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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED FEBRUARY 1, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission file number 1-10767
VALUE CITY DEPARTMENT STORES, INC.
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(Exact name of registrant as specified in its charter)
Ohio 31-1322832
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(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
3241 Westerville Road, Columbus, Ohio 43224
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(Address of principal executive offices) (Zip Code)
(614) 471-4722
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Registrant's telephone number, including area code
Securities registered pursuant to Section 12(b) of the Act:
Title of each class: Name of each exchange on which registered:
Common Shares, without par value 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 the filing
requirements for at least the past 90 days. YES _X_ NO ___
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 Act). YES _____ NO __X_
Aggregate market value of voting stock held by non-affiliates of the registrant,
12,840,124 Common Shares, based on the $2.43 closing sale price on August 2,
2002, was $31,201,501.
Indicate the number of shares outstanding of each of the registrant's classes of
common stock, as of the latest practicable date: 33,923,374 Common Shares were
outstanding at April 2, 2003.
TABLE OF CONTENTS
ITEM NO. PAGE
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PART I
1. Business..........................................................................3
2. Properties.......................................................................13
3. Legal Proceedings................................................................14
4. Submission of Matters to a Vote of Security Holders..............................14
PART II
5. Market for the Registrant's Common Equity and Related Stockholder Matters........15
6. Selected Financial Data..........................................................16
7. Management's Discussion and Analysis of Financial
Condition and Results of Operations...........................................17
7A. Quantitative and Qualitative Disclosures about Market Risk ......................24
8. Financial Statements and Supplementary Data......................................25
9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure...........................................25
PART III
10. Directors and Executive Officers of the Registrant...............................26
11. Executive Officer Compensation...................................................30
12. Security Ownership of Certain Beneficial Owners and Management...................33
13. Certain Relationships and Related Transactions...................................34
14. Controls and Procedures..........................................................37
PART IV
15. Exhibits, Financial Statement Schedule and Reports on Form 8-K...................38
Signatures............................................................................39
Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, by the
Chief Executive Officer..........................................................40
Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, by the
Chief Financial Officer..........................................................41
TABLE OF CONTENTS TO FINANCIAL STATEMENTS AND SCHEDULES
Independent Auditors' Report.........................................................F-1
Consolidated Balance Sheets..........................................................F-2
Consolidated Statements of Operations................................................F-3
Consolidated Statements of Shareholders' Equity......................................F-4
Consolidated Statements of Cash Flows................................................F-5
Notes to Consolidated Financial Statements...........................................F-6
SCHEDULES
II - Valuation and Qualifying Accounts...............................................S-1
Index to Exhibits....................................................................E-1
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PART I
ITEM 1. BUSINESS.
As used in this Annual Report on Form 10-K and except as the context
otherwise may require, "Company", "we", "us", and "our" refers to Value City
Department Stores, Inc. and its subsidiaries, including but not limited to, DSW
Shoe Warehouse, Inc. and Filene's Basement, Inc.
FORWARD-LOOKING INFORMATION
This document contains forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933 and Section 21E of the Securities
Exchange Act of 1934. You can identify such forward-looking statements by the
words "expects", "intends", "plans", "projects", "believes", "estimates", and
similar expressions. In the normal course of business, we, in an effort to help
keep our shareholders and the public informed about our operations, may from
time to time issue such forward-looking statements, either orally or in writing.
Generally, these statements relate to business plans or strategies, projected or
anticipated benefits or other consequences of such plans or strategies, or
projections involving anticipated revenues, earnings or other aspects of
operating results. We base the forward-looking statements on our current
expectations, estimates, and projections. We caution you that these statements
are not guarantees of future performance and involve risks, uncertainties, and
assumptions that we cannot predict. In addition, we have based many of these
forward-looking statements on assumptions about future events that may prove to
be inaccurate. Therefore, the actual results of the future events described in
the forward-looking statements in this Annual Report on Form 10-K or elsewhere,
could differ materially from those stated in the forward-looking statements.
Additional information concerning factors that could cause actual results to
differ materially from those in our forward-looking statements is contained
under the caption "Management's Discussion and Analysis of Financial Condition
and Results of Operations."
GENERAL
We are managed in three operating segments: Value City Department Stores
("Value City"), DSW Shoe Warehouse ("DSW") and Filene's Basement.
VALUE CITY. We operate a chain of 116 department stores located in Ohio,
Pennsylvania and 13 other Midwestern, Eastern and Southern states, principally
under the name Value City. For over 80 years, our strategy has been to provide
exceptional value by offering a broad selection of brand name merchandise at
prices substantially below conventional retail prices. Our Value City stores
carry men's, women's and children's apparel, housewares, giftware, home
furnishings, toys, jewelry, shoes and health, beauty care items and commodities,
with apparel comprising well over one-half of total sales. Our Value City stores
average 87,000 square feet which allow us to offer over 100,000 different items
of merchandise similar to the items found in traditional department, specialty
and discount stores. Our pricing strategy is supported by our ability to
purchase large quantities of goods in a variety of special buying opportunities.
For many years, we have had a reputation in the marketplace as a purchaser of
buy-outs and manufacturers' closeouts.
DSW. We also operate a chain of 126 DSW stores located throughout the
United States. Our DSW stores are a chain of upscale shoe stores offering a wide
selection of dress and casual footwear below traditional retail prices. These
stores average 25,000 square feet with up to 45,000 pairs of women's and men's
designer brand shoes and athletic footwear per store. Additionally, Shonac
Corporation, the parent company of DSW, pursuant to license agreements with
Value City and Filene's Basement, operates the licensed shoe departments in
principally all Value City and Filene's Basement stores. Results of operations
of licensed shoe departments are included with the Value City and Filene's
Basement segments. In July 2002, Shonac Corporation entered into a Supply
Agreement with Stein Mart to supply merchandise to some of Stein Mart's shoe
departments. Stein Mart operations are included with the DSW segment.
FILENE'S BASEMENT. Finally, we operate 20 Filene's Basement stores
located principally in the Northeast United States. Our Filene's Basement stores
average 40,000 square feet and specialize in top tier brand name merchandise of
men's and women's apparel, jewelry, shoes, accessories and home goods.
See Note 12 of Notes to Consolidated Financial Statements beginning on
page F-20 of this annual report for information regarding our segments.
HISTORY OF OUR BUSINESS
We opened our first Value City department store in Columbus, Ohio in
1917. Until our initial public offering on June 18, 1991, Value City department
stores operated as a division of Schottenstein Stores Corporation ("SSC"). SSC
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owns approximately 53% of our stock. We also have a number of ongoing related
party agreements and arrangements that exist with SSC. These are more fully
described in Item 13 of this report beginning on page 34.
In July 1997, we entered agreements with Mazel Stores, Inc. ("Mazel") to
create VCM, Ltd. ("VCM"), a 50/50 joint venture. VCM operated the licensed
health and beauty care, toy and sporting goods departments in our Value City
stores and beginning in fiscal 2000, the food department was added. We accounted
for our fifty percent interest in the joint venture under the equity method.
Effective at the close of business February 2, 2002, we purchased Mazel's
interest in the partnership.
Effective May 3, 1998, we purchased 99.9% of the common stock of Shonac
Corporation from Nacht Management, Inc. and SSC. In September 2000, we purchased
the remaining shares to give Value City 100% ownership. Shonac had been the shoe
licensee in principally all of the Value City stores since its inception in 1969
and has operated the DSW chain of retail shoe stores since the opening of the
first store in 1991.
On November 19, 1999, we acquired 100% of the common stock of Gramex
Retail Stores, Inc. ("Gramex"), a chain of 15 discount stores operating in the
greater St. Louis metropolitan area. Of the 15 stores acquired and after
liquidation of the existing inventory, 13 stores were converted to the Value
City format. Six stores received only minor improvements and were reopened in
March 2000. The other 7 stores were remodeled based on our current Value City
format and were reopened in April 2000.
On March 17, 2000, we acquired substantially all of the assets and the
assumption of certain liabilities of Filene's Basement Corp., a Massachusetts
corporation, and Filene's Basement, Inc., a wholly owned subsidiary of Filene's
Basement Corp. We continue to operate the 14 Filene's Basement stores acquired
on March 17, 2000 and reopened the 3 Filene's Basement stores previously closed
in the Washington D.C. area.
VALUE CITY DEPARTMENT STORES
We operate a chain of 116 department stores located in Ohio,
Pennsylvania and 13 other Midwestern, Eastern and Southern states, principally
under the name Value City. For over 80 years, our strategy has been to provide
exceptional value by offering a broad selection of brand name merchandise at
prices substantially below conventional retail prices.
MERCHANDISING
Selection. Value City is a full-line, off-price retailer carrying men's,
women's and children's apparel, housewares, giftware, home furnishings, toys,
jewelry, shoes, health, beauty care items and commodities. Value City is
de-emphasizing departments such as automotive, hardware and sporting goods to
focus more area to its predominately female customer. Off-price retailing, as
distinguished from traditional full-price retailing and discount or off-brand
merchandising, is characterized by the purchase of primarily high quality brand
name merchandise, at prices below normal cost to most retailers. A portion of
the cost savings is then passed on to customers through lower prices. The Value
City customer we generally attract with these items and price points are budget
minded and moderate-income customers. Our Value City stores strive to offer
customers one-stop-shopping for the categories of merchandise we carry. The
large size of our Value City stores facilitates the offering of a wide range of
merchandise categories with broad, deep selections of goods within each
category. Value City stores average 87,000 square feet and carry over 100,000
different items of merchandise similar to the items found in traditional
department, specialty and discount stores. We continually refine the Value City
merchandise mix eliminating less productive departments and introducing new
merchandise categories to improve store profitability and meet the changing
needs of our customers.
We believe our customers are attracted to Value City stores. We
recognize the need of continuous new offerings and flow of value-priced
merchandise acquired in special purchases. At the same time, Value City
maintains a broad and consistent range of goods, it purchases continuing lines
of merchandise and draws upon its vendor contacts to ensure constant
availability of certain basic categories of merchandise as well as current
fashion trends.
Value Pricing. Value City stores offer quality brand name merchandise at
prices typically 50% to 70% below initial prices charged by traditional
department stores for similar items and at prices comparable to or lower than
prices charged by other off-price retailers. We can offer exceptional values
because our buyers purchase merchandise directly from manufacturers and other
vendors generally at prices substantially below those paid by conventional
retailers. This allows us to pass on the savings directly to our budget minded
and moderate-income customers. See "Supplier Relationships and Purchasing" on
page 5 of this annual report for more information.
