ITEM 1. BUSINESS --------
(a) The Registrant, an Ohio corporation with principal offices in Hudson, Ohio, is a leading national specialty retailer that operates retail stores in the fabric and craft industry. Although the Company was incorporated in February 1951, the business conducted by its predecessors began in 1943 when the first store was opened in Cleveland, Ohio offering fabrics and notions for sale under the name "Cleveland Fabric Shops."
The Registrant's principal business is conducted in the retail fabric and craft industry through specialty stores which sell a wide variety of fashion and decorator fabrics, notions, crafts, patterns and sewing accessories. On October 2, 1994, the Registrant acquired Cloth World, a division of Brown Group Inc. This acquisition added 342 stores to the number of stores being operated at that time. At January 27, 1996, the Registrant operated 936 stores in 48 states. The majority of the Registrant's stores currently do business under the names of "Jo-Ann Fabrics," "Cloth World," "Jo-Ann Fabrics and Crafts" and "New York Fabrics."
The total number of stores in operation at January 27, 1996 by state was as follows:
The following table sets forth the number of stores opened, closed and acquired by the Registrant during each of the past five fiscal years:
At the end of fiscal 1996, 87% of the Registrant's stores were superstores (over 9,000 square feet). In fiscal 1997, the Registrant expects to open approximately 50 to 60 new stores while closing 60 to 70 smaller locations.
The Registrant's stores are located in leased facilities that average approximately 12,309 square feet. These stores are located in strip shopping centers, malls and free standing buildings. The Registrant varies its merchandising selection and inventory levels to conform with the various store layouts.
The Registrant, in general, owns all of the fixtures used in its stores. The Registrant believes that it effectively utilizes its selling space and that its equipment is maintained and suitable for its requirements. It is the Company's policy to transfer fixtures and inventory from closed stores to new or existing stores. During the fiscal year ended January 27, 1996, the average investment in each new store was approximately $128,000 for leasehold improvements and additional fixtures. The Registrant converted 302 Cloth World stores to the Jo-Ann Fabrics and Crafts format adding to these stores a broader selection of merchandise. The average investment per converted store was approximately $61,000 for leasehold improvements and additional fixtures and $104,000 for incremental inventory. It is the Registrant's policy to charge operations for its pre-opening expenses as incurred, which is generally the same period as the store is opened. Store pre-opening costs consist chiefly of the cost of training sales personnel, advertising, stocking and incidental supplies.
Each of the Registrant's stores sells a wide variety of merchandise primarily for customers to make their own clothing and to complete home decorating and craft projects. The fabrics that are sold by the Registrant include woolens, rayons, cottons, laces, synthetics, drapery and home furnishings and are customarily sold by the yard. Notions sold by the Registrant include cutting instruments, trimmings, buttons, threads, and zippers. Crafts sold by the Registrant include seasonal merchandise, craft supplies, fabric paints, beads and jewelry, florals and stitchery.
The Registrant had 874 stores in operation for the full fiscal year ended January 27, 1996, with average sales of $893,000 per store. All items are sold for cash, through the use of various bank charge plans including the private label charge plan, which was introduced in the fourth quarter of fiscal 1996.
In each of its stores the Registrant employs a store manager, merchandise manager and in some locations an operations manager, and full-time and part-time sales associates as required. Each store is under the supervision of a district manager who reports to a regional manager.
Substantially all of the merchandising functions, including purchasing, allocation and distribution, in addition to accounting, information systems, real estate, advertising, and non-merchandise purchasing functions are centralized at the Registrant's corporate offices. The objective of the centralized control system is to allow each store manager and sales associate the opportunity to devote maximum effort toward sales of merchandise and
customer service.
The Registrant's centralized human resource department and field management organization are responsible for recruiting new store managers. A prospective store manager is assigned to an existing store as a manager-trainee for several weeks and receives in-depth on-the-job training. In addition, periodic training seminars are conducted for existing store managers. Sales associates are trained on the job.
For the three fiscal years ended January 27, 1996, the Registrant's business resulted from sales of the following principal products:
The sales information presented above excludes the Cargo Express Stores housewares division, which has been classified as a discontinued operation since fiscal 1993 and ceased operation in the first quarter of fiscal 1995.
(b) The Registrant is a specialty retailer that operates retail stores in the fabric and craft industry.
(c) The following information is furnished in response to Item 101 (c) and (d) of Regulation S-K.
STATUS OF PRODUCT OR LINE OF BUSINESS. During the last fiscal year, there has been no public announcement nor is there a public announcement anticipated, about either a new product line or line of business involving the investment of a material portion of the Registrant's assets.
SOURCE AND AVAILABILITY OF RAW MATERIALS. There are various sources of supply available for each category of merchandise sold by the Registrant. The Registrant has no long-term purchase commitments with any of its suppliers. The Registrant imports approximately 14.2% of its purchases, which are bought in United States currency.
PATENTS, TRADEMARKS, LICENSES, FRANCHISES AND CONCESSIONS. The Registrant does not own material patents, trademarks, licenses, franchises, and/or concessions. The Registrant does business primarily under the names "Jo-Ann Fabrics", "Cloth World", "Jo-Ann Fabrics and Crafts" and "New York Fabrics."
SEASONAL BUSINESS. The Company's business exhibits seasonality which is typical for most retail companies, with much stronger sales in the second half of the year than the first half of the year. In general, net earnings are highest during the months of September through December, when sales volumes provide significant operating leverage. Conversely, net earnings are substantially lower during the relatively low-volume sales months of January through August. Capital requirements needed to finance the Company's operations fluctuate during the year and reach their highest levels during the second and third fiscal quarters as the Company increases its inventory in anticipation of its peak selling season.
