for fiscal 2003. There was
no difference between the LIFO and first-in, first-out (FIFO) cost methods at
January 31, 2004 and February 1, 2003. In fiscal 2002, the Company's LIFO
reserve was reduced by $2.9 million to zero, as a result of price index
deflation for various products in ending inventory.
Consolidated selling, general and administrative expenses as a percent
of net sales for fiscal 2003 were 20.3 percent compared with 19.6 percent in
fiscal 2002. ShopKo's selling, general and administrative expenses as a percent
of net sales for fiscal 2003 were 18.9 percent compared with 17.7 percent for
last year primarily attributable to the effect of EITF No. 02-16. Pamida's
selling, general and administrative expenses for fiscal 2003 were 21.6 percent
of net sales compared with 21.7 percent in fiscal 2002. The decrease is
primarily related to sales leveraging (45 basis points), the effect of EITF No.
02-16 (35 basis points) and lower insurance costs (31 basis points), offset by
increased payroll costs associated with pharmacy growth (60 basis points) and
additional costs associated with store closings, impairments and remodels (47
basis points).
Consolidated depreciation and amortization expenses as a percent of net
sales were 2.6 percent in both fiscal 2003 and fiscal 2002.
Interest expense for fiscal 2003 decreased 27.4 percent to $37.9
million when compared with fiscal 2002. The decrease was primarily due to lower
debt levels. The Company does not anticipate further significant reductions in
interest expense in future periods.
The Company's effective tax rate for fiscal 2003 was 38.9 percent
compared with 39.7 percent for fiscal 2002.
FISCAL 2002 COMPARED TO FISCAL 2001
The 1.1 percent decrease in ShopKo comparable store sales during fiscal
2002 was primarily the result of decreased general merchandise sales and
adjustments to the advertising calendar, partially offset by continued strong
sales in retail health services. Changes in ShopKo comparable store sales in
fiscal 2002 by category were as follows: Retail Health, 9.0%; Hardlines, (4.7)%;
and Softlines, (3.4)%. The 4.8 percent decrease in Pamida comparable store sales
reflected lower general merchandise sales, partially offset by strong pharmacy
sales. Changes in Pamida comparable store sales in fiscal 2002 by category were
as follows: Pharmacy, 17.5%; Hardlines, (8.1)%; and Softlines, (7.8)%. The
Company believes the soft retail environment, a decline in consumer confidence
and increased competition in certain markets, as well as an increasingly
promotional environment, especially in the fourth quarter, negatively affected
sales.
Consolidated gross margin as a percent of net sales for fiscal 2002 was
25.7 percent compared with 23.9 percent for fiscal 2001. Consolidated gross
margin dollars increased 3.4 percent to $833.3 million for the same period.
ShopKo's gross margin as a percent of net sales was
32
25.7 percent for fiscal 2002 compared with 24.7 percent for fiscal 2001. ShopKo
gross margins were favorably impacted by a reduction in the LIFO reserve of $1.9
million for fiscal 2002 and $11.1 million for fiscal 2001. The decrease in the
LIFO reserve resulted from significant deflation experienced in the price index
for various inventory products. ShopKo's gross margin dollars increased 0.7
percent to $630.8 million for the same period. The improvement in gross margin
as a percent of net sales was a result of a 63 basis point improvement in
merchandise margin rates, partially offset by the lower LIFO reserve reduction.
Pamida's gross margin as a percent of net sales was 25.8 percent for
fiscal 2002 compared with 21.5 percent for fiscal 2001. Pamida's gross margin
dollars increased 12.7 percent to $202.5 million for the same period. Pamida
Retail gross margins were favorably impacted by a reduction in the LIFO reserve
of $1.0 million for fiscal 2002 and $5.1 million for fiscal 2001. The decrease
in the LIFO reserve resulted from significant deflation experienced in the price
index for various inventory products. The 429 basis point improvement in
Pamida's gross margin as a percent of net sales was primarily attributable to
reduced shrink expense (204 basis points), better merchandise margin rates (200
basis points) and reduced distribution expense (44 basis points), partially
offset by lower vendor allowances (34 basis points) and a lower LIFO reserve
reduction. The Company believes that better inventory management improved gross
margin in both divisions during fiscal 2002, which helped to offset the sales
decline.
Consolidated selling, general and administrative expenses as a percent
of net sales for fiscal 2002 were 19.6 percent compared with 18.2 percent in
fiscal 2001. ShopKo's selling, general and administrative expenses as a percent
of net sales for fiscal 2002 were 17.7 percent compared with 16.6 percent for
fiscal 2001. Pamida's selling, general and administrative expenses as a percent
of net sales were 21.7 percent for fiscal 2002 compared with 20.0 percent in
fiscal 2001. The increases at both divisions were primarily attributable to a
lack of sales leverage (56 and 130 basis points at ShopKo and Pamida,
respectively) and increases in employee incentive plans and liability insurance
costs (33 and 75 basis points at ShopKo and Pamida, respectively).
Consolidated depreciation and amortization expenses as a percent of net
sales for fiscal 2002 were 2.6 percent compared with 2.7 percent in fiscal 2001.
