ITEM 1. BUSINESS
OVERVIEW
Frank's Nursery & Crafts, Inc. ("Frank's", the "Company" or the "Registrant") operates the largest chain (as measured by sales) in the United States of specialty retail stores devoted to the sale of lawn and garden products. In addition, the Company sells dried and artificial flowers and arrangements, Christmas merchandise, and home decor. As of January 28, 2001, the Company operated 218 retail stores in 14 states primarily in the East, Middle Atlantic and Midwest regions of the country under the name Frank's Nursery & Crafts(R). References to "Holdings" refer to the sole shareholder of Frank's, FNC Holdings Inc. (formerly known as General Host Corporation), a New York Corporation. In December 1997 Holdings was acquired by The Cypress Group LLC ("Cypress"), a New York based private equity group. Unless otherwise stated, all statistics in this Item were compiled as of January 28, 2001("fiscal year 2000").
Frank's was incorporated under the laws of the State of Michigan in 1957. The Company operates entirely in one industry segment, the lawn and garden retail industry as defined below. The Company's principal executive offices are located at 1175 West Long Lake, Troy, Michigan 48098, and its telephone number is (248) 712- 7000.
RECENT DEVELOPMENTS
Subsequent to the end of fiscal year 2000, on February 19, 2001 (the "Petition Date"), the Company and Holdings (the "Debtors") each filed a voluntary petition under Chapter 11 of the United States Bankruptcy Code ("Chapter 11") within the United States Bankruptcy Court for the District of Maryland, Baltimore Division (the "Court"). An Official Committee of Unsecured Creditors has been appointed in the Chapter 11 cases. In a Chapter 11 filing, substantially all liabilities as of the Petition Date are subject to compromise or other treatment under a plan of reorganization. Generally, actions to enforce or otherwise effect payment of all pre-petition liabilities are stayed while the Debtors continue their business operations as debtors-in-possession. In addition, in the Chapter 11 cases, the Debtors may reject executory contracts and lease obligations. In the Chapter 11 cases the Debtors obtained a $100 million debtor-in-possession financing agreement to finance the Company's working capital requirements and retire the Company's pre-petition debt under its Senior Revolving Credit Facility.
The Company's decision to seek Chapter 11 protection was, in part, the consequence of several developments during fiscal year 2000 relating to sales, asset disposition and funding.
During the first half of 2000, corresponding to the Company's peak lawn and garden season, adverse weather patterns across the Company's principal retail markets negatively impacted its lawn and
garden product sales. For the first half of 2000, the Company reported a total sales decline of 7% compared to the corresponding period in 1999, while comparable store sales declined 8.7%. During the third quarter of 2000, the Company decided to close 44 under-performing stores, liquidate their inventories, and sell 33 of the 44 closed stores, all of which were Company-owned properties. During the fourth quarter of 2000, consistent with the general softness in sales and heavy price promotional activities throughout the retailing industry, it became apparent that the Company's Trim-a-Tree holiday season sales were below expectations. In the later part of the fourth quarter, it also became apparent that the Company's expectations from property sales were not achievable, in part, because of deteriorating retail real estate and financial market conditions overall.
During January of 2001, notwithstanding excess borrowing availability under its existing bank credit facilities, the Company was unable to draw down sufficient funding to meet its planned working capital needs because its banks asserted (although the Company disputed) that various conditions to borrowing had not been met. In the relatively short period between the time that its credit facilities were curtailed and the necessity of securing alternative financing, it became apparent that the most appropriate method to secure financing, ensure product availability for the spring season, and achieve restructuring objectives was through Chapter 11 filings.
The Company's objectives include ensuring a successful spring season and proposing a reorganization plan that will provide for prompt emergence from Chapter 11.
THE LAWN AND GARDEN INDUSTRY
The Company believes that the overall retail market for lawn and garden products, defined to include green goods for both outdoor and indoor usage, fertilizers, gardening accessories, lawn and patio furniture, Christmas Trim-a-Tree merchandise and snow removal, power equipment, barbecues and watering accessories, was approximately $84.6 billion in 2000 and grew at 3.5% over the $81.7 billion estimated for 1999. The Company also believes that, for the 10 years covering the period 1991 through 2000, the lawn and garden industry grew at a compound annual growth rate of approximately 5%. Among other factors, the Company believes that the principal reasons for this sustained growth were the popularity of gardening as a leisure activity, new home construction and favorable demographic trends such as the aging of the baby-boomer population. The industry growth in 2000 was lower than the ten year annual growth rate due largely to unusual weather patterns especially in the midwest and east where a cold and wet spring and summer depressed sales.