DEPENDENCE ON SINGLE OR FEW CUSTOMERS. The Registrant is engaged in the retail sale of merchandise to the general public and, accordingly, no part of the business of the Registrant is dependent upon a single customer or a few customers. During the fiscal year ended January 27, 1996, no one store accounted for more than 1% of total sales.
BACKLOG OF ORDERS. The Registrant is engaged in the retail sale of merchandise to the general public on a cash and carry basis and, accordingly, has no backlog of orders.
COMPETITIVE CONDITIONS. The retail fabric and craft industry is highly competitive. The Registrant's stores compete with other specialty fabric and craft retailers, craft retailers and mass merchants on the basis of assortment, price and convenience. Some of the Registrant's competitors, particularly mass merchants, have greater financial and other resources than the Registrant. The retail fabric and craft industry is contracting and consolidating after several years of intense competition. With the acquisition of Cloth World in fiscal 1995, the Registrant became the leading national fabric and craft retailer with approximately twice as many stores as the next largest fabric and craft retail competitor. In addition to its national competitors, the Registrant also competes with many individual retailers and regional chains.
RESEARCH AND DEVELOPMENT. During the three fiscal years ended January 27, 1996, the Registrant has not incurred any material expense on research activities relating to the development of new products or services or the improvement of existing products or services that were company-sponsored or customer-sponsored.
ENVIRONMENTAL DISCLOSURE. The Registrant is not engaged in manufacturing. Accordingly, the Registrant does not believe that compliance with federal, state and local provisions regulating the discharge of material into the environment or otherwise relating to the protection of the environment will have any material effects upon the capital expenditures, earnings or competitive position of the Registrant.
NUMBER OF EMPLOYEES. The Registrant has approximately 17,200 permanent full-time and part-time employees, 16,200 of whom work in the Registrant's retail stores. Additional part-time employees are hired during peak selling periods. Approximately 460 employees in the Hudson distribution center are covered by a collective bargaining agreement with the United Steelworkers of America, Upholstery and Allied Industries Division. This agreement expires in May 1998. The Registrant considers its relationships with its employees to be good.
FOREIGN OPERATIONS AND EXPORT SALES. Although the Registrant imports a significant percentage of its merchandise from foreign countries, the loss of any sources of supply from any of such foreign countries would not be material to the business of the Registrant. The Registrant had no export sales.
ITEM 2.
ITEM 2. PROPERTIES
The Registrant's corporate offices and distribution center are located in an approximately 1,400,000 square foot Registrant-owned facility on approximately 120 acres in Hudson, Ohio. The distribution operations occupy approximately 1,000,000 square feet and an additional 100,000 square feet are used by the Registrant's corporate offices and a "laboratory" store. The Registrant leases approximately 200,000 square feet of the facility to unrelated third parties and the remaining square footage is available for lease. The Registrant believes that the facility will meet its requirements for the foreseeable future. Adjacent to the Hudson facility, the Registrant owns approximately 100 acres of undeveloped land, which it holds for sale.
The remaining properties occupied by the Registrant are leased retail store facilities that are located primarily in high-traffic shopping centers. All store leases are operating leases generally for periods up to ten years with renewal options for up to twenty years. Certain retail store leases contain escalation clauses and in some cases provide for contingent rents based on a percent of sales in excess of defined minimums. During the fiscal year ended January 27, 1996, the Registrant incurred $67,087,000 of expenses for store rentals.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS -----------------
The Company was notified by the staff of the Securities and Exchange Commission that the staff tentatively intends to recommend that the Commission bring an enforcement action against the Company, its chief executive officer, its chief financial officer and a former officer in connection with the Company's financial statements for its fiscal year ended February 1, 1992, and for the immediately following three quarters, and with the adequacy of certain disclosures relating to such periods. The staff contends that the financial statements were not accurate because of the manner in which the Company calculated one of its inventory-related reserves for such periods. The accounting issues that have been raised are not related to any current period, and no current accounting policies or financial statements are in question. The Company has filed a written response, and met, with the staff to explain the Company's position on the issues raised. If any action is brought, the Company intends to vigorously contest it.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS ---------------------------------------------------
None.
Executive Officers of the Registrant ------------------------------------
The information below is included in this report pursuant to instruction 3 to item 401 (b) of Regulation S-K.
The Executive Officers of the Registrant are as follows:
PART II
ITEM 5.
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER ---------------------------------------------------------------- MATTERS -------
On August 2, 1995, the shareholders approved a recapitalization amendment to the Articles of Incorporation, which became effective on that date, creating a new class of non-voting common shares designated as Class B Common Shares and changing each outstanding common share into one Class A and one Class B Common Share. The Class A and Class B common stock are traded on the New York Stock Exchange under the ticker symbols FCA-A and FCA-B, respectively. The number of Class A and Class B Common shareholders of record as of March 29, 1996 were 916 and 912, respectively.
The quarterly high and low stock prices for the fiscal years 1996 and 1995 are presented in the table below:
(a) The Class A Common Shares market price data has been restated to reflect the recapitalization amendment, which had the effect of a two-for-one stock split.
(b) The Class B Common Shares were issued as part of the recapitalization amendment, effective August 2, 1995.
The Registrant intends to follow a dividend policy of retaining earnings for the operation and growth of its business. Payment of dividends in the future will be determined by the Board of Directors in light of appropriate business conditions. The Registrant did not pay dividends on its common stock during fiscal 1996 and fiscal 1995.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
FINANCIAL SUMMARY Fabri-Centers of America, Inc. (Thousands of dollars, except per share data)
(a) The number of shares and per share data have been restated to give effect to the Recapitalization Amendment, effective August 2, 1995, which has been accounted for as if it were a two-for-one stock split. (b) Ratio of pre-tax earnings before interest, discontinued operation, extraordinary item and cumulative effect of accounting change to net interest expense.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS ----------------------------------------------------------------------- OF OPERATIONS -------------
Except where otherwise noted, Management's Discussion and Analysis of Financial Condition and Results of Operations pertains to the Company's continuing operations.