The decrease for fiscal 2002 was attributable to the Company no longer
amortizing goodwill and to a significant reduction of assets placed in service
during 2001 compared with prior years.
During fiscal 2002, the Company recorded an additional pre-tax charge
of $6.0 million associated with nine remaining stores included in the original
reorganization plan, that have not yet been disposed of by the Company.
Interest expense for fiscal 2002 decreased 20.5 percent to $52.3
million when compared with fiscal 2001. The decrease was primarily due to lower
debt levels.
The Company's effective tax rate for fiscal 2002 was 39.7 percent
compared with 43.4 percent for fiscal 2001. The decrease in the effective rate
was primarily due to the discontinuation of goodwill amortization as a result of
our adoption of SFAS No. 142. In fiscal 2001, a substantial amount of our
goodwill amortization was non-deductible for tax purposes.
33
Critical Accounting Policies and Estimates
The preparation of consolidated financial statements in conformity with
accounting principles generally accepted in the United States of America
requires the appropriate application of certain accounting policies, many of
which require management to make estimates and assumptions about future events
and their impact on amounts reported in our financial statements and related
notes. Since future events and their impact cannot be determined with certainty,
the actual results will inevitably differ from our estimates. Such differences
could be material to the financial statements.
Management believes its application of applicable accounting policies,
and the estimates inherently required therein, are reasonable. Management
periodically reevaluates these accounting policies and estimates in the
preparation of our financial statements and makes adjustments when facts and
circumstances dictate a change. We have identified certain critical accounting
policies which are described below.
Merchandise inventory. Our merchandise inventory is carried at the
lower of cost or market on a last-in, first-out (LIFO) basis utilizing the
average cost method of accounting. The valuation of inventories at cost requires
certain management judgments and estimates, including among others, the
assessment of shrinkage rates, obsolescence and the impact on inventory values
of using the lower of cost or market valuation method. In valuing the inventory,
the Company undertakes physical inventories at least annually at its stores and
distribution centers and adjusts inventory values regularly to reflect market
conditions and business trends. The Company estimates losses of inventory due to
shrinkage based upon historical experience by store and by merchandise
department, which are then verified by physical inventory counts. The Company's
experience has been that there is little fluctuation or risk in the estimate of
obsolescence or lower of cost or market reserve because (i) of the Company's
inventory turnover rate, (ii) a large percentage of our inventory is returnable
to our vendors for cost and (iii) the Company is able to receive vendor support
monies if product is sold below expected prices. The non-returnable inventory
goes through a markdown process that liquidates the inventory, generally at
prices in excess of cost.
Goodwill & Intangible Assets - Net. The Company adopted SFAS No. 142,
"Goodwill and Other Intangible Assets", effective February 3, 2002. Under SFAS
No. 142, the Company no longer amortizes goodwill and other intangible assets
with indefinite useful lives. Instead, the carrying value is evaluated for
impairment on an annual basis.
During fiscal 2002, the Company completed its assessment of the
impairment of goodwill of the Pamida Retail segment in accordance with the
guidelines provided by SFAS No. 142. Management considered several factors in
making its assessment, including an independent appraisal of the Pamida Retail
segment. The fair value of the Pamida Retail segment was determined by the
appraiser based on a combination of a discounted cash flow analysis and an
analysis of market prices of other retail companies. The fair values of the
underlying assets and liabilities were determined using standard valuation
practices, including income capitalization, sales comparisons, market rent
analysis, relief from royalty and replacement cost. As a result of this
assessment, the Company recorded a charge of $186.1 million related to the write
down of all goodwill recorded on the Company's balance sheet, all of which
related to the Pamida Retail segment.
The Company has received a report from an independent appraiser
containing an analysis of intangible assets with indefinite lives, which
primarily consist of a trademark associated with the Pamida Retail segment. No
impairment was recorded as a result of this assessment.
34
Restructuring Reserve. In connection with the reorganization plan
announced in the fourth quarter of fiscal 2000 to close 23 ShopKo retail stores,
a distribution center, and to downsize its corporate workforce, the Company
incurred a pre-tax charge of $125.0 million related to inventory and property
write-downs, lease termination and property carrying costs, and employee
separation and other costs. The inventory and fixed asset write-down reserves
were recorded in the fourth quarter of fiscal 2000, and the Company closed all
23 stores and a distribution center in fiscal 2001. The Company utilized all of
the employee severance reserve prior to fiscal 2002. Of the 24 properties
initially covered by the restructuring reserve, six were disposed of in fiscal
2001 and nine were disposed of in fiscal 2002. One additional property was sold
in fiscal 2003, leaving eight remaining properties covered by the restructuring
reserve. There are four leased properties; one lease expires in 2012 and three
leases expire in 2018.