The lawn and garden market is highly seasonal, with the spring season accounting for the majority of annual product sales. The market for green goods is generally non-branded and highly differentiated by both specimen and quality while the market for hard goods, fertilizers and chemicals is composed of both national and private label brands. At the retail level the lawn and garden market is highly fragmented and consists of national and regional chains of specialty retailers, mass merchants and home centers as well as thousands of local, independent garden centers and nurseries. With the exception of the garden center and nursery segment, few retailers operate their lawn and garden centers on a year round basis or as full line lawn and garden retailers. The Company believes that the top ten retailing companies represented approximately 16% of industry sales in 1999. The Company believes that the primary competitive factors in lawn and garden retailing include breadth of product assortment, product quality, price and knowledgeable service. The Company believes that it competes effectively on the above factors, as well as others, and that its competence in the retailing of lawn and garden products will enable it to gain market share in the future from increased penetration of its existing markets as well as from geographic expansion to new ones.
COMPANY STRATEGY
After the acquisition of General Host by Cypress, Frank's management set out to reposition the Company's merchandising strategy and concentrate on three major sectors: lawn and garden, floral and home decor and Christmas Trim-a-Tree. Merchandising lines such as pet foods and general and juvenile crafts, among others, which had been a part of Frank's range prior to the acquisition, were deemed no longer appropriate to these new directions and a phased discontinuation plan was put into effect. This plan was essentially completed during fiscal year 2000.
The Company's core strategy centers on the lawn and garden market where the Company intends to enhance its leadership position within the specialty retailing segment of that market. The Company's objective is to provide the gardening enthusiast with the broadest assortment of quality plants, growing products, specialty tools and gardening accessories at competitive prices backed by knowledgeable service.
The Company also provides the leading assortment of floral and home decor products, including premium artificial flowers and arrangements for the do-it-yourself decorator as well as to those preferring finished arrangements. In addition, a leading assortment of decorative candles, vases and floral containers, ribbons, picture frames and accent pieces for the home or patio is offered. Product positioning is tied closely to garden and nature themes.
The Company's Christmas Trim-a-Tree selection is aimed at providing its customers with the broadest assortment of quality artificial trees, wreaths, tree decorations, lights and holiday decor and to serve as a one-stop shopping destination for these holiday related purchases.
The Company utilizes extensive marketing and advertising efforts to communicate with its customers through newspaper advertising, weekly inserts and radio. The Company also makes extensive use of public relations, local sponsorships and promotions to enhance the branding of its stores.
During fiscal year 2000, the Company began the installation of a new point-of-sale system aimed at substantially enhancing transaction processes and improving customer service flows at its store check-out areas. Installation of the system was completed at approximately 50% of the stores during fiscal year 2000 with the balance planned for completion by spring 2001.
During fiscal 2000, the Company opened six new stores, of which four were in a new market, Tidewater, Virginia. All the stores opened in fiscal 2000 incorporated the new prototype store designs. The Company opened one additional new prototype store on April 7, 2001. The Company does not currently intend to open additional stores while operating in Chapter 11, but does believe that the long term strategy of the Company should include an aggressive store opening program supported by a geographic diversification.
The Company believes that the strategy outlined above is sound and unaffected by the Chapter 11 filing. However, the Company performed an in-depth evaluation of individual store sales, profitability and growth potential during fiscal year 2000 and identified 44 stores to be closed. These stores were closed and the inventory liquidated by the end of March 2001. Further store profitability analysis was completed in early 2001, which identified an additional 22 leased stores for closing. It is anticipated that these stores will be closed by the end of June 2001. An additional two stores were closed; one in December 2000 and the other in March 2001, bringing the total closed stores to 68. The Company believes that the remaining 196 stores as of April 30, 2001 represent a viable base for the future growth of the Company. The Company, however, intends to continue monitoring store performance and will make additional adjustments if appropriate.
PRODUCT CATEGORIES
The Company operates a chain of specialty retail stores devoted to the sale of lawn and garden, Christmas and floral and home decor. The principal products sold at the Company's retail stores are as follows:
LAWN AND GARDEN. As the nation's largest specialty retailer of lawn and garden products, the Company enjoys a strong franchise in the lawn and garden business. The Company offers customers one of the widest selections of live plants in the industry.