Well known designer labels, brand names and original retailer names are
prominently displayed throughout our Value City stores. Many items carry labels
and/or original price tags showing brand names identifiable with major
designers, manufacturers and retail stores, as well as tags showing original
retail, comparable or "nationally advertised" prices. In certain cases,
suppliers may require removal of labels or original retail price tags as a
condition to a special purchase arrangement. See "Supplier Relationships and
Purchasing" on page 5 of this annual report for more information.
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SUPPLIER RELATIONSHIPS AND PURCHASING
An important factor in our operations has been the relationships we have
developed with our various suppliers and our many years of experience in
purchasing merchandise directly from manufacturers and other vendors at prices
substantially below those generally paid by conventional retailers. Over the
years, our buyers have established excellent relationships with suppliers
including a reputation for the ability to purchase entire lots of merchandise.
Continuously, we seek to find and negotiate special purchase opportunities.
Dynamics of the markets continue to change and as a result of our relationships
and experience many suppliers offer special purchase opportunities to us prior
to attempting to dispose of merchandise through other channels. Manufacturers of
brand name merchandise are not reluctant to sell merchandise to Value City for
resale at our discounted prices. By selling their merchandise through our retail
stores, we are able to assure suppliers the merchandise will be sold without
disturbing the suppliers' regular channels of distribution.
Although we cannot quantify the reduction in price we pay for special
purchases compared to the prices paid by our competitors for similar purchases,
we believe that such special purchases are made at prices sufficiently favorable
to enable us to offer merchandise to our customers at very competitive price
points.
We purchase merchandise from more than 4,700 suppliers, none of which
accounted for a material percentage of purchases during the past fiscal year. We
do not maintain any long-term or exclusive commitments to purchase merchandise
from any one supplier, except for greeting cards. We regularly purchase
overstocked or overproduced items from manufacturers and other retailers,
including end-of-season, out-of-season and end-of-run merchandise and
manufacturers' slight irregulars. From time to time, but less frequently from
our historical practice, we purchase all or substantially all of the inventories
of financially distressed retailers and make other special purchases. We also
have started to more aggressively seek advantageous buying opportunities and
sourcing overseas, particularly in non-apparel categories.
Our distribution facilities are designed to enable us to prioritize the
processing of merchandise on short notice and to deliver merchandise to stores
within days of receipt. This allows our buyers to purchase merchandise very late
in the season, when prices tend to be more favorable, and still deliver the
merchandise to stores before the end of the season. At the same time, we are
capable of devoting warehouse space to out-of-season goods for our Value City
stores. This merchandise is generally warehoused until the most opportune time
to offer it in our Value City stores, which in most cases is the next season.
This ability to purchase and quickly distribute or hold merchandise in
substantial quantities has enabled us to offer high-quality merchandise to
customers at prices significantly below usual retail prices. We believe that
this ability distinguishes us from the typical discount or department store and
provides us with a competitive advantage in making purchases as favorable
opportunities arise.
The relatively large size of our Value City stores provides us with the
flexibility to purchase full lots of merchandise that may not be available to
other off-price retailers with smaller stores requiring more targeted purchases.
Although there is growing competition for the kinds of special purchases that we
seek, we believe that, because of the factors discussed above, we will be able
to obtain sufficient supplies of desirable merchandise at favorable prices in
the future.
ADVERTISING AND PROMOTION
We commit substantial resources to advertising and believe our marketing
strategy is one of the keys to our future success. Value City advertises
frequently in print, including newspapers, circulars and flyers, and on
television and radio. The promotional strategy is carefully planned and budgeted
to include not only institutional and seasonal promotions, but also weekly
storewide sales events highlighting recent buy-outs and other specially
purchased brand name merchandise designed to maximize customer interest. In some
cases, a supplier may prohibit the advertising or non-store promotion of its
brand name. We are continually trying to improve our place in the market and
have begun to utilize more outside third party resources to accomplish this by
developing a better brand recognition.
STORES
Store Location and Design. We believe our budget and moderate-income
customers are attracted to our stores principally by the wide assortment of
quality items at substantial savings.
Our Value City stores average approximately 87,000 square feet, with
approximately 70% of the total area of each store representing selling space.
The stores are generally laid out on a single level, with central traffic aisles
providing access to major departments. Each department strives to display and
stock large quantities and assortments of merchandise, giving the store a full
appearance. We are taking steps to improve the shopping experience of our
customers. We look at the signage, store layout, including aisles and
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department locations within the store, to place fashion forward and into view
and to provide convenience to the hurried customer.
Our Value City stores are generally open from 9:30 a.m. until 9:30 p.m.
Monday through Saturday and 11:00 a.m. until 6:00 p.m. on Sunday. All of the
stores are located in leased facilities. Of the 116 Value City stores open as of
April 2, 2003, 33 are freestanding, 56 are in shopping centers and 27 are in
enclosed malls.
Store Operations. We offer customers a convenient, pleasurable shopping
experience and a high level of satisfaction. Value City's training program is
utilized to assure every associate maintains the highest level of
professionalism and places customer service at the forefront.
All of our Value City stores are designed for self-service shopping,
although sales personnel are available to help customers locate merchandise and
to assist in the selection and fitting of apparel and footwear. In all stores, a
customer service desk is conveniently located generally adjacent to the central
checkout area. To promote the ease of checkout we have invested in point of sale
scanning systems that expedite the checkout process by providing automated check
and credit approval and price lookup. Sales associates are trained to create a
"customer-friendly" environment. We accept all major credit cards, and also
provide a private label credit card program at Value City stores. Private label
and other credit card sales are nonrecourse to us, with the servicing agent
assuming all of the credit risk. Value City offers a layaway program in most of
its stores for our budget and moderate-income customers and maintains a
reasonable return policy.
Our stores are organized into separate geographic regions and districts,
each with a territory or district manager. Territory and district managers are
headquartered in their region and spend the majority of their time in their
stores to ensure adherence to merchandising, operational and personnel
standards. The typical staff for a Value City store consists of a store manager
and several assistants, and full and part-time hourly associates. Each store
manager reports directly to one of the territory or district managers, and each
of the territory or district managers reports to a Regional Vice President who
in turn reports to the Vice President of Operations.
Our store managers function both as administrators and merchants. All
managers are responsible on a day-to-day basis for maintenance of displays and
inventories in all departments, the overall condition of their stores, customer
relations, personnel hiring and scheduling, and all other operational matters
arising in the stores. Each store manager is compensated, in part, based on the
performance of his or her store. Our store managers are an important source of
information concerning local market conditions, trends and customer preferences.
We prefer to fill management positions through promotion of existing
associates. A store management training program is maintained to develop the
management skills of associates and to provide a source of management personnel
for future store expansion.
Expansion. We have increased our department store base from 74 stores at
the start of fiscal 1994 to 116 stores at the end of fiscal 2002. No new
department stores were added in Fiscal 2002 or Fiscal 2001 and none are planned
for Fiscal 2003, however we will continue to explore exceptional real estate
opportunities. Our past expansion has been accomplished by leasing newly
constructed locations or by acquiring existing locations from other retailers.
We continually refurbish our stores by updating the merchandise
displays, department locations and in-store signage. The costs of refurbishing
on a per store basis are generally not substantial. On an annual basis, we
select stores to be remodeled, which generally involves more significant changes
to the interior than the exterior of the store. We have in the past utilized our
own internal architectural design staff, construction crews and carpentry shop
to assist in refurbishing and remodeling store interiors and to build in-store
display tables and racks.
DISTRIBUTION
We use a regionalized distribution strategy with 6 distribution centers
located in Columbus, Ohio. The aggregate area of the distribution facilities is
approximately 2,300,000 square feet; however, use of multi-tier processing
levels in some of the distribution centers substantially increases their
operating capacity. In addition, to expedite the flow of merchandise to certain
clusters of stores, we use a third party processor located in New Jersey.
Our distribution facilities utilize material handling equipment,
including mechanized conveyor systems to separate and collate shipments to the
stores. Our distribution facilities are designed to allow priority delivery of
late season purchases and fast-moving merchandise to have it in our stores
quickly to take full advantage of the remaining selling season.
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Merchandise is processed, ticketed and consolidated prior to shipment to
the stores to ensure full-truck loads to minimize shipping costs. We lease our
fleet of road tractors and approximately 70% of our semi-rig trailers, with the
remainder being owned. Our fleet makes the majority of all deliveries to the
stores.
LICENSE AGREEMENT
Value City uses the Shonac Corporation, the parent company of DSW, to
operate the shoe departments in principally all the Value City stores. The
inter-company activity is eliminated in our consolidated financial statements.
In a few stores, Value City licenses space to third party licensees. Licensees
supply their own merchandise and generally supply their own store fixtures.
Licensed departments complement the operations of our stores and facilitate the
uniformity of the in-store merchandising strategy, including the overall
emphasis on value.
SEGMENT SEASONALITY
Value City customer traffic increases in the early Spring, back to
school and the Christmas holiday season. These seasonal periods in operations
are critical to Value City's annual operating targets.
SERVICE MARKS, TRADEMARKS AND TRADENAMES
The service mark "Value City" has been registered by SSC in the U.S.
Patent and Trademark Office. Our four department stores in Columbus operate
under the tradename "Schottenstein's," which has been registered in the State of
Ohio. We are entitled to use such names for the sole purpose of operating
department stores on an exclusive basis pursuant to a perpetual license from
SSC. SSC also operates a chain of furniture stores under the name "Value City
Furniture." We have also registered in the U.S. Patent and Trademark Office
various trademarks used in our marketing program.
DSW SHOE WAREHOUSE
Our DSW stores' mission is to be each customer's favorite retailer of
branded footwear by satisfying customer expectations for selection, convenience
and value. We use the tagline "The Shoes of the Moment. The Deal of a Lifetime."
and offer a "Reward Your Style" program to reward frequent shoppers.
MERCHANDISING
Selection. DSW stores attract customers because of their wide assortment
of top quality name brand dress, casual and athletic footwear for men and women
together with a regularly changing selection of more fashion-oriented footwear.
Our DSW stores are large, contemporary, warehouse formats, that average 25,000
square feet and allow us to sell a large selection of branded footwear in a
clean and simple environment.
Value Pricing. DSW price points are targeted to be up to 50% lower than
the regular prices of other specialty retailers and traditional department
stores. DSW continually strives to improve its merchandise sourcing to maintain
quality, lower costs and shortened delivery cycles. Identifying and building
relationships with cost-efficient manufacturers and suppliers of quality
merchandise is essential to DSW's merchandising strategy.