On October 2, 1994, the Company acquired substantially all of the assets of Cloth World, a division of Brown Group Inc. ("Cloth World") for approximately $97,000,000 in cash and assumed liabilities. The funds used to acquire Cloth World were provided by internally generated funds and borrowings under a credit facility. The acquisition has been recorded using the purchase method, and accordingly, the results of operations of Cloth World have been included in the Company's consolidated financial statements since the date of acquisition.
RESULTS OF OPERATIONS
The following table shows the percentage of net sales for the periods indicated and the percentage change in dollar amounts from period to period of certain items included in the Consolidated Statements of Income.
Net sales for fiscal 1996 increased 23.2 percent, or $157,338,000, to $834,617,000 from $677,279,000 in fiscal 1995. Sales from the Cloth World stores acquired in October of fiscal 1995 accounted for $142,552,000 of the increase. Comparable store sales for fiscal 1996 increased 3.2 percent over the prior year. This increase is primarily a result of expanded notions product offerings and store closings by competitors in certain markets. Throughout fiscal 1996, 302 Cloth World stores were converted to the Jo-Ann Fabrics and Crafts format. These stores will be included in the comparable store sales calculation beginning with the anniversary of their conversion date. In fiscal 1996, the Company opened 62 superstores and closed 90 stores, ending the year with 936 stores in operation, of which 812 were superstores. Net sales for fiscal 1995 increased 16.4 percent, or $95,208,000, to
$677,279,000 from $582,071,000 in fiscal 1994, largely due to $86,189,000 of sales generated from the Cloth World stores in the last 17 weeks of the year. Comparable store sales, which decreased during the first half of fiscal 1995, improved during the remainder of the year, achieving an increase on a full-year basis of 1.0 percent over the prior year. The increase is primarily attributable to implementing a plan to improve customer service, enhance store presentation, and expand product assortment. In fiscal 1995, the Company opened 38 superstores, acquired 342 Cloth World stores and closed 71 stores, many of which were in overlapping market areas, ending the year with 964 stores in operation, of which 804 were superstores.
Gross profit increased $79,316,000 in fiscal 1996 compared to fiscal 1995 and increased $46,565,000 in fiscal 1995 compared to fiscal 1994, primarily as a result of the increase in sales volume. As a percentage of net sales, gross profit was 45.3 percent in fiscal 1996, 44.1 percent in fiscal 1995 and 43.3 percent in fiscal 1994. The improvement in gross profit margins over the past two years primarily resulted from improved purchasing and inventory management.
Selling, general and administrative expenses as a percentage of net sales were 40.5 percent in fiscal 1996, 40.0 percent in fiscal 1995 and 40.4 percent in fiscal 1994. The increase from fiscal 1995 to fiscal 1996 resulted from higher distribution service center expenses and store-level payroll expenses offset in part by lower information systems development expenses. A surge in volume through the distribution center, related to the Cloth World stores, created difficult operating conditions and higher distribution service center expenses during the third and fourth quarters of fiscal 1996. Payroll expense percentages in the Cloth World stores tend to be higher than in the Jo-Ann locations due to the relative per-store sales volumes. The decline from fiscal 1994 to fiscal 1995 resulted from significantly lower information system development expenses offset in part by higher store-level expenses directed at improving customer service.
Net interest expense was $11,982,000 in fiscal 1996, $8,418,000 in fiscal 1995 and $5,547,000 in fiscal 1994. The increase from fiscal 1995 to 1996 was due primarily to an increase in average bank borrowings as a result of the acquisition and subsequent conversion of the Cloth World stores and higher inventory levels in the Jo-Ann Fabric and Crafts Stores. The increase from fiscal 1994 to 1995 was due primarily to higher interest rates on bank borrowings, in line with the general increase in short-term interest rates.
The Company's effective income tax rate was 37.5 percent in fiscal 1996, 38.5 percent in fiscal 1995 and 37.5 percent in fiscal 1994. See Note 12 of Notes to Consolidated Financial Statements for additional information on income taxes.
Cargo Express Stores, the Company's retail housewares division, has been reported as a discontinued operation since fiscal 1993, when the Company adopted a plan for its sale. In the fourth quarter of fiscal 1994, the Company decided to liquidate the division and, accordingly, an after-tax provision of $5,201,000, or $0.28 per share, was recorded for the loss on disposal and estimated operating losses to be incurred through date of disposal. No additional provision was necessary to complete the liquidation of Cargo Express.
In the first quarter of fiscal 1994, the Company recorded, as a cumulative effect of accounting change, a one-time benefit of $399,000, or $0.02 per share, from the adoption of SFAS 109, "Accounting for Income Taxes."
Earnings from continuing operations before cumulative effect of accounting change for fiscal 1996 increased 48.8 percent, or $5,724,000 to $17,458,000 from $11,734,000 in fiscal 1995. Earnings from continuing operations before cumulative effect of accounting change for fiscal 1995 increased 68.6 percent, or $4,775,000, to $11,734,000 from $6,959,000 in fiscal 1994.
Management believes that inflation has not had a significant effect on the growth of net sales or on earnings from continuing operations over the past three years.
The Company's business exhibits seasonality which is typical for most retail companies, with much stronger sales in the second half of the year than the first half of the year. In general, net earnings are highest during the months of September through December, when sales volumes provide significant operating leverage. Conversely, net earnings are substantially lower during the relatively low-volume sales months of January through August. Capital requirements needed to finance the Company's operations fluctuate during the year and reach their highest levels during the second and third fiscal quarters as the Company increases its inventory in anticipation of its peak selling season.