The amount of the asset write-downs and reserves for lease termination
and property carrying costs are based in part on management's estimates as to
the timing for disposition of, sales proceeds from, and disposition costs of the
closed facilities. The Company's intention has been, and continues to be, to
relieve all obligations associated with the closed facilities. Due to continuing
softness in the retail real estate market, as well as a growing number of vacant
retail properties coming on the market as the Company's competitors continue to
restructure and downsize their operations, in fiscal 2002 the Company engaged a
real estate consulting firm to evaluate the obligations of the remaining four
leased closed stores and potential sales prices for the remaining five owned
closed store properties. Based on this evaluation, the Company lowered the
estimated valuations of the properties. Disposition of some properties has taken
longer than originally estimated. As a result, the Company took an additional
$5.6 million pre-tax impairment charge on the owned properties and an additional
$0.4 million charge for future lease obligations on the leased properties during
the fourth quarter of fiscal 2002.
As of January 31, 2004, the remaining reserve for lease termination and
related property carrying costs was $14.5 million and the remaining property
write-down reserve was $11.7 million. The Company believes the reserves are
adequate, and continues to negotiate lease terminations with landlords and
actively market closed stores for sale. However, due to the unfavorable retail
real estate market described earlier, sales of owned stores and lease
terminations have been slower than anticipated. Accordingly, the level of
reserves could prove to be inadequate and additional charges may be required.
The Company will continue to evaluate the adequacy of the amounts reserved as it
proceeds with the disposition of the real estate and termination of the leases.
Vendor Allowances. The Company records vendor allowances and discounts
in the income statement when the purpose for which those monies were designated
is fulfilled. Allowances provided by vendors generally relate to inventory
recently sold and, accordingly, are reflected as reductions of cost of sales as
merchandise is sold. Vendor allowances received for advertising or fixturing
programs reduce the Company's expense or cost for the related advertising or
fixturing program. As discussed previously, the Company recognizes vendor
allowances based on the provisions of EITF No. 02-16, which was adopted by the
Company in fiscal year 2003.
LIQUIDITY AND CAPITAL RESOURCES
The Company's liquidity requirements are met primarily by cash
generated from operations, with remaining funding requirements provided by
short-term and long-term borrowings. Cash provided by operating activities was
$107.0 million, $209.7 million and $234.1 million in fiscal 2003, 2002 and 2001,
respectively. The decreases in fiscal 2003 and 2002 resulted primarily from
changes in inventory levels (an increase of $6.6 million in fiscal 2003 compared
with a decrease of
35
$51.2 million in fiscal 2002 and a decrease of $100.0 million in 2001). The
Company finances a significant portion of its operations through vendor
financing. As of January 31, 2004, accounts payable totaled $253.3 million. The
Company currently maintains favorable terms with its vendors, however these
terms could change based on the Company's operating performance in the future.
As of January 31, 2004, the Company had $210.1 million of long-term
debt outstanding, comprising $154.9 million of Senior Unsecured Notes and
approximately $55.2 million of long- term notes payable. During fiscal 2003, the
Company funded the retirement of $89.2 million in aggregate principal amount of
Senior Unsecured Notes due August 2003. The remaining Senior Unsecured Notes
have maturity dates in November 2004 and March 2022, with approximately $55.3
million principal amount of Senior Unsecured Notes maturing in November 2004. A
more detailed description of these notes is contained in Note D of the Notes to
the Consolidated Financial Statements. Subject to certain limitations set forth
in our Amended Secured Credit Facility (described below), proceeds of the
facility or funds from other sources may be used to retire or repurchase Senior
Unsecured Notes. During fiscal 2003, the Company purchased a combined total of
$4.6 million in principal amount of the outstanding Senior Unsecured Notes due
in November 2004. The Company anticipates funding the retirement of the notes
due November 2004 through a combination of operating cash flow and available
borrowings under the Amended Secured Credit Facility. Payments due under the
Senior Unsecured Notes could be accelerated in the event the Company defaults on
any obligation in excess of $25.0 million.
In addition to the Senior Unsecured Notes, the Company had $82.3
million outstanding under its Amended Secured Credit Facility as of the end of
fiscal 2003 compared with $40.0 million outstanding as of the end of fiscal
2002. On March 12, 2001, the Company entered into a $600.0 million senior
secured revolving credit and term loan facility. During fiscal 2002, the Company
voluntarily terminated the term loan portion of this facility, reducing the
overall commitment under the facility from $600.0 million to $500.0 million as
of the end of fiscal 2002. During the third quarter of fiscal 2003, the Company
entered into the Amended Secured Credit Facility, which is also secured by the
Company's inventory and accounts receivable. The Amended Secured Credit Facility
provides for revolving credit borrowings of up to $450.0 million, bearing
interest at the bank's base rate plus a margin of 0.0% to 0.25% or the
Eurodollar rate plus a margin of 1.5% to 2.0%, depending on borrowing
availability under the facility.
The Amended Secured Credit Facility terminates August 19, 2007, limits
the payment of dividends, new indebtedness, repurchases of common stock and
capital expenditures, and requires the Company to meet financial performance
covenants relating to borrowing availability and minimum operating cash flows as
defined therein. The consequences of failing to comply with the various
covenants and requirements range from increasing the interest rate, to
restrictions on cash management, to default and acceleration of the debt. The
indebtedness under the Amended Secured Credit Facility can be declared
immediately due and payable in the event other Company debt in excess of $10.0
million is accelerated. During fiscal 2003 and 2002, the Company was in
compliance with all covenants of the secured