SUPPLIER RELATIONSHIPS AND PURCHASING
DSW's merchandising group constantly monitors current fashion trends as
well as historical sales trends to identify popular styles and styles that may
become popular in the upcoming season. Once our buyers determine the styles and
merchandise mix for any upcoming season, they focus on purchasing the
appropriate quantities of each category at the lowest cost and the highest
quality available.
DSW believes it has good relationships with its vendors. Merchandise is
purchased from both domestic and foreign suppliers directly or through agents.
Vendors include suppliers who either manufacture their own merchandise or supply
merchandise manufactured by others, or both. DSW believes that, consistent with
the retail footwear industry as a whole, most of its domestic vendors import a
large portion of their merchandise from abroad. We have implemented quality
control programs under which buyers inspect incoming merchandise for fit, color
and material, as well as for overall quality of manufacturing. As the number of
DSW locations increase, we believe there will be adequate sources available to
acquire and/or produce a sufficient supply of quality goods in a timely manner
and on satisfactory economic terms.
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ADVERTISING AND PROMOTION
Our DSW stores currently use a broadcast campaign, primarily radio and
television, focusing on the slogan "The Shoes of the Moment. The Deal of a
Lifetime." This campaign is supplemented by print promotions and, increasingly,
television. In addition, a valuable marketing tool for DSW is the "Reward Your
Style" loyal customer program. Customers are asked to join the program during
the checkout procedure. By analyzing the member database, as well as the sales
transactions of those members, we are able to direct the advertising to
encourage repeat shopping and to reach targeted customers. DSW also sponsors
certain LPGA events.
STORES
Store Location and Design. Our DSW stores average approximately 25,000
square feet, with about 87% of the total area of each store representing selling
space. The stores' exteriors feature black and white color schemes and in many
cases, windows with striped awnings. The store interiors are well lighted and
feature a unique display concept, a simple case presentation which groups the
shoes together by style. Interior signage is tasteful and kept to a minimum. The
shoe stores are generally laid out on a single level, with the cases of shoes
forming the aisles in the stores. This allows customers to view the entire store
when they enter. Of the 128 DSW stores open as of April 2, 2003, 13 are
freestanding, 93 are in shopping centers and 22 are in enclosed malls. The
stores are generally open from 10:00 a.m. until 9:00 p.m. Monday through
Saturday and 12:00 p.m. until 6:00 p.m. on Sunday. The stores are located in
leased facilities, except for one location.
Store Operations. At DSW, all associates receive Retail Results
University training in both product knowledge and sales/service. This in-house
training program emphasizes acknowledgment of all customers, customized levels
of service, and realization of sales opportunities at all moments of customer
contact.
All of our DSW stores are designed for self-service shopping, although
sales personnel are available to help customers locate merchandise and to assist
in the selection and fitting of footwear. In all stores, a customer service desk
is conveniently located generally adjacent to the central checkout area. To
promote the ease of checkout we have invested in point of sale scanning systems
that expedite the checkout process by providing automated check and credit
approval and price lookup. Sales associates are trained to create a
"customer-friendly" environment. DSW accepts all major credit cards.
Our stores are organized into separate geographic regions and districts,
each with a territory or district manager. Territory and district managers are
headquartered in their region and spend the majority of their time in their
stores to ensure adherence to merchandising, operational and personnel
standards.
The typical staff for a DSW store consists of a store manager and two
assistant managers who supervise 20 to 25 full and part-time hourly associates.
Each store manager reports directly to one of 17 district managers who in turn
report to one of 2 regional managers who in turn report to the head of
operations.
Our store managers function both as administrators and merchants. All
managers are responsible on a day-to-day basis for maintenance of displays and
inventories in all departments, the overall condition of their stores, customer
relations, personnel hiring and scheduling, and all other operational matters
arising in the stores. Each store manager is compensated, in part, based on the
performance of his or her store. Our store managers are an important source of
information concerning local market conditions, trends and customer preferences.
We prefer to fill management positions through promotion of existing
associates. A store management training program is maintained to develop the
management skills of associates and to provide a source of management personnel
for future store expansion.
Expansion. We plan to open 25 to 30 new DSW shoe stores during fiscal
2003. We intend to open new DSW stores in both existing and new markets with an
emphasis on locating stores in highly visible sites on high traffic streets in
relatively affluent trade areas. Factors considered in evaluating new store
sites include store size, configuration, demographics and lease terms. We seek
to cluster stores in targeted metropolitan areas to enhance name recognition,
share advertising costs and achieve economies of scale in management and
distribution.
Based upon our experience, we estimate the average cost of opening a new
DSW shoe store ranges from approximately $1.0 million to $2.0 million, including
leasehold improvements, fixtures, inventory, pre-opening expenses and other
costs. Preparations for opening a DSW shoe store generally take eight to ten
weeks. We charge pre-opening expenses to operations as incurred. It has been our
experience that new stores generally achieve profitability and contribute to net
income following the first year of operations. It is not uncommon to receive
lease incentives for our DSW store openings.
We continually refurbish our stores by updating the merchandise displays
and in-store signage. The costs of refurbishing on a per store basis are
generally not substantial. On an annual basis, we select stores to be remodeled,
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which generally involves more significant changes to the interior than the
exterior of the store. We maintain our own architectural design staff,
construction crews and carpentry shop to assist in refurbishing and remodeling
store interiors and to build in-store display tables and racks.
DISTRIBUTION
Shonac and DSW's principal offices and distribution center operations
were relocated in Spring 2001 to a new 700,000 square foot facility located in
Columbus, Ohio. This distribution center facility uses a modern warehouse
management system and material handling equipment, including new conveyor
systems, to separate and collate shipments to our stores. The design of the
distribution center facilitates the prompt delivery of priority purchases and
fast selling footwear to stores so we can take full advantage of each selling
season. We have entered a 15-year lease with 3 five-year option periods with an
affiliate of SSC for this facility.
LICENSE AGREEMENTS WITH VALUE CITY AND FILENE'S BASEMENT
Shonac Corporation, the parent company of DSW, operates the shoe
departments in principally all Value City and Filene's Basement stores. The
results of operations for the licensed shoe departments are included with Value
City and Filene's Basement.
In July 2002, Shonac entered into a Supply Agreement with Stein Mart to
supply merchandise to some of Stein Mart's shoe departments. As of April 2,
2003, Shonac was supplying merchandise to 160 Stein Mart stores.
SEGMENT SEASONALITY
The shoe business experiences increased sales in both early Spring and
Fall seasons in relationship to the change in footwear desired by the DSW
customer. These seasonal factors are critical to DSW's operating targets.
SERVICE MARKS, TRADEMARKS AND TRADENAMES
We have registered in the U.S. Patent and Trademark Office a number of
trademarks and service marks, including: DSW; DSW Shoe Warehouse; Coach and
Four; Crown Shoes; Reward Your Style; Flites; Jonathan Victor; Kristi G; Lakota
Trail; Landmarks; Sandler; Shoes by Kari; and Sylvia Cristie.
FILENE'S BASEMENT
Filene's Basement strategy focuses on providing the top teir brand names
at everyday low prices for men's and women's apparel, jewelry, shoes,
accessories and home goods.
MERCHANDISING
Selection. Filene's Basement stores average 40,000 square feet and offer
branded apparel, home goods, accessories and retail stocks purchased directly
from major upscale retailers. The branded merchandise represents a focused
assortment of fashionable, nationally recognized men's and women's apparel,
shoes, accessories and home goods bearing prominent designers' and
manufacturers' names. Branded merchandise constitutes most of the product line
and is often obtained through opportunistic purchases from a diverse group of
quality manufacturers and vendors, including direct imports from some of the
most prominent European designers.
Value Pricing. Our Filene's Basement stores' merchandise assortment is
typically priced at levels 30%-60% below regular prices at traditional
department and specialty stores. These discounts are achieved by buying
in-season closeouts and values at advantageous prices and offering them for sale
at lower markups than those of traditional department stores. We are also able
to keep the cost of merchandise low because we do not require markdown or
advertisement allowances, or anticipation of returns from vendors, all of which
are typical in the department store industry.
SUPPLIER RELATIONSHIPS AND PURCHASING
We believe the acquisition of Filene's Basement in March 2000, a
well-known institution in Boston since 1908, parallels our merchandising
philosophy of delivering value-priced merchandise to our customers. Because of
the longstanding relationships Filene's Basement has with vendors, it receives
quality buying opportunities at competitive prices. These longstanding
relationships make Filene's Basement a prime choice for vendors with overruns,
department store cancellations and unmet volume objectives.
9
ADVERTISING AND PROMOTION
Filene's Basement employs a multi-media approach, using print, broadcast
and direct mail. The communication strategy is designed to target customer
segments and generate increased store trips and cross shopping opportunities.
STORES
Store Location and Design. Our Filene's Basement Boston store is a
landmark institution recognized by generations of New England families and
visitors as a source of quality off-price men's and women's merchandise. The
downtown location is famous for a unique marketing concept - the Automatic
Markdown Plan - whereby certain merchandise is automatically discounted based on
the number of days the merchandise has been on the sales floor. Filene's
Basement believes the Automatic Markdown Plan, found only in the downtown Boston
location, generates a sense of shopping urgency and creates customer excitement
and loyalty. Filene's Basement subleases 178,000 square feet (approximately
65,300 square feet of selling space) on four floors. The sublease terminates in
2009 with rights on behalf of Filene's Basement to extend until 2024. The Boston
store generated approximately 20% of Filene's Basement's total sales.
Most of our Filene's Basement stores are located in suburban areas, near
large residential neighborhoods, and average approximately 40,000 square feet of
selling space per store. The downtown Boston location and stores in New York,
Chicago and Washington D.C. are located in urban areas. Filene's Basement
operates 19 branch stores in six states and the District of Columbia. Generally,
the branch store's selling space uses a prototypical "racetrack" aisle layout
for merchandise presentation. The branch stores are designed to be convenient
and attractive in their merchandise presentation, dressing rooms, checkouts and
customer service areas. Their merchandise mix is similar to that of the Boston
flagship store. Because of the operational complexities associated with
transferring the Automatic Markdown Plan to the branch stores, the branch stores
do not operate under the Automatic Markdown Plan, although markdowns are taken
as required.