LIQUIDITY AND CAPITAL RESOURCES
Fiscal 1996 was a year of continued investment by the Company. The conversion of 302 of the Cloth World stores to the Jo-Ann Fabrics and Crafts format required expenditures of approximately $18,400,000 for store fixtures and leasehold improvements and $31,500,000 for craft and seasonal inventory. Total assets increased $52,344,000 to $479,648,000, at January 27, 1996, compared to $427,304,000 at January 28, 1995. Working capital increased $33,910,000 to $232,157,000, at fiscal year end 1996, compared to $198,247,000 at the end of the prior year. The ratio of current assets to current liabilities improved to 2.8:1 at January 27, 1996, from 2.6:1 at January 28, 1995. Debt to capitalization ratio increased to 46.2 percent at fiscal year end 1996 from 44.0 percent at the end of the prior year.
Net cash used for operating activities in fiscal 1996 was $1,959,000, compared to $64,612,000 provided by operating activities during the prior year. A $47,414,000 increase in merchandise inventories in fiscal 1996 was funded mainly from cash generated from net earnings before depreciation and amortization and from an increase in accounts payable. The increase in inventory was primarily the result of adding a broader selection of merchandise to the Cloth World stores and expanding notions offerings in all stores. The liquidation of approximately $20,000,000 of incompatible Cloth World inventory, as a result of closing certain acquired stores and the Cloth World distribution facility, as well as other operating activities, contributed to the cash generated from operations in fiscal 1995.
Capital expenditures were $34,732,000 in fiscal 1996, $11,740,000 in fiscal 1995, and $8,491,000 in fiscal 1994. Aside from the expenditures to convert Cloth World stores in fiscal 1996, the change in capital expenditures among the years relates directly to the number of stores opened each year. For fiscal 1997, the Company expects to open approximately 50 to 60 new stores and close 60 to 70 smaller stores. Capital expenditures are expected to be approximately $20,000,000 during fiscal 1997.
On August 2, 1995, the shareholders approved a recapitalization amendment to the Articles of Incorporation, which became effective on that date, creating a new class of non-voting common shares designated as Class B Common Shares and changing each outstanding common share into one Class A and one Class B Common Share. Additionally, the number of authorized Common Shares was increased from 75,000,000 to 150,000,000, consisting of 75,000,000 Class A Common Shares and 75,000,000 Class B Common Shares. Pursuant to this amendment, the Common Shares, with a stated value of $0.10 per share, were changed into one Class A Common Share and one Class B Common Share, with each class having a stated value of $0.05 per share. As a result of the recapitalization, 9,191,514 Class A Common Shares and 9,191,514 Class B Common Shares were outstanding as of the effective date. All earnings per share amounts have been restated to reflect the recapitalization, which has been accounted for as a two-for-one stock split.
During fiscal 1996, the Company purchased 16,829 Class A and 15,135 Class B Common Shares for approximately $383,000. Subsequent to January 27, 1996, the Company purchased 407,111 Class A and 450,142 Class B Common Shares on the open market. The aggregate purchase price of these shares was approximately $9,000,000 which was funded through the revolving credit facility. The remaining number of shares that can be acquired pursuant to prior authorization by the Board of Directors is 597,025 Class A and 557,025 Class B Common Shares.
The Company was notified by the staff of the Securities and Exchange Commission that the staff tentatively intends to recommend that the Commission bring an enforcement action against the Company, its chief executive officer, chief financial officer and a former officer in connection with the Company's financial statements for its fiscal year ended February 1, 1992, and for the immediately following three quarters, and with the adequacy of certain disclosures relating to such periods. The staff contends that the financial statements were not accurate because of the manner in which the Company calculated one of its inventory-related reserves for such periods. The accounting issues that have been raised are not related to any current period, and no current accounting policies or financial statements are in question. The Company has filed a written response, and met, with the staff to explain the Company's position on the issues raised. If any action is brought, the Company intends to vigorously contest it. Based on information currently available, Management does not believe the impact, if any, of this matter would have a material adverse effect on the Company's financial position.
The Company has an unsecured $200,000,000 revolving credit facility with a group of eight banks that expires on September 30, 1998. The Company may borrow up to a maximum of $220,000,000, subject to further limitations during specified time frames, by utilizing funds available under this credit facility and other lines of credit. As of January 27, 1996, the Company had borrowings of $98,500,000 under the revolving credit facility and other lines of credit. The Company continues to maintain excellent vendor and banking relationships and has sufficient resources, including unused credit facilities, to meet its operating needs and fund its capital expenditures for fiscal 1997.
FORWARD-LOOKING STATEMENTS
Certain statements contained in this report that are not historical facts are forward-looking statements that are subject to certain risks and uncertainties that could cause actual results to differ materially from those set forth in the forward-looking statement. These risks and uncertainties include, but are not limited to, changes in customer demand, changes in trends in the fabric and craft industry, changes in competitive pricing for products, the impact of competitor store openings and closings, the availability of acceptable store locations, the availability of merchandise, general economic conditions and other risk factors discussed in documents filed by the Company with the Securities and Exchange Commission.
ITEM 8.