The Company believes that its reputation for a broad selection and high quality of live goods is the principal reason that draws customers to its stores. This strength allows the Company to offer a wide assortment of other lawn and garden products including fertilizers, mulches, garden tools, planting accessories, decorative planters and other related merchandise. In addition the Company markets its own line of private label lawn and garden products under the Frank's name. The lawn and garden business is also characterized by strong gross margins.
Lawn and garden sales are highest in the spring with the largest impact being in the first fiscal quarter and the early part of the second fiscal quarter, then declining during middle and late summer. There is an early fall sales season in these products that is less significant than the spring sales season. In the winter months, sales of such products are minimal and limited essentially to indoor plants.
FLORAL AND HOME DECOR. The Company's floral and home decor products include a varied assortment of dried, silk and acrylic flowers for the do-it-yourself decorator as well as complete floral arrangements. The Company also offers a broad assortment of decorative candles, picture frames, framed art and accent pieces for the home or patio. These products exhibit high inventory turns, strong gross margins and low seasonality. The floral and home decor assortment is positioned to tie closely with the Company's lawn and garden emphasis.
The Company has improved its presentation of floral and home decor products by installing new fixtures in the majority of its stores. The Company intends to support this business category with significant advertising in order to familiarize the consumer with the new store look resulting from the new presentation mentioned above, coupled with the phase out of certain basic craft categories which is now substantially completed.
Floral sells steadily throughout the year, and is stimulated by early spring, fall and late winter promotions. During the winter months (outside of the Christmas season) floral constitutes a large portion of the Company's sales.
CHRISTMAS. During the Christmas holiday season, the Company's second most important selling season after spring, the Company transforms substantial portions of its stores into Christmas trim-a-tree layouts and offers a broad selection of seasonal merchandise and Christmas decoration for the holiday season. The Company provides one of the largest selections of artificial trees, indoor and outdoor lights, wreaths and holiday plants as well as a wide array of trim-a-tree items. Christmas merchandise is sold almost entirely in November and December.
SEASONALITY
The Company's business is highly seasonal and subject to the impact of weather conditions, which may affect consumer purchasing patterns. In fiscal 2000, 43% of the Company's sales occurred during the spring season (late March to mid-June) and 23% occurred during the Christmas season (November to late December). Normally, spring is the most profitable season, and Christmas is the next most profitable season. Operating losses usually are experienced
during the other periods of the year. The Company's slowest selling seasons are typically the period from the beginning of the calendar year until the start of the spring selling season, and from mid-July to October.
VENDORS
Substantially all of the plants and products the Company sells are purchased from approximately 770 outside vendors. Alternative sources of supply are generally available for all products sold by the Company.
STORE OPERATIONS AND MANAGEMENT
The Company's stores are normally open 87 hours per week, with the average store opening at 8 a.m. and closing at 9 p.m.
The average store has approximately 20-25 part and full-time employees, including a store manager, an assistant manager and up to six department specialists responsible for the various product lines. The permanent store staff is generally supplemented at seasonal peaks by temporary employees.
EMPLOYEES
At January 28, 2001 the Company's employee base was approximately 5,100 including seasonal employees. The Company's entire employee base is non-union and management considers its employee relations to be good.
DISTRIBUTION
The Company operates distribution centers in Harrisburg, Pennsylvania and Howe, Indiana. In addition, the Company leases temporary third party distribution centers for the Christmas season.
These centers delivered approximately 50% of all merchandise to the stores in 2000, primarily using contract carriers. The balance of the products are delivered directly to stores by vendors.
ITEM 2.
ITEM 2. PROPERTIES
The Company is headquartered in two facilities located in Troy, Michigan. One building is 27,000 square feet and is subject to a lease which expires in November 2007. The second building measures approximately 28,000 square feet and is subject to a lease which expires in December 2005.
The Company currently leases a 292,300 square foot distribution facility in Harrisburg Pennsylvania as well as a 346,515 square foot facility in Howe, Indiana. The lease on the Harrisburg facility expires in March 2002, with one five-year renewal option. The Howe property carries a lease expiring in June 2002 with two five-year renewal options.
As of January 28, 2001, the Company operated 218 Frank's stores, 153 of which were leased (39 of which are subject to ground leases) and 65 were owned. The following is a summary of store properties by state:
In addition, 44 stores were operated as of January 28, 2001 as closing stores by a third party liquidation company. Thirty-three of these stores are owned, ten are leased and one is a ground lease.
The Company owns one and leases eight additional store locations which were previously operated as Frank's stores. The Company is actively engaged in the leasing, sub-leasing and releasing of these properties. In fiscal 2000 the Company closed one store and opened six new locations.