Store Operations. All of our Filene's Basement stores are designed for
self-service shopping, although sales personnel are available to help customers
locate merchandise and to assist in the selection and fitting of apparel and
footwear. In all stores, a customer service desk is conveniently located
generally adjacent to the central checkout area. To promote the ease of checkout
we have invested in point of sale scanning systems that expedite the checkout
process by providing automated check and credit approval and price lookup. Sales
associates are trained to create a "customer-friendly" environment. Filene's
Basement accepts all major credit cards, and also provides a private label
credit card program. Private label and other credit card sales are nonrecourse
to us, with the servicing agent assuming all of the credit risk. Filene's
Basement maintains a reasonable return policy.
Our Filene's Basement stores' typical staff consists of a general
manager, an assistant store manager, merchandising group managers and full and
part-time associates. Each general manager reports to the group store manager
who in turn reports to the Senior Vice President, Director of Stores.
Our store managers function both as administrators and merchants. All
managers are responsible on a day-to-day basis for maintenance of displays and
inventories in all departments, the overall condition of their stores, customer
relations, personnel hiring and scheduling, and all other operational matters
arising in the stores. Each store manager is compensated, in part, based on the
performance of his or her store. Our store managers are an important source of
information concerning local market conditions, trends and customer preferences.
We prefer to fill management positions through promotion of existing
associates.
Expansion. We plan to open 1 to 3 new Filene's Basement stores during
fiscal 2003. Based upon our experience, we estimate the average cost of opening
a new Filene's Basement store is between $2.0 million to $3.0 million.
Preparations for opening a Filene's Basement store generally take eight to ten
weeks. We charge pre-opening expenses to operations as incurred. It has been our
experience that new stores generally achieve profitability and contribute to net
income following the first full year of operations.
We continually update our stores by changing the merchandise displays
and in-store signage. The annual cost of refurbishing on a per store basis is
generally not substantial and is treated as maintenance. We utilize our own
architectural design staff, construction crews and carpentry shop as needed to
assist in the refurbishing and remodeling of a store or to build in-store
display tables and racks.
DISTRIBUTION
Filene's Basement's merchandise is processed and distributed from a
457,000 square foot leased distribution facility situated on 32.8 acres with
adjacent rail service in Auburn, Massachusetts, outside of metropolitan Boston,
Massachusetts.
10
LICENSE AGREEMENT
Filene's Basement licenses cosmetics and certain other incidental
departments to independent third parties. The aggregate annual license fees for
fiscal year ended February 1, 2003 were approximately $120,000. Filene's
Basement also uses Shonac Corporation, the parent company of DSW, to manage the
in-store shoe departments on a lease department basis. The inter-company
activity is eliminated in our consolidated financial statements.
Licensees supply their own merchandise and generally supply their own
store fixtures. In most instances, licensees utilize our associates to operate
their departments. The licensees reimburse us for all costs associated with such
associates. Licensed departments are operated under our general supervision and
licensees are required to abide by our policies with regard to pricing, quality
of merchandise, refunds and store hours. Licensed departments complement the
operations of our stores and facilitate the uniformity of the in store
merchandising strategy including the overall emphasis on values.
SEGMENT SEASONALITY
Filene's Basement customer traffic increases in the early Spring and the
Christmas holiday seasons. These seasonal periods are critical to Filene's
Basement's annual operating targets.
SERVICE MARKS, TRADEMARKS AND TRADENAMES
Filene's Basement has an exclusive, perpetual, worldwide, royalty-free
license to use the name Filene's Basement and Filene's Basement of Boston
trademark and service mark registrations as well as certain other tradenames.
Filene's Basement's exclusive licensee status with respect to these registered
marks has been recorded with the United States Patent and Trademark Office and
relevant state offices.
MANAGEMENT INFORMATION AND CONTROL SYSTEMS
We believe a high level of automation is essential to maintaining and
improving our competitive position. We rely upon computerized systems to provide
information at all levels, including warehouse operations, store billing,
inventory control, merchandising and automated accounting.
We utilize point of sale ("POS") registers with full scanning
capabilities to increase speed and accuracy at customer checkouts and facilitate
inventory restocking. An automated system to capture and control layaways is
integrated into the POS system.
We utilize automated distribution center systems to track and control
the receipt, processing, storage and shipping of product to the stores.
Value City has embarked on major projects to replace its legacy systems
with industry leading solutions from JDA, Manhattan Associates and Cornel Mayo
Associates. JDA's planning, allocation, merchandise management and retail data
warehouse systems will provide improved inventory productivity and merchandise
assortments for our stores. Manhattan Associates' warehouse management system
will improve the efficiency of our distribution centers and speed the flow of
merchandise to our stores. The Cornel Mayo Associates' POS software will be
implemented in all Value City stores and all POS registers will be replaced to
improve the customer transaction experience and drive back office efficiency. A
new wireless hand held computer will be implemented in conjunction with the POS
system for markdown and inventory processing and can be used for "queue busting"
during very busy shopping periods. Value City is automating its corporate
environment with a document management system to move toward an efficient,
paperless environment. Value City systems run on two AS/400's and open systems
computers.
DSW has undertaken several major initiatives to build upon the Essentus
merchandise management system and Retek warehouse management systems that
support the company. An EDI (electronic data interchange) project is underway
to utilize product UPC barcodes and electronic exchange of purchase orders,
shipping notifications and invoices with our top vendors. At this time, 70% of
DSW's product is processed using the UPC bar code which has reduced processing
costs and improved flow of goods through the distribution center to the stores.
New, state-of-the-art, completely wireless NCR POS system has been rolled out
to all DSW stores resulting in a faster, easier customer checkout and a more
efficient back office operation. A completely wireless store supports fast and
easy new store openings. In order to support the continued growth of DSW, JDA's
planning and allocation systems will be implemented to improve inventory
productivity and store assortments. Business Intelligence tools in conjunction
with Datamarts are used for business analysis and decision support. DSW systems
run on UNIX computer systems.
Filene's Basement installed new wireless hand held computers and
printers in all stores to improve efficiency and accuracy of ticketing. Filene's
Basement plans to implement JDA's planning, allocation and retail data warehouse
systems in the future to augment the capabilities of its JDA merchandise
management system and its JDA Windss POS system. Filene's
11
Basement also intends to replace its legacy warehouse management system with
Manhattan Associates' warehouse management system in the future. Filene's
Basement shares an AS/400 with Value City.
A focus of IT (information technology) is to leverage our technology
infrastructure and systems whenever appropriate to simplify and become more
efficient. All companies are now supported by enterprise financial, human
resource and e-mail systems.
ASSOCIATES
We employ experienced Human Resource professionals to provided
leadership and direction to us and our management team. The mission of the Human
Resource department includes optimizing associate effectiveness to improve
quality of work products, superior customer service, shareholder value and our
profits.
As of April 2, 2003, we had approximately 17,400 associates of which
8,800 were full-time and the balance were part-time. Approximately 2,000 of
these associates in 21 stores are covered by collective bargaining agreements.
Group hospitalization, surgical, medical, vision, dental, disability and
life insurance benefits and a 401(k) plan are provided to full-time non-union
associates. We are a co-sponsor with SSC in these plans. We also sponsor an
associate stock purchase plan and a stock option plan for salaried associates.
We believe that, in general, we have satisfactory relations with all of
our associates.
COMPETITION
The retail industry is highly competitive. We compete with a variety of
conventional and discount retail stores, including national, regional and local
independent department and specialty stores, as well as with catalog operations,
on-line providers, factory outlet stores and other off-price stores. We compete
with other retailers for real estate opportunities with other department store
and specialty store operators.
In the discount or off-price retailing segment, we differentiate
ourselves through our store format and the breadth of value product offering.
Our large stores differ from most other off-price retailers that tend to operate
substantially smaller stores focusing predominantly on either hard or soft
goods. Our large stores facilitate our merchandise offering and broad range of
brands and products.
In addition, because we purchase much of our inventory
opportunistically, we compete for merchandise with other national and regional
off-price apparel and discount outlets. Many of our competitors handle identical
or similar lines of merchandise and have comparable locations, and some have
greater financial resources than we do.
Competitive factors important to our customers include fashion, value,
merchandise selection, brand name recognition and, to a lesser degree, store
location. We compete primarily on the basis of value, merchandise quality and
selection. We believe our competitive advantages include: our reputation in the
marketplace for being able to purchase entire lots of merchandise; our ability
to either quickly distribute or hold the merchandise for sale at the most
opportune time; our full-line merchandise and style offerings; and our range of
brand names.
12
ITEM 2. PROPERTIES.
Set forth in the following table are the locations of stores we operated
as of February 1, 2003:
Filene's
Value City DSW Basement Total
---------- ---------- ---------- -----------
Arizona - 1 - 1
California - 9 - 9
Colorado - 4 - 4
Connecticut - 2 - 2
Delaware 3 - - 3
Florida - 7 - 7
Georgia 4 4 - 8
Illinois 16 6 2 24
Indiana 7 3 - 10
Kansas - 3 - 3
Kentucky 4 - - 4
Maryland 8 4 - 12
Massachusetts - 5 8 13
Michigan 9 8 - 17
Minnesota - 3 - 3
Missouri 7 2 - 9
Nevada - 2 - 2
New Hampshire - 1 - 1
New Jersey 7 6 1 14
New York - 11 4 15
North Carolina 1 1 - 2
Ohio 23 11 1 35
Oklahoma - 1 - 1
Pennsylvania 18 9 1 28
Tennessee 1 3 - 4
Texas - 11 - 11
Virginia 4 7 - 11
Washington D.C. - - 3 3
West Virginia 4 - - 4
Wisconsin - 2 - 2
---------- ---------- ---------- -----------
116 126 20 262
----------- ---------- ----------- -----------
We maintain buying offices in Columbus, Ohio; Boston, Massachusetts; New
York, New York and Los Angeles, California. We operate 7 warehouse/distribution
complexes located in Columbus, Ohio and one distribution facility in Auburn,
Massachusetts. In addition, to expedite the flow of merchandise to certain
clusters of stores, we use third party processors located principally in New
Jersey. Our executive offices occupy approximately 45,000 square feet in a
building which includes a store and also serves as one of our apparel
distribution centers.
The stores and all of the warehouse, buying and executive office
facilities are leased or subleased except for one owned shoe store location. As
of February 1, 2003, we leased or subleased 32 stores and 6 warehouse facilities
and a parcel of land from SSC or entities affiliated with SSC. The remaining
stores and warehouses are leased from unrelated entities. Most of the store
leases provide for an annual rent based upon a percentage of gross sales, with a
specified minimum rent.