ITEM 8. FINANCIAL STATEMENT AND SUPPLEMENTARY DATA ------------------------------------------
The following consolidated financial statements of the Registrant are included in Part II, Item 8:
Consolidated Balance Sheets - January 27, 1996 and January 28, 1995
Consolidated Statements of Income for the three fiscal years ended January 27,
Consolidated Statements of Shareholders' Equity for the three fiscal years ended January 27, 1996
Consolidated Statements of Cash Flows for the three fiscal years ended January 27, 1996
Notes to Consolidated Financial Statements
Report of Management
Report of Independent Public Accountants
CONSOLIDATED BALANCE SHEETS FABRI-CENTERS OF AMERICA, INC. (THOUSANDS OF DOLLARS)
See notes to consolidated financial statements
CONSOLIDATED STATEMENTS OF INCOME FABRI-CENTERS OF AMERICA, INC. (THOUSANDS OF DOLLARS, EXCEPT SHARE AND PER SHARE DATA)
See notes to consolidated financial statements
CONSOLIDATED STATEMENTS OF CASH FLOWS FABRI-CENTERS OF AMERICA, INC. (THOUSANDS OF DOLLARS)
See notes to consolidated financial statements
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY FABRI-CENTERS OF AMERICA, INC. (THOUSANDS OF DOLLARS)
See notes to consolidated financial statements
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The consolidated financial statements include the accounts of Fabri-Centers of America, Inc., and its wholly owned subsidiaries (the "Company"). These statements present the Company's Cargo Express Stores division as a discontinued operation, which ceased operation in the first quarter of fiscal 1995. Except where otherwise noted, the Notes to Consolidated Financial Statements pertain to the Company's continuing operations. All significant intercompany accounts and transactions have been eliminated.
NATURE OF OPERATIONS
The Company is a fabric and craft retailer with 936 retail stores in 48 states. The stores primarily operate under the names Jo-Ann Fabrics, Jo-Ann Fabrics and Crafts, Cloth World, and New York Fabrics and feature a broad line of fashion and decorator fabrics, related notions, crafts, floral, and seasonal items.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the Company's financial statements and accompanying notes to financial statements. Actual results could differ from those estimates.
CASH AND CASH EQUIVALENTS
Cash equivalents consist of highly liquid investments with a maturity of three months or less at the time of purchase. At January 28, 1995, the Company held cash equivalents of $11,500,000 stated at cost. No cash equivalents were held at January 27, 1996.
FINANCIAL INSTRUMENTS
The Company believes that the carrying value of cash equivalents approximates their fair value. All other financial instruments are considered to have a fair value which approximates carrying value at January 27, 1996 and January 28, 1995, unless otherwise specified.
The Company occasionally enters into interest rate swap and interest rate cap agreements to hedge against interest rate risk. The interest differentials from these swaps and caps are recorded as interest expense as incurred.
STORE OPENING EXPENSES
Store opening expenses are charged to operations as incurred, which is generally the same period that the store is opened.
ADVERTISING COSTS
The Company expenses production costs of advertising the first time the advertising takes place. The Company had prepaid advertising costs of $1,026,000 and $1,163,000 at January 27, 1996 and January 28, 1995, respectively. Advertising expense was $23,053,000, $18,087,000, and $14,798,000 for fiscal 1996, 1995, and 1994, respectively.
PROPERTY AND EQUIPMENT
Depreciation of buildings, furniture and fixtures, and leasehold improvements is provided principally by the straight-line method. The major classes of assets and ranges of annual depreciable rates are as follows:
Buildings 2-1/2% - 10% Furniture and fixtures 6-2/3% - 20% Leasehold improvements 6-2/3% - 20%
Maintenance and repair expenditures are charged to expense as incurred and betterments and major renewals are capitalized.
INTANGIBLE ASSETS
Other assets includes the value assigned for trade names, favorable lease interest, and other intangible assets acquired in connection with purchased businesses totaling $3,969,000 and $4,781,000 as of fiscal year end 1996 and 1995, respectively, and are being amortized primarily on a straight-line basis over 5 to 20 years. Amortization expense was $812,000, $841,000, and $844,000, in fiscal 1996, 1995, and 1994, respectively.
STOCK-BASED COMPENSATION
The Company grants stock options for a fixed number of shares to employees with an exercise price equal to the fair value of the shares at the date of the grant. The Company accounts for stock option grants in accordance with APB 25, "Accounting for Stock Issued to Employees," and accordingly, recognizes no compensation expense related to stock options. In October 1995, the FASB issued SFAS 123, "Accounting for Stock-Based Compensation," which allows for a fair value based method of accounting for employee stock options and similar equity instruments. The Company does not intend to adopt the recognition and measurement provisions of SFAS 123.
IMPAIRMENT OF LONG-LIVED ASSETS
In fiscal 1996 the Company adopted SFAS 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," which requires impairment losses to be recorded on long-lived assets used in operations when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are less than the assets' carrying amount. SFAS 121 also addresses the accounting for long-lived assets that are expected to be disposed of. The effect of adopting SFAS 121 was not material.
RECLASSIFICATIONS
Certain amounts in the fiscal 1995 and fiscal 1994 financial statements have been reclassified in order to conform with the presentation for fiscal 1996.
STORE INVENTORIES
Store physical inventories are taken on a cycle basis throughout the fiscal year. Store inventories subsequent to the physical inventory are charged at cost for shipments of merchandise to the stores and are relieved at cost for the sale of merchandise.
INCOME TAXES
Effective January 31, 1993, the Company adopted SFAS 109, "Accounting for Income Taxes." Under SFAS 109, deferred taxes are determined based on estimated future tax effects of differences between the financial statement and
tax bases of assets and liabilities giving consideration to enacted tax laws. As permitted by SFAS 109, the Company elected not to restate the financial statements for any prior years.
NOTE 2 - MERCHANDISE INVENTORIES
Inventories are stated at the lower of cost or market. Approximately 98 and 99 percent of inventories were valued using the last-in, first-out (LIFO) method at January 27, 1996, and January 28, 1995, respectively. The value of inventories stated on the LIFO method at January 27, 1996, and January 28, 1995, are not materially different from their current cost.
NOTE 3 - MORTGAGE RECEIVABLE
In fiscal 1993, the Company sold its former headquarters and distribution center to an unrelated third party for cash and a long-term promissory note due 2003. The promissory note bears interest at a rate of 6.0 percent through April 30, 1998, 8.0 percent from May 1, 1998, through April 30, 2001, and 9.0 percent thereafter. This note is secured by a purchase money mortgage.