The Company's existing stores are generally located on three- acre sites. A typical store in which the overhang area leading to the yard has been enclosed includes 18,500 square feet of indoor space (16,000 square feet of sales area and 2,500 square feet of storage area), 17,000 square feet of outdoor selling area and ample onsite parking. The stores are designed in a "supermarket" format familiar to customers, and shopping is done with carts in wide aisles with attractive displays. Traffic design is intended to enhance the opportunity for impulse purchases. Most stores are free-standing and located adjacent to or near shopping centers; some stores are part of strip centers.
In fiscal 2001 the Company plans to open one new store. The aggregate cost of any future expansion is dependent upon the method of financing new stores. Such methods include build-to-suit leases, conversion of existing buildings, and land purchases with Company-funded construction. The cost of these methods ranges from approximately $500,000 per store for build-to-suit leases to $3 to $3.5 million per store for Company-owned stores including the purchase of land. The new prototype stores introduced in 1999 are located on approximately four-acre sites. The stores are designed with 23,000 square feet of indoor selling space and 32,000 of outdoor selling area inclusive of 6000 sq. ft. of enclosed nursery area. The Company intends to open new stores via build-to-suit operating leases whenever possible.
ENVIRONMENTAL MATTERS
The Company and its operations are subject to Environmental Laws. As an owner/lessor or former owner/lessor of numerous properties, as well as a seller of certain environmentally sensitive products such as herbicides and pesticides, the Company has an inherent risk of liability under Environmental Laws, including, for example, contamination that may have occurred in the past on its current or former properties or as a result of its operations. The Company believes it complies in all material respects with applicable Environmental Laws and does not anticipate any obligations with respect to Environmental Laws that would have a material adverse effect on its operations. The Company may also be affected by Holdings' or Holdings' present or former subsidiaries' liabilities and potential liabilities with respect to Environmental Laws, which have been and may continue to be significant to Holdings.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
In the normal course of business the Company is subject to various claims. These claims should be resolved in connection with the Company's Chapter 11 cases. In the opinion of management, any ultimate liability arising from or related to these claims should not have a material adverse effect on future results of operations or the financial position of the Company.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Not applicable.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following table of selected financial data should be read in conjunction with the Financial Statements included in Item 14 and Management's Discussion and Analysis of Financial Condition and Results of Operations included in Item 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Results of Operations
FISCAL 2000 COMPARED TO FISCAL 1999
Net Sales. Sales were $437 million for the 2000 fiscal year compared to $487.3 million for the 1999 fiscal year, a decrease of 10.3%. Comparable store sales declined 10.8%. Comparative net sales were negatively impacted by lower lawn and garden sales resulting from unfavorable weather patterns in virtually all markets where the Company operates with the midwest and northeast especially adversely effected. In addition, Christmas trim-a-tree sales declined as a result of general softness in retail during that period, and craft sales decreased due to a lower number of customers resulting from the lawn and garden and Christmas factors explained above.
Cost of Sales Including Buying and Occupancy. Cost of sales including buying and occupancy expenses were $317.1 million in fiscal 2000 compared to $337.2 million in fiscal 1999. This reduction of $20.1 million amounted to a 6% decrease. Cost of sales, as a percentage of net sales, increased by 3.4 percentage points to 72.6% in 2000 compared to 69.2% in 1999. Included in the fiscal 2000 costs were $3.2 million of charges for a lower of cost or market reserve for the inventory liquidated under the 2000 store closure program (refer to Note 2 of the Notes to Financial Statements for further discussion). Buying and occupancy costs increased by approximately 3.6% or $2.6 million due principally to increased occupancy costs of $3.5 million for new stores opened during fiscal 1999 and 2000. These cost increases and the 10.3% sales decline contributed to a 2.4% increase in buying and occupancy costs as a percentage of sales. Overall merchandise margins approximated the prior year.
Selling, General & Administrative Expense. Selling, general and administrative expense for fiscal 2000 was $136.7 million compared to $137.7 million in fiscal 1999. The decline of $1 million includes the effect of a $2.5 million increase in payroll and other store expenses for new stores opened in fiscal 1999 and 2000. As a percentage of net sales, selling, general and administrative expenses increased by 3.1 percentage points to 31.3% in 2000 compared to 28.2% in 1999.
Operating Income (defined as "net sales less cost of sales including buying and occupancy costs, and selling, general and administrative expenses"). The operating loss for fiscal