Our office, warehouse and distribution facilities for our Value City,
DSW and Filene's Basement businesses are adequate for our current needs and we
believe that such facilities, with certain modifications and additional
equipment will be adequate for our foreseeable future demands. In Spring 2001,
to support the planned growth of our DSW shoe warehouse business, we
consolidated and relocated the related back office and distribution operations
of our shoe business to a new 700,000 square foot facility located in Columbus,
Ohio. The facility is leased from an affiliate of SSC and has a 15 year base
term with 3 five-year option periods.
13
ITEM 3. LEGAL PROCEEDINGS.
We are involved in various legal proceedings that are incidental to the
conduct of our business. We estimate the range of liability related to pending
litigation where the amount and range of loss can be estimated. We record our
best estimate of a loss when the loss is considered probable. Where a liability
is probable and there is a range of estimated loss, we record the minimum
estimated liability related to the claim. In the opinion of management, the
amount of any liability with respect to these proceedings will not be material.
As additional information becomes available, we assess the potential liability
related to our pending litigation and revise our estimates. Revisions in our
estimates and potential liability could materially impact our results of
operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Not applicable.
14
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS.
The following table sets forth the high and low sales prices of our
Common Shares as reported on the NYSE Composite Tape during the periods
indicated. As of April 2, 2003, there were 532 shareholders of record.
HIGH LOW
Fiscal 2001:
First Quarter $9.45 $6.65
Second Quarter 11.50 5.60
Third Quarter 6.30 2.50
Fourth Quarter 6.45 2.98
Fiscal 2002:
First Quarter $4.62 $3.04
Second Quarter 4.40 2.20
Third Quarter 2.68 1.55
Fourth Quarter 3.73 1.50
Fiscal 2003:
First Quarter (through April 2, 2003) 2.05 1.48
We have paid no dividends and presently anticipate that all of our
future earnings will be retained for development of our businesses and we do not
anticipate paying cash dividends on our common shares during fiscal 2003. The
payment of any future dividends will be at the discretion of our board of
directors and will depend upon, among other things, future earnings, operations,
capital requirements, our general financial condition and general business
conditions. The payment of dividends is restricted under our credit facilities.
In connection with our refinancing, we amended and restated our $75
million convertible loan on June 11, 2002. Pursuant to the terms of the
convertible loan, the lenders may, at their option, convert the convertible loan
into shares of our common stock at a conversion rate of $4.50 per share, subject
to adjustment. We relied on the exemption from registration contained in Section
4(2) of the Securities Act of 1933 for this issuance.
In connection with our refinancing, on September 26, 2002 we issued
warrants to purchase 2,954,792 shares of our common stock at $4.50 per share,
subject to adjustment. We relied on the exemption from registration contained in
Section 4(2) of the Securities Act of 1933 for this issuance.
15
ITEM 6. SELECTED FINANCIAL DATA.
The following table sets forth for the periods indicated various
selected financial information. The 12 month period ended January 30, 1999 is
presented for comparative purposes. Such selected consolidated financial data
should be read in conjunction with the Consolidated Financial Statements of
Value City Department Stores, Inc. including the notes thereto, set forth in
Item 8 of this Annual Report on Form 10-K and "Management's Discussion and
Analysis of Financial Condition and Results of Operations" set forth in Item 7
of this Annual Report on Form 10-K.
Transition For the
12 Months Period Fiscal
Ended 6 Months Year
For the Fiscal Year Ended (unaudited) Ended Ended
-------------------------------------------------- ----- -----
2/1/03 2/2/02 2/3/01(1) 1/29/00 1/30/99 1/30/99(1) 8/1/98(2)
- --------------------------------------------------------------------------------------------------------------------------------
(dollars in thousands, except per share amounts)
Net Sales (3) $2,450,719 $2,283,878 $2,213,017 $1,670,176 $1,364,030 $780,263 $1,161,379
Operating Profit (loss) $33,922 $(16,344) $(135,601) $65,788 $51,266 $40,815 $38,544
Income (loss) before
extraordinary charge
and cumulative effect
of accounting change $485 $(28,723) $(101,791) $33,468 $24,871 $20,256 $29,359
Extraordinary charge $(2,070) -- -- -- -- -- --
Cumulative effect of
accounting change $(2,080) -- -- -- -- -- --
Net (Loss) Income $(3,665) $(28,723) $(101,791) $33,468 $24,871 $20,256 $20,359
Basic earnings (loss)
per share before
extraordinary item and
cumulative effect of
accounting change $0.01 $(0.85) $(3.03) $1.03 $0.77 $0.63 $0.64
Extraordinary charge ($0.06) -- -- -- -- -- --
Cumulative effect of
accounting change $(0.06) -- -- -- -- -- --
------ ------ ------ ------ ------ ------ ------
Basic (loss) earnings
per share $(0.11) $(0.85) $(3.03) $1.03 $0.77 $0.63 $0.64
Diluted (loss) Earnings
per Share $(0.11) $(0.85) $(3.03) $1.02 $0.76 $0.62 $0.63
Total Assets $831,799 $880,311 $908,009 $744,181 $574,427 $574,427 $684,078
Working Capital $181,390 $228,775 $211,402 $205,011 $165,527 $165,527 $204,784
Current Ratio 1.60 1.79 1.66 1.82 1.98 1.98 1.88
Long-term Obligations $264,664 $337,199 $326,449 $144,168 $101,447 $101,447 $165,648
Number of (4):
Value City Stores 116 117 119 105 97 97 95
DSW Stores 126 104 78 58 44 44 43
Filene's Basement Stores 20 20 19 -- -- -- --
Net Sales per Selling Sq. Ft. (5) $224 $233 $234 $221 $235 $126 $229
Comparable Sales Change (6) (3.5)% (2.4)% (1.1)% 7.2% 6.0% 3.3% 5.9%
(1) Fiscal 2000 includes 53 weeks; all other years contain 52 weeks. The six
month period includes 26 weeks.
(2) The operations of Shonac and Valley Fair are included from the date of
acquisition, May 3, 1998.
(3) Excludes sales of licensed departments. In fiscal 1998, sales from our
toys and sporting goods departments became licensed departments operated
by VCM, Ltd., a 50/50 joint venture with Mazel Stores, Inc. Effective
February 2, 2002, we acquired Mazel's 50% interest in VCM.
(4) Includes all stores operating at the end of the fiscal year.
(5) Presented in whole dollars and excludes licensed departments and stores
not operated during the entire fiscal period.
(6) Comparable Store Sales Change excludes licensed departments. A store is
considered to be comparable in its second full fiscal year of operation.
For fiscal year 2000, comparable store sales are computed using like
52-week periods.
16
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
RISK FACTORS THAT MAY AFFECT FUTURE RESULTS
The following factors, among others, in some cases have affected the
matters discussed in Management's Discussion and Analysis of Financial Condition
and Results of Operations. These same factors could affect our future financial
performance in 2003 and beyond to differ materially from those expressed or
implied in any such forward-looking statements. These factors include: the
decline in demand for our merchandise, productivity and profitability, marketing
strategies, liquidity, vendor and their factor relations, flow of merchandise,
compliance with our credit agreements, the availability of desirable store
locations on suitable terms, changes in consumer spending patterns, consumer
preferences and overall economic conditions, the impact of competition and
pricing, changes in weather patterns, changes in existing or potential duties,
tariffs or quotas, paper and printing costs, the ability to hire and train
associates and development of management information systems.
Our operations have been historically seasonal, with a disproportionate
amount of sales and a majority of net income occurring in the back-to-school and
Christmas selling seasons for Value City and Filene's Basement. DSW seasonal
sales occurs both in early Spring and Fall. As a result of seasonality, any
factors negatively affecting us during these periods, including adverse weather,
the timing and level of markdowns or unfavorable economic conditions, could have
a material adverse effect on our financial condition and results of operations
for the entire year.
CRITICAL ACCOUNTING POLICIES
Management's Discussion and Analysis discusses the results of operations
and financial condition as reflected in our consolidated financial statements,
which have been prepared in accordance with generally accepted accounting
principles. As discussed in Note 1 to our Consolidated Financial Statements, the
preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
commitments and contingencies at the date of the financial statements and
reported amounts of revenues and expenses during the reporting period. On an
ongoing basis, management evaluates its estimates and judgments, including, but
not limited to, those related to inventory valuation, depreciation,
amortization, recoverability of long-lived assets including intangible assets,
the calculation of retirement benefits, estimates for self insurance reserves
for health and welfare, workers' compensation and casualty insurance, income
taxes, contingencies, litigation and revenue recognition. Management bases its
estimates and judgments on its historical experience and other relevant factors,
the results of which form the basis for making judgments about the carrying
values of assets and liabilities that are not readily apparent from other
sources. The process of determining significant estimates is fact specific and
takes into account factors such as historical experience, current and expected
economic conditions, product mix, and in some cases, actuarial and appraisal
techniques. We constantly re-evaluate these significant factors and make
adjustments where facts and circumstances dictate.
While we believe that our historical experience and other factors
considered provide a meaningful basis for the accounting policies applied in the
preparation of the consolidated statements, we cannot guarantee that our
estimates and assumptions will be accurate. As the determination of these
estimates requires the exercise of judgement, actual results inevitably will
differ from those estimates, and such differences may be material to the
financial statements.
We believe the following represent the most critical estimates and
assumptions, among others, used in the preparation of our consolidated financial
statements. We have discussed the selection, application and disclosure of the
critical accounting policies with our audit committee.
- Revenue recognition. Revenues from our retail operations are
recognized at the latter of point of sale or the delivery of
goods to the customer. Retail revenues are reduced by a
provision for anticipated returns based on our historical trends
by our customers.
- Cost of sales and merchandise inventories. We use the retail
method of accounting for substantially all of our merchandise
inventories. Merchandise inventories are stated at the lower of
cost, determined using the first-in, first-out basis, or market
using the retail inventory method. The retail method is widely
used in the retail industry due to its practicality. Under the
retail inventory method, the valuation of inventories at cost
and the resulting gross margins are calculated by applying a
calculated cost to retail ratio to the retail value of
inventories. The cost of the inventory reflected on our
consolidated balance sheet is decreased by charges to cost of
sales at the time the retail value of the inventory is lowered
through the use of markdowns. Hence, earnings are negatively
impacted as merchandise is marked down prior to sale. Reserves
to value inventory at the lower of cost or market were $32.5
million and $33.5 million at the end of fiscal 2002 and 2001,
respectively.