NOTE 4 - RECAPITALIZATION AMENDMENT
On August 2, 1995, the shareholders approved a recapitalization amendment to the Articles of Incorporation ("Recapitalization Amendment"), which became effective on that date, creating a new class of non-voting common shares designated as Class B Common Shares and changing each outstanding common share into one Class A and one Class B Common Share. Additionally, the number of authorized Common Shares was increased from 75,000,000 to 150,000,000, consisting of 75,000,000 Class A Common Shares and 75,000,000 Class B Common Shares. Pursuant to this amendment, the Common Shares, with a stated value of $0.10 per share, were changed into one Class A Common Share and one Class B Common Share, with each class having a stated value of $0.05 per share. As a result of the recapitalization, 9,191,514 Class A Common Shares and 9,191,514 Class B Common Shares were outstanding as of the effective date. All earnings per share amounts have been restated to reflect the recapitalization amendment, which has been accounted for as if it were a two-for-one stock split.
NOTE 5 - CAPITAL STOCK
The following table details the common stock ($0.05 stated value) activity for fiscal 1996 and fiscal 1995:
Subsequent to January 27, 1996, the Company purchased 407,111 Class A and 450,142 Class B Common Shares on the open market. The aggregate purchase price of these shares was approximately $9,000,000 which was funded through the revolving credit facility.
At January 27, 1996, and January 28, 1995, there were 5,000,000 shares of serial preferred stock, without par value, authorized for issuance, none of which are outstanding. At January 27, 1996, there were 75,000,000 Class A Common Shares and 75,000,000 Class B Common Shares authorized for issuance and at January 28, 1995, there were 75,000,000 Common Shares authorized for issuance.
SHAREHOLDERS' RIGHTS PLAN
As a result of the Recapitalization Amendment on August 2, 1995, the Board of Directors approved the second amendment to the Shareholders' Rights Plan, which had originally been adopted by the Board of Directors on October 22, 1990, and amended March 9, 1992. The effect of the amendment was to automatically adjust the Initial Purchase Price, the Adjusted Purchase Price, and the Redemption Price (all as defined below) to be equal to one half of the then current price. In addition, the definition of "Common Shares" as used in the Rights Plan was amended to include only the Class A Common Shares, and provisions were added to the Rights Plan to provide that rights are associated
only with Class A Common Shares. Under the Rights Plan, as amended, the rights are exercisable only if a person or group buys or announces a tender offer for 20 percent or more of the outstanding Class A Common Shares or the Board of Directors declares a person or group to be an "adverse person." When exercisable, each right initially entitles a holder to purchase one Class A Common Share for $105.75 (the "Initial Purchase Price"). If at any time after the rights become exercisable, the Company is acquired in a merger or certain other business transactions occur, each right would then enable the holder thereof to purchase one common share of the acquiring company, or under certain circumstances, one Class A Common Share of the Company for $0.50 (the "Adjusted Purchase Price"). The rights, which do not have voting privileges, expire in 2000, but may be redeemed by the Board of Directors prior to that time, under certain circumstances, for $0.005 per right (the "Redemption Price"). Until the rights become exercisable, they have no dilutive effect on earnings per share.
NOTE 6 - LEASES
Principally all of the Company's retail stores operate out of leased facilities. All store leases are operating leases, generally for periods up to 10 years with renewal options for up to 20 years. Certain leases contain escalation clauses and, in some cases, provide for contingent rents based on a percent of sales in excess of defined minimums. The Company in certain instances is required to pay its prorata share of real estate taxes and common area maintenance expenses. The Company also leases certain store fixtures, generally under five-year lease terms. The following is a schedule of future minimum rental payments under non-cancelable operating leases as of January 27, 1996:
Rent expense was as follows:
The Company has entered into lease commitments for new stores to be opened after January 27, 1996. The aggregate minimum rentals applicable to these locations, which are included in the future minimum rental payments, amount to $2,140,000.
NOTE 7 - CONVERTIBLE SUBORDINATED DEBENTURES (DUE MARCH 1, 2002)
The Debentures bear interest at 6 1/4 percent, payable semi-annually on March 1 and September 1. Prior to the effective date of the Recapitalization Amendment, the Debentures were convertible in integral multiples of $1,000 by a holder into Common Shares of the Company at a conversion price of $48.75 per share (equivalent to a conversion rate of approximately 20.513 Common Shares per $1,000 principal amount of Debentures). After the effective date of the Recapitalization Amendment, each Debenture is convertible into approximately 20.513 Class A Common Shares and approximately 20.513 Class B Common Shares per $1,000 principal amount. The Debentures are subject to redemption, at the option of the Company, in whole or in part, at a redemption price of 103.6 percent of the principal amount, which decreases in equal increments annually through March 1, 1999, and remains at 100 percent thereafter. At January 27, 1996, and January 28, 1995, the fair value of these debentures was $49,575,000 and $43,877,000, respectively, based upon quoted market price for the same issue.
NOTE 8 - RESTRICTED STOCK AWARDS
Restricted shares of the Company's common stock have been awarded to executive officers and senior management under the 1994 Executive Incentive Plan that succeeded the Executive Incentive Plan. The vesting periods for these restricted shares are generally five years with all rights to such restricted stock terminating without any payment of consideration by the Company unless the grantee remains in the continuous employment of the Company throughout the vesting period. Unearned compensation resulting from the issuance of shares under these plans is being amortized over the vesting periods, and the unamortized portion has been reflected as a reduction of shareholders' equity. On the effective date of the Recapitalization Amendment, all holders of common stock under these plans were given one Class A Common Share and one Class B Common Share for each Common Share outstanding. Under these plans, 605,250 Class A Common Shares and 605,250 Class B Common Shares have been reserved that may be awarded to executive officers and senior management personnel. At January 27, 1996, 216,250 Class A restricted shares and 174,250 Class B restricted shares were outstanding under the plans and 389,000 Class A Common Shares and 431,000 Class B Common Shares are available for future awards under the 1994 Executive Incentive Plan.