17
Inherent in the calculation of inventories are certain
significant management judgements and estimates including,
setting the original merchandise retail value or markon, markups
of initial prices established, reduction of pricing due to
customer's value perception or perceived value known as
markdowns and estimates of losses between physical inventory
counts or shrinkage, which combined with the averaging process
within the retail method, can significantly impact the ending
inventory valuation at cost and the resulting gross margins.
- Long-lived assets. In evaluating the fair value and future
benefits of long-lived assets, we perform an analysis of the
anticipated undiscounted future cash flows of the related
long-lived asset and reduce the carrying value by the excess
where the recorded value exceeds the fair value.
During fiscal 2002, we recorded two different charges related to
long-lived assets. The first charge was for goodwill impairment
as a result of the implementation of SFAS 142 which requires
that goodwill no longer be amortized, but would be subject to
annual fair value based impairment tests. The initial tests for
goodwill impairment, as of February 3, 2002, resulted in a
non-cash charge of $3.4 million, $2.1 million net of taxes,
which is reported in our Consolidated Statement of Operations as
of February 1, 2003 in the caption "Cumulative effect of
accounting change." Substantially all of the charge relates to
goodwill associated with our purchase of Mazel's interest in VCM
and is included in the net loss for the year ended February 1,
2003. At the end of the current fiscal year we have on our books
$37.6 million of goodwill subject to annual testing. The second
charge of $0.6 million related to long-lived assets at store
operating units. The result of reviewing undiscounted cash flows
for stores under SFAS 144, identified stores where the recorded
value of the asset exceeded the fair value.
During fiscal 2001, we recorded a charge of $4.9 million for the
write-down of capitalized development and software costs related
to discontinued information systems and a goodwill write-down of
$1.5 million relating to a previous acquisition.
We believe at this time that the long-lived assets' carrying
values and useful lives continue to be appropriate. To the
extent these future projections or our strategies change, the
conclusion regarding impairment may differ from our current
estimates.
- Self-insurance reserves. We record estimates for certain health
and welfare, workers compensation and casualty insurance costs
that are self-insured programs. These estimates are based on
actuarial assumptions and are subject to change based on actual
results. Should a greater amount of claims occur compared to
what was estimated for costs of certain health and welfare,
workers compensation and casualty insurance increase beyond what
was anticipated, reserves recorded may not be sufficient and
additional costs to the consolidated financial statements could
be required.
- Pension. The obligations and related assets of defined benefit
retirement plans are presented in Note 6 of the Notes to
Consolidated Financial Statements. Plan assets, which consist
primarily of marketable equity and debt instruments, are valued
using market quotations. Plan obligations and the annual pension
expense are determined by independent actuaries and through the
use of a number of assumptions. Key assumptions in measuring the
plan obligations include the discount rate, the rate of salary
increases and the estimarted future return on plan assets. In
determining the discount rate, we utilize the yield on
fixed-income investments currently available with maturities
corresponding to the anticipated timing of the benefit payments.
Salary increase assumptions are based upon historical experience
and anticipated future management actions. Asset returns are
based upon the anticipated average rate of earnings expected on
the invested funds of the plans. At February 1, 2003, the
weighted-average actuarial assumption of our plans were:
discount rate 6.5%, assumed salary increases 4% and long-term
rate of return on plan assets 8% - 9%. To the extent actual
results vary from assumptions, earnings would be impacted.
- Customer loyalty program. We maintain a customer loyalty program
for our DSW operations in which customers receive a future
discount on qualifying purchases. Upon reaching the target
level, customers may redeem these discounts on a future
purchase. Generally, these future discounts must be redeemed in
one year. We accrue the estimated costs of the anticipated
redemptions of the discount earned at the time of the initial
purchase and charge such costs to selling, general and
administrative expense based on historical experience. The
estimates of the costs associated with the loyalty program
require us to make assumptions related to customer purchase
levels and redemption rates. Accrued liability as of February 1,
2003 and February 2, 2002 were $2.2 million and $1.8 million,
respectively. To the extent assumptions of purchases and
redemption rates vary from actual results, earnings would be
impacted.
18
- Income taxes. We do business in numerous jurisdictions that
impose taxes. Management is required to determine the aggregate
amount of income tax expense to accrue and the amount which will
be currently payable based upon tax statutes of each
jurisdiction. The estimation process involves adjusting income
determined by the application of generally accepted accounting
principles for items that are treated differently by the
applicable taxing authorities. Deferred tax assets and
liabilities are reflected on our balance sheet for temporary
differences that will reverse in subsequent years. If different
management judgements had been made, our tax expense, assets and
liabilities could be different. See Note 1 to our Consolidated
Financial Statements on page F-6 of this Annual Report for a
discussion of our significant accounting policies.
RESULTS OF OPERATIONS
We operate three business segments. Value City and Filene's Basement
segments operate full-line, off-price department stores. Our DSW segment sells
better-branded off-price shoes and accessories. As of February 1, 2003, a total
of 116 Value City, 20 Filene's Basement and 126 DSW stores were open. The
following table sets forth, for the periods indicated, the percentage
relationships to net sales of the listed items included in our Consolidated
Statements of Operations for each individual segment and our Company in total.
For the Year Ended
-----------------------------------------------------------------------------------
2/1/03 2/2/02 2/3/01
52 Weeks 52 Weeks 53 Weeks
-----------------------------------------------------------------------------------
Net sales, excluding sales
licensed departments 100.0% 100.0% 100.0%
Cost of sales (61.8) (62.6) (67.5)
-----------------------------------------------------------------------------------
Gross profit 38.2 37.4 32.5
Selling, general and
administrative expenses (37.1) (38.9) (39.3)
License fees from affiliates
and other operating income 0.3 0.8 0.7
-----------------------------------------------------------------------------------
Operating Profit (loss) 1.4 (0.7) (6.1)
Interest expense, net (1.3) (1.3) (1.3)
Equity in loss of joint venture - - (0.1)
-----------------------------------------------------------------------------------
Income (loss) before extraordinary
item, cumulative effect of accounting
change and income taxes 0.1 (2.0) (7.5)
(Provision) benefit for income taxes (0.1) 0.7 2.9
-----------------------------------------------------------------------------------
(Loss) income before extraordinary item
and cumulative effect of accounting
change - (1.3) (4.6)
Extraordinary (charge), net of income
taxes and cumulative effect of
accounting change, net of income taxes (0.2) - -
-----------------------------------------------------------------------------------
Net (loss) income (0.2)% (1.3)% (4.6)%
===================================================================================
FISCAL YEAR ENDED FEBRUARY 1, 2003 COMPARED TO FISCAL YEAR ENDED FEBRUARY 2,
2002
Sales. Sales for the fifty-two weeks ended February 1, 2003(fiscal
2002), increased by 7.3% to $2.45 billion from $2.28 billion in the fifty-two
week period of fiscal year 2001. By segment comparable store sales were:
19
2002 2001
---- ----
Value City Department Stores (5.1)% (3.7)%
DSW (0.1)% 0.0%
Filene's Basement 0.3% 2.2%
------------------------------------------------------------------------------------
Total (3.5)% (2.4)%
====================================================================================
Comparable store sales percentage declines are attributable to highly
competitive and promotional retail environment and the effects of a softening
economy experienced by our segments. Value City's non-apparel comparable sales
decreased 3.8% for the twelve months and apparel comparable sales declined 6.6%
for the year. The apparel divisions of children's, men's and ladies' divisions
had comparable sales declines of 8.4%, 9.9% and 2.7%, respectively in fiscal
2002. DSW reflected a slightly negative comparable store rate as overall sales
rose almost $119.6 million to $629.0 million for the year. The DSW increase
includes a net increase of 22 stores. The Filene's Basement segment's sales rose
$9.8 million to $303.2 million for the fiscal year including a slight increase
in comparative store sale percentage. Filene's Basement total stores opened
remained unchanged due to a single opening and closing during the fiscal year.
Gross profit. Consolidated gross profit increased $81.7 million from
$854.4 million to $936.1 million, and increased as a percentage of net sales
from 37.4% to 38.2%. The Value City segment gross profit improvement is the
result of additional focus on purchase cost and retail pricing. In addition,
Value City increased control over inventory and reduced the loss associated with
shrink from the prior year. Gross profit for our DSW segment improved with
effort towards better initial markup and markdown control. Our Filene's Basement
segment gross profit was negatively affected by early and excess markdowns
required to sell and reduce inventories. Gross profit, as a percent of sales by
segment, were:
2002 2001
---- ----
Value City Department Stores 38.9% 37.6%
DSW 39.4% 38.2%
Filene's Basement 32.2% 35.1%
----------------------------------------------------------------------------
Total 38.2% 37.4%
============================================================================
SG&A. For the year, consolidated SG&A increased $20.8 million to $909.6
million or 37.1% of sales. Our fifty-two week period ended February 1, 2003
includes approximately $0.6 million for FASB 144 write-off, $1.1 million for
store closings, $6.0 million for severance costs related to work force
reductions during the year and the relocation of our Value City merchandising
office from Boston to New York. The relocation of the Value City buyers from
Boston to New York City provide merchants with a closer proximity to our markets
and vendors. In addition, we evaluated stores with negative or inadequate cash
flows to determine if any assets were impaired. New store openings in the period
were limited to our DSW and Filene's Basement segments. Preparations for opening
a DSW store or a Filene's Basement store generally take eight to ten weeks.
Pre-opening costs are expensed as incurred. It has been our experience that new
stores for each of our segments generally achieve profitability and contribute
to net income after the first full year of operations. No Value City stores were
opened less than twelve months during fiscal 2002. Twenty-two DSW stores were
opened less than twelve months in fiscal 2002 and had a pre-tax net operating
loss of $2.6 million, including $2.6 million of pre-opening expenses. Twenty-six
DSW stores were opened less than twelve months during fiscal 2001 and had a
pre-tax net operating loss of $2.5 million, including $0.1 million of
pre-opening expenses. Filene's Basement had one store opened less than twelve
months in fiscal 2002 with a pre-tax net operating loss of $54,000, including
$0.6 million of pre-opening expenses. SG&A as a percent of sales by segment
were:
2002 2001
---- ----
Value City Department Stores 37.8% 40.6%
DSW 37.2% 37.4%
Filene's Basement 33.7% 32.9%
----------------------------------------------------------------------------
Total 37.1% 38.9%
============================================================================
License fees from affiliates. License fees from affiliates and others
decreased $9.6 million, or 78.5%, from $12.2 million to $2.6 million, and
decreased as a percentage of net sales from 0.5% to 0.1%. Fees from the VCM
joint venture of $9.7 million in 2001, did not occur in the current year as the
operations have been included in current year as the joint venture was purchased
at the close of business on February 2, 2002. The current year balance
represents fees received from other unaffiliated licensees.