NOTE 9 - STOCK OPTION PLAN
Nonqualified and incentive stock options have been granted to certain officers and key employees under the Company's 1990 Employee Stock Option and Stock Appreciation Rights Plan ( the "1990 Plan") at prices not less than fair market value of the common stock at the date of grant. The 1990 Plan also permits the granting of stock appreciation rights, with respect to all or part of the common stock subject to any option granted under this plan. The options and stock appreciation rights (SAR's) become exercisable to the extent of one-fourth of the optioned shares for each full year of employment following the date of grant and generally expire 10 years after the date of the grant. As a result of the Recapitalization Amendment, one Class A Common Share and one Class B Common Share was substituted for each Common Share reserved for future grant and each Common Share subject to outstanding options. For options outstanding at the effective date, the option exercise price was reduced by one-half. Future options and stock appreciation rights granted can relate to Class A Common Shares, Class B Common Shares, or a combination of both.
The following is a summary of stock option activity (restated to reflect the effect of the Recapitalization Amendment, which has been accounted for as a two-for-one stock split):
Under the 1988 Stock Option Plan for Non-Employee Directors (the "Directors Plan"), the Company may grant stock options at prices not less than the fair market value of the common shares at the date of grant. The options become exercisable to the extent of one-fourth of the optioned shares for each full year of continuous service after the date of grant and generally expire 10 years after the date of the grant. As a result of the Recapitalization Amendment, one Class A Common Share and one Class B Common Share was substituted for each existing Common Share, subject to outstanding options. For options outstanding at the effective date, the option exercise price was reduced by one-half. The number of shares available for future option grants remained unchanged and shall be made in Class A shares. During fiscal 1995, 20,000 Class A Common Share options and 20,000 Class B Common Share options were granted at $7.44 per share (restated for the Recapitalization Amendment) and no options were exercised. No options were granted or exercised during fiscal 1994 or fiscal 1996. At January 27, 1996, 75,000 Class A stock options and 75,000 Class B stock options remain outstanding, of which 56,250 Class A stock options and 56,250 Class B stock options are currently exercisable and 40,000 Class A stock options are reserved for future grants.
NOTE 10 - EMPLOYEES' SAVINGS AND PROFIT SHARING PLAN AND POSTRETIREMENT BENEFITS
The Company sponsors a tax-deferred savings plan (the "Savings Plan") whereby eligible employees may elect quarterly to contribute up to the lesser of 10 percent of annual compensation or the statutory maximum. The Company makes a 50 percent matching contribution in the form of the Company's common stock, up to a maximum employee contribution of 4 percent of the employee's compensation. Employer contributions of the Company's common stock have been made through the issuance of shares out of the treasury or by purchasing shares on the open market. Upon effectiveness of the Recapitalization Amendment, each Common Share held by the Savings Plan was
converted into one Class A Common Share and one Class B Common Share. The Savings Plan was amended to reflect the existence of two classes of common stock. The amount of the Company's matching contribution in fiscal year 1996, 1995, and 1994 was $759,000, $600,000, and $516,000, respectively. Plan assets included 360,525 shares of Class A Common Stock and 296,565 shares of Class B Common Stock at January 27, 1996, and 255,781 shares of Common Stock at January 28, 1995. The Company does not provide postretirement health care benefits. Therefore, SFAS 106, "Employer's Accounting for Postretirement Benefits Other Than Pensions," has no impact on the Company's financial position or results of operations.
NOTE 11 - LONG-TERM DEBT
The Company has an unsecured $200,000,000 three-year revolving credit agreement (the Credit Facility) with a group of eight banks (the Bank Group) that expires September 30, 1998. The Company pays a facility fee on the revolving credit commitment amount and pays a commitment fee on the unused portion of the Credit Facility, each of which ranges from .125 percent to .25 percent based on the achievement of specified ranges of certain financial covenants. Interest on borrowings under the Credit Facility is payable at an applicable margin over prime, federal funds or LIBOR rates. The applicable margin ranges between .5 percent and 2.5 percent, based on the achievement of specified ranges of certain financial covenants. The Credit Facility contains financial covenants which limit the Company's capital expenditures and defined leverage ratio, as well as require the Company to maintain a minimum defined current ratio, working capital, tangible net worth, fixed charge coverage ratio and current funded indebtedness ratio. The maximum allowable combined outstanding debt for the Credit Facility and additional bank borrowings is $220,000,000, subject to limitations of revolving credit borrowings during specified time frames throughout the commitment period. The fair value of the Credit Facility approximates its carrying value as a result of its interest rate being variable and based on current market rates. The Company has an interest rate cap agreement with one of the banks in the Bank Group. The interest rate cap establishes a maximum interest rate payable when the variable rate exceeds a certain rate. The total notional amount under the interest rate cap is $20,000,000, having a capped LIBOR rate of 8 percent, terminating October 7, 1996. The Company has an interest rate swap agreement under which it pays to the counter-party interest at a fixed rate of 7.3 percent and the counter-party pays to the Company at a variable rate based on LIBOR, on a current notional amount of $10,000,000, terminating October 4, 1996. The estimated fair values, at January 27, 1996 and January 28, 1995, of the interest rate cap and swap agreements, based on the present value of expected future cash flows, were immaterial. The Company's weighted average interest rate and weighted average borrowings under revolving credit facilities were 6.95 percent and $100,700,000 during fiscal 1996, 5.56 percent and $65,600,000 during fiscal 1995 and 4.00 percent and $68,000,000 during fiscal 1994, respectively.
NOTE 12 - INCOME TAXES
Effective January 31, 1993, the Company adopted SFAS 109, "Accounting for Income Taxes." The cumulative effect of the accounting change increased net earnings for fiscal 1994 by $399,000 or $0.02 per share. The significant components of income tax expense are as follows:
The reconciliation of income tax at the statutory rate to total income tax expense is as follows:
The significant components of the Company's deferred tax assets and liabilities are as follows:
The Company did not record any valuation allowances against deferred tax assets as of January 27, 1996, and January 28, 1995.
NOTE 13 - EARNINGS PER SHARE
Primary earnings per share and earnings per share assuming full dilution equal net earnings divided by the weighted average number of common shares, after giving effect for the assumed exercise of dilutive stock options under the treasury stock method. The Convertible Subordinated Debentures are considered a common share equivalent in calculating earnings per share assuming full dilution; however, they are not included in the earnings per share calculation assuming full dilution for each of the fiscal years presented because they are anti-dilutive.
The following table presents information necessary to calculate primary earnings per share and earnings per share assuming full dilution for the fiscal years presented:
The number of shares and earnings per share amounts have been restated to give effect to the increased number of shares outstanding as a result of the Recapitalization Amendment.
NOTE 14 - CLOTH WORLD ACQUISITION
On October 2, 1994, the Company acquired substantially all of the assets of Cloth World, a division of Brown Group Inc. ("Cloth World") for approximately $97,000,000 in cash and assumed liabilities. The funds used to acquire Cloth World were provided by internally generated funds and borrowings under a credit facility. The acquisition has been recorded using the purchase method, and accordingly, the results of operations of Cloth World have been included in the Company's consolidated financial statements since the date of acquisition. Cloth World, with fiscal 1994 sales of $224,000,000, operated 342 specialty fabric stores in 26 states with a concentration in the southern half of the United States. Summarized below are the unaudited consolidated results of operations of the Company, including Cloth World on a pro forma basis, as if Cloth World had been acquired as of the beginning of the periods presented:
The pro forma financial information above is presented for informational purposes only and is not necessarily indicative of the operating results that would have occurred had the Cloth World acquisition been consummated at the beginning of the periods presented. In addition, they are not intended to be a projection of future results and do not reflect synergies that might be achieved from combined operations.
NOTE 15 - DISCONTINUED OPERATION
In December 1993, the Company adopted a plan to liquidate its retail housewares division, Cargo Express Stores ("Cargo Express"), which has been reported as a discontinued operation since fiscal 1993, when the Company adopted a plan for its sale. In the fourth quarter of fiscal 1994, the Company decided to liquidate the division, and, accordingly an after-tax provision of $5,201,000 (net of tax benefit of $3,121,000), or $0.28 per share, was recorded primarily for the write-off of fixed assets and estimated costs to complete the liquidation, including estimated operating losses to be incurred through the disposal date of $691,000, or $0.04 per share. During the first quarter of fiscal 1995, the Company completed the liquidation of Cargo Express, which did not require the recognition of any additional gain or loss. Net sales for Cargo Express were $5,381,000 and $51,334,000 for fiscal years 1995 and 1994, respectively. Interest had been allocated to Cargo Express based on a calculation considering the Company's cost of capital and the average working capital and net fixed assets of Cargo Express.
NOTE 16 - LEGAL PROCEEDINGS
The Company was notified by the staff of the Securities and Exchange Commission that the staff tentatively intends to recommend that the Commission bring an enforcement action against the Company, its chief executive officer, its chief financial officer and a former officer in connection with the Company's financial statements for its fiscal year ended February 1, 1992, and for the immediately following three quarters, and with the adequacy of certain disclosures relating to such periods. The staff contends that the financial statements were not accurate because of the manner in which the Company calculated one of its inventory-related reserves for such periods. The accounting issues that have been raised are not related to any current period, and no current accounting policies or financial statements are in question. The Company has filed a written response, and met, with the staff to explain the Company's position on the issues raised. If any action is brought, the Company intends to vigorously contest it. Based on information currently available, Management does not believe the impact, if any, of this matter would have a material adverse effect on the Company's financial position.
NOTE 17 - QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
(a) Primary and fully diluted earnings per common share calculations for each quarter are based on the weighted average number of shares and share equivalents outstanding during each respective quarter. Thus, the sum of quarterly earnings per share amounts may not necessarily be equal to the full-year earnings per common share. See Note 13.
REPORT OF MANAGEMENT
TO THE SHAREHOLDERS OF FABRI-CENTERS OF AMERICA, INC.
We have prepared the accompanying consolidated financial statements and related information included herein for the years ended January 27, 1996, January 28, 1995 and January 29, 1994. The opinion of Arthur Andersen LLP, the Company's independent public accountants, on those financial statements is included. The primary responsibility for the integrity of the financial information included in this annual report rests with management. This information is prepared in accordance with generally accepted accounting principles, based on our best estimates and judgements and giving due consideration to materiality. The Company maintains accounting and control systems which are designed to provide reasonable assurance that assets are safeguarded from loss or unauthorized use, and which produce records adequate for preparation of financial information. There are limits inherent in all systems of internal control based on the recognition that the cost of such systems should not exceed the benefits to be derived. We believe our system provides this appropriate balance. The Board of Directors pursues its responsibility for these financial statements through the Audit Committee, composed exclusively of outside directors. The committee meets periodically with management, internal auditors and our independent public accountants to discuss the adequacy of financial controls, the quality of financial reporting, and the nature, extent and results of the audit effort. Both the internal auditors and independent public accountants have private and confidential access to the Audit Committee at all times.