Other operating income. Other operating income decreased $0.9 million,
or 16.8%, from $5.7 million to $4.8 million and decreased as a percentage of net
sales from 0.3% to 0.2%. Other operating income is comprised of layaway fees and
vending income. These sources of income vary based on customer traffic and
contractual arrangements.
20
Operating profit. Operating profit increased to $33.9 million from a
loss of $16.3 million, and increased as a percentage of net sales from a loss of
0.7% to a profit of 1.4%.
Interest expense. Interest expense, net of interest income, increased
$4.0 million from $28.5 million to $32.5 million due primarily to an increase in
interest rates as a result of new term debt, offset partially by a decrease in
average borrowings. Interest expense also included amortization of debt discount
of $1.3 million.
Equity in loss of joint venture. Equity in loss of joint venture in
fiscal 2001 of $0.4 million was the result of operations in the 50/50 joint
venture with Mazel. We acquired Mazel's interest at the close of business
February 2, 2002 and have included the operations of these departments in the
consolidated statements presented.
Income (loss) before extraordinary item. Income (loss) before
extraordinary item, cumulative affect of accounting change and income taxes
increased $46.7 million from a loss of $45.3 million to income of $1.4 million,
and as a percentage of sales from a loss of 2.0% to income of 0.1% as a result
of the above factors.
Extraordinary charge. During the year, we entered into new term debt
agreements and a revolving line of credit. The resulting write-off of previous
costs associated with the old debt was $2.1 million net of tax, or 0.1% of
sales.
Cumulative effect of accounting change. We also implemented a new
accounting principle during fiscal 2002 resulting in the impairment of goodwill.
The charge for the application of the new principle was $2.1 million net of tax,
or 0.1% of sales. We retained a valuation professional to assist in the
calculation of impairment. Our initial test was performed as of the beginning of
the fiscal year while our annual test occurred in the middle of the fourth
quarter. Goodwill will be subject to annual impairment tests and results of such
tests cannot be predicted.
FISCAL YEAR ENDED FEBRUARY 2, 2002 COMPARED TO FISCAL YEAR ENDED FEBRUARY 3,
2001
Sales. Sales for the fifty-two weeks ended February 2, 2002 (fiscal
2001), increased by 3.2% to $2.28 billion from $2.21 billion in the fifty-three
week period of 2000. Excluding the extra week in fiscal 2000, total sales
increased 5.2% and same store sales declined 2.4%. Fiscal 2001 sales include
$293.4 million attributable to Filene's Basement, which was acquired in March
2000. Filene's Basement sales in the prior year were $249.1 million. By segment
comparable store sales were:
2001 2000
---- ----
Value City Department Stores (3.7)% (4.3)%
DSW 0.0 % 19.1%
Filene's Basement 2.2 % n/a
------------------------------------------------------------------------------------
Total (2.4)% (1.1)%
====================================================================================
Sales from the Value City segment include the non-apparel comparable
sales that increased 3.3% for the twelve months. The apparel comparable sales
declined 5.9% for the year including a positive comparable of 3.7% for children
while men's and ladies declined 4.7% and 10.7%, respectively. DSW sales
increased almost $100.0 million to $509.4 million for the year to date period,
including a net increase of 26 stores. Comparable stores for DSW were flat.
Gross profit. Consolidated gross profit increased $134.3 million from
$720.1 million to $854.4 million, and increased as a percentage of net sales
from 32.5% to 37.4%. Last year's gross margin included a $105.4 million charge
for the realignment of excess inventory quantities. Excluding the charge the
gross margin percent to sales would have been 37.3% in fiscal 2000.
SG&A. SG&A increased $18.5 million to $888.7 million or 38.9% of sales.
The fifty-two week period ended February 2, 2002 includes approximately $24.7
million, or $0.47 per share, for employee benefit, severance costs, write off of
software development efforts, DSW warehouse relocation and fees associated with
the terminated sale of DSW and Filene's Basement. The fifty-three week period
ended February 3, 2001 included pretax charges of $4.6 million for asset
impairment and severance costs. New DSW stores added approximately $67.0 million
of SG&A expenses.
Based upon our experience, we estimate the average cost of opening a new
department store to range from approximately $4.5 million to $6.5 million and
the cost of opening a new shoe store to range from approximately $1.0 million to
$2.0 million including leasehold improvements, fixtures, inventory, pre-opening
expense and other costs. Similar costs for a Filene's Basement store are in the
$2.0 million to $3.0 million range. Preparations for opening a Value City store
generally take between eight and twelve weeks and preparations for a DSW store
or a Filene's Basement store generally take eight to ten weeks. Pre-opening
costs are expensed as incurred. It has been our experience that new stores
generally achieve profitability and contribute to net income after the first
full year of operations. Twenty-three Value City stores were opened less than
twelve months during fiscal 2000 and had pre-tax operating losses of $22.8
million, including $4.5 million of pre-opening expense. Twenty-six DSW stores
were opened less than twelve months in fiscal 2001 and had a pre-tax net
operating loss of $2.5 million, including $0.1 million of pre-opening expenses.
21
Twenty DSW stores were opened less than twelve months during fiscal 2000 and had
a pre-tax net operating loss of $6.5 million, including $4.6 million of
pre-opening expenses.
License fees from affiliates. License fees from affiliates increased
$0.9 million, or 8.0%, from $11.3 million to $12.2 million, and remained at 0.5%
as a percentage of net sales. License fees are from the VCM joint venture and
unaffiliated third party licensees.
Other operating income. Other operating income increased $2.4 million,
or 76.1%, from $3.3 million to $5.7 million, and increased as a percentage of
net sales from 0.2% to 0.3%. Other operating income is comprised of layaway fees
and vending income. These sources of income vary based on customer traffic and
contractual arrangements.
Operating loss. Operating loss decreased $119.3 million from a loss of
$135.6 million to a loss of $16.3 million, and decreased as a percentage of net
sales from a loss of 6.1% to a 0.7% loss as a result of the above factors.
Interest expense. Interest expense, net of interest income, decreased
$2.0 million from $30.5 million to $28.5 million, due primarily to a decrease in
interest rates, offset partially by slightly higher average borrowings.
Equity in loss of joint venture. Equity in loss of joint venture
decreased $0.9 million from a loss of $1.3 million to a loss of $0.4 million.
Loss before income taxes. Loss before benefit for income taxes decreased
$122.1 million from a loss of $167.4 million to a loss of $45.3 million, and
decreased as a percentage of sales from a loss of 7.5% to a 2.0% loss as a
result of the above factors.
SEASONALITY
Our business is affected by the pattern of seasonality common to most
retail businesses. Historically, the majority of our sales and operating profit
have been generated during the back-to-school and Christmas selling seasons for
our Value City and more recently the Filene's Basement segments. The shoe
business experiences increased sales in both early Spring and Fall seasons in
relationship to the change in footwear desired by the DSW customer.
FISCAL YEAR
We follow a 52/53-week fiscal year that ends on the Saturday nearest to
January 31. Fiscal 2002 and 2001 contain 52 weeks and fiscal 2000 has 53 weeks.
INCOME TAXES
Our effective tax rate for fiscal 2002 was 66.0% versus 36.5% for fiscal
2001. The overall increase in the effective tax rate was primarily due to the
increase in non-deductible expenses for tax purposes and the fluctuation in
taxable income.
ADOPTION OF ACCOUNTING STANDARDS
The Financial Accounting Standards Board ("FASB") periodically issues
Statements of Financial Accounting Standards ("SFAS"), some of which require
implementation by a date falling within or after the close of the fiscal year.
In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations." SFAS No. 143 addresses financial accounting and
reporting for obligations associated with the retirement of tangible long-lived
assets and the associated asset retirement costs. Under this Statement,
obligations that meet the definition of a liability will be recognized
consistently with the retirement of the associated tangible long-lived assets.
This Statement is effective for financial statements issued for fiscal years
beginning after June 15, 2002. We are currently assessing the impact of SFAS No.
143. At this time, we have yet to determine the effect of this pronouncement on
its results of operations and financial position.
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB
Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections." The standard rescinds FASB Statements No. 4 and 64 that deal with
issues relating to the extinguishment of debt. The standard also rescinds FASB
Statement No. 44 that deals with intangible assets of motor carriers. The
standard modifies SFAS No. 13, "Accounting for Leases," so that certain capital
lease modifications must be accounted for by lessees as sale-leaseback
transactions. Additionally, the standard identifies amendments that should have
been made to previously existing pronouncements and formally amends the
appropriate pronouncements. This Statement is effective for fiscal years
beginning after May 15, 2002. The adoption of SFAS No. 145 will not have a
significant effect on our results of operations or our financial position. For
fiscal year 2003, we will be required to reclassify the loss on the
extinguishment of debt from extraordinary to interest expense, in the condensed
consolidated statements of operations, under the provisions of SFAS No. 145.
22
In November 2002, the FASB issued FASB Interpretation No. 45 ("FIN 45"),
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others, an interpretation of FASB
Statements No. 5, 57 and 107 and Rescission of FASB Interpretation No. 34." FIN
45 clarifies the requirements of SFAS No. 5, "Accounting for Contingencies,"
relating to the guarantor's accounting for, and disclosure of, the issuance of
certain types of guarantees. The disclosure provisions of FIN 45 are effective
for the current fiscal year. However, the provisions for initial recognition and
measurement are effective on a prospective basis for guarantees that are issued
or modified after December 31, 2002, irrespective of a guarantor's year-end. We
have no guarantees as of February 1, 2003.
In December 2002, the FASB issued SFAS No. 148, "Accounting for
Stock-Based Compensation." The statement amends the disclosure requirements of
FASB Statement No. 123 "Accounting for Stock-Based Compensation." The standard
as implemented by us requires additional disclosure in the "Summary of
Significant Accounting Policies" and the affect on earnings and earnings per
share both basic and diluted.
In January 2003, the FASB issued FIN 46, "Consolidation of Variable
Interest Entities." FIN 46 clarifies the application of Accounting Research
Bulletin No. 51, Consolidated Financial Statements, to certain entities in which
equity investors do not have the characteristics of a controlling financial
interest or do not have sufficient equity at risk for the entity to finance its
activities without additional subordinated financial support from other parties.
FIN 46 requires a variable interest entity to be consolidated by a company, if
that company is subject to a majority of the risk of loss from the variable
interest entity's activities or entitled to receive a majority of the entity's
residual returns or both. FIN 46 also requires disclosures about variable
interest entities that a company is not required to consolidate but in which it
has a significant variable interest. The consolidation requirements of FIN 46
apply immediately to variable interest entities created after January 31, 2003
and to existing entities in the first fiscal year or interim period beginning
after June 15, 2003. Certain of the disclosure requirements apply to all
financial statements issued after January 31, 2003, regardless of when the
variable interest entity was established. We have no variable interest entities
as of February 1, 2003.
INFLATION
The results of operations and financial condition are presented based
upon historical cost. While it is difficult to accurately measure the impact of
inflation because of the nature of the estimates required, management believes
that the effect of inflation, if any, on the results of operations and financial
condition has been minor.
LIQUIDITY AND CAPITAL RESOURCES
Net working capital was $181.4 million and $228.8 million at February 1,
2003 and February 2, 2002, respectively. Current ratios at those dates were 1.6
and 1.8, respectively. Net cash provided by operating activities totaled $90.3
million and $48.7 million in fiscal 2002 and 2001, respectively.
Net cash used for capital expenditures was $41.8 million and $40.2
million for fiscal 2002 and 2001, respectively. During fiscal 2002, capital
expenditures included $11.1 million for new stores, $13.7 million for
improvements in existing stores, $10.0 million for office, warehousing and
operations of our shoe business and $7.0 million for MIS equipment upgrades and
new systems. Proceeds from lease incentives are amortized as a reduction of rent
expense over the life of the lease.
On June 11, 2002, we, together with our principal subsidiaries, entered
into a $525.0 million refinancing that consists of three separate credit
facilities: (i) a new three-year $350.0 million revolving credit facility (the
"Revolving Credit Facility"), (ii) two $50.0 million term loan facilities
provided equally by Cerberus Partners, L.P. and Schottenstein Stores Corporation
(the "Term Loans"), and (iii) an amended and restated $75.0 million senior
convertible loan, initially entered into by us on March 15, 2000, which is held
equally by Cerberus Partners, L.P. and SSC (the "Convertible Loan").
$350 Million Revolving Credit Facility
Under the Revolving Credit Facility, the borrowing base formula is
structured in a manner that allows us and our subsidiaries availability based on
the value of inventories and receivables. Primary security for the Revolving
Credit Facility is provided by a first priority lien on all of our inventory and
accounts receivable, as well as certain intercompany notes and payment
intangibles. The Revolving Credit Facility also has a second priority perfected
interest in all of the collateral securing the Term Loans. Interest on
borrowings is calculated at the bank's base rate or Eurodollar rate plus 2.00%
to 2.75%, depending upon the level of average excess availability we maintain.
$100 Million Term Loans
The Term Loans are comprised of a $50.0 million Term Loan B and a $50.0
million Term Loan C. All obligations under the Term Loans are senior debt,
ranking pari passu with the Revolving Credit Facility and the Convertible Loan.
We and our principal subsidiaries are obligated on the Term Loans.
23
The Term Loans stated rate of interest per annum during the initial two
years of the agreement is 14% if paid in cash and 15% if we elect a paid-in-kind
("PIK") option. During the first two years of the Term Loans, we may pay all
interest by PIK. During the final year of the Term Loans, the stated rate of
interest is 15.0% if paid in cash or 15.5% by PIK and the PIK option is limited
to 50% of the interest due.
We issued on September 26, 2002, 2,954,792 warrants ("Warrants") to
purchase shares of common stock, at an initial exercise price of $4.50 per
share, to the Term Loan C Lenders. The number of shares issuable upon the
exercise of the Warrants and the per share exercise price are subject to
adjustment upon the occurrence of specified events. The Warrants are exercisable
at any time prior to June 11, 2012. We have granted the Term Loan C Lenders
registration rights with respect to the shares issuable upon exercise of the
Warrants. The value placed on the Warrants was $6.1 million and the related debt
discount is amortized into interest expense over the life of the debt.
$75 Million Senior Convertible Loan
We have amended and restated our $75.0 million Convertible Loan dated
March 15, 2000. As amended, borrowings under the Convertible Loan will bear
interest at 10% per annum. At our option, interest may be PIK during the first
two years, and thereafter, at our option, up to 50% of the interest due may be
PIK until maturity. The Convertible Loan is guaranteed by all principal
subsidiaries and is secured by a lien on assets junior to liens granted in favor
of the Revolving Credit Facility and Term Loans. The Convertible Loan is not
prepayable until June 11, 2007. The agent has the right to designate two
observers to our Board of Directors for so long as the agent is the beneficial
owner of at least 50% of the advances initially made by it and has the right to
designate two individuals to our Board of Directors for so long as the agent is
the beneficial owner of at least 50% of the conversion shares issued upon
conversion of the advances initially made by it.
The Convertible Loan is convertible at the option of the holders into
shares of our common stock at an initial conversion price of $4.50. The
conversion price is subject to adjustment upon the occurrence of specified
events.
Achievement of expected cash flows from operations and compliance with
the covenants of our credit agreements (see Note 4 to the Consolidated Financial
Statements) are dependent upon a number of factors, including the attainment of
sales, gross profit, expense levels, vendor relations, and flow of merchandise
that are consistent with our financial projections. Future limitations of credit
availability by Factor organizations and/or vendors will restrict our ability to
obtain merchandise and services and may impair operating results. Although
operating results for fiscal 2002 were below plan, we believe that cash
generated by operations, along with the available proceeds from our credit
agreements and other sources of financing will be sufficient to meet our
obligations for working capital, capital expenditures, and debt service
requirements. However, there is no assurance that we will be able to meet our
projections. Further, there is no assurance that extended financing will be
available in the future if we fail to meet our projections or on terms
acceptable to us.
ACQUISITIONS
Effective with the close of business on February 2, 2002 by acquisition
of our partner's interest in VCM for $8.4 million, we now own 100% of VCM and
operate the health and beauty care, toy, sporting goods and food departments in
our Value City stores.
On March 17, 2000, we completed the acquisition of substantially all of
the assets and assumed certain liabilities of Filene's Basement Corp., a
Massachusetts corporation, and Filene's Basement, Inc., a wholly owned
subsidiary of Filene's Basement Corp. The purchase price included cash of $3.5
million paid at closing, $1.2 million to be paid over a period not to exceed
three years, 403,208 shares of our common stock with an agreed value of $5.5
million and the assumption of specified liabilities. The assumed liabilities
included the payment of amounts outstanding under Filene's Basement
debtor-in-possession financing facility of approximately $22.5 million and
certain trade payable and other obligations which were paid in the ordinary
course of business. Allocation of the purchase price has been determined based
on fair market valuation of the net assets acquired. The acquisition was funded
by cash from operations and a portion of the proceeds from the credit agreement.
In April 2003, we paid the remaining balance of the purchase obligation of
approximately $6.0 million.
These acquisitions were funded by cash from operations and a portion of
the proceeds from the Credit Agreement.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
We are exposed to market risk from changes in interest rates, which may
adversely affect our financial position, results of operations and cash flows.
In seeking to minimize the risks from interest rate fluctuations, we manage
exposures through our regular operating and financing activities and, when
deemed appropriate, through the use of derivative financial instruments. We do
not use financial instruments for trading or other speculative purposes and are
not party to any leveraged financial instruments.
24
We are exposed to interest rate risk primarily through our borrowings
under our Revolving Credit Facility. At February 1, 2003, direct borrowings
aggregated $64.0 million. The Revolving Credit Facility permits debt commitments
up to $350.0 million, matures on June 11, 2005 and generally bears interest at a
floating rate of LIBOR plus 2.0% to 2.75% based on the average excess
availability during the previous quarter. We utilize interest rate swap
agreements to effectively establish long-term fixed rates on borrowings under
the Revolving Credit Facility, thus reducing a portion of our interest rate
risk. These swap agreements, which are designated as cash flow hedges, involve
the receipt of variable rate amounts in exchange for fixed rate interest
payments over the life of the agreements. At February 1, 2003, we had
outstanding swap agreements with notional amounts totaling $75.0 million, for
which the interest rate has been locked at a fixed rate of 6.99% until April
2003.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
Our financial statements and financial statement schedule and the
Independent Auditors' Report thereon are filed pursuant to this Item 8 and are
included in this report beginning on page F-1.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
25
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The members of our Board of Directors (the "Board") are elected at the
Annual Meeting. The number of members of our Board has been fixed at fourteen by
action of the Board pursuant to the Code of Regulations (By-laws). Board members
serve until the Annual Meeting following their election or until their
successors are duly elected and qualified.
Set forth below is certain information relating to the directors.
Name Age Principal Occupation
- ---------------------- --- ------------------------------------------------------------------------------
Jay L. Schottenstein 48 Director of our Company since June 1991. Chairman of our
Company, American Eagle Outfitters, Inc. and SSC since March
1992 and Chief Executive Officer from April 1991 to July 1997
and from July 1999 to December 2000. Mr. Schottenstein served
as Vice Chairman of SSC from 1986 until March 1992 and a
director of SSC since 1982. He served SSC as President of the
Furniture Division from 1985 through June 1993 and in various
other executive capacities since 1976. Mr. Schottenstein is
also a director of American Eagle Outfitters, Inc., which is a
company with a class of securities registered pursuant to
Section 12 of the Securities Exchange Act of 1934. (1)
Henry L. Aaron 68 Director of our Company since January 2000. Mr. Aaron
presently serves as Senior Vice President of the Atlanta
National League Baseball Club, Inc. and as Vice President of
Business Development for the CNN Airport Network, along with a
number of other private business interests.
Ari Deshe 52 Director of our Company since October 1997. Chairman and Chief
Executive Officer since 1996 and President and Chief Executive
Officer from 1993 to 1996 of Safe Auto Insurance Company, a
property and casualty insurance company. Prior to that, Mr.
Deshe served as President of Safe Auto Insurance Agency from
1992 to 1993 and President of Employee Benefit Systems, Inc.
from 1982 to 1992. Mr. Deshe is also a director of American
Eagle Outfitters, Inc., which is a company with a class of
securities registered pursuant to Section 12 of the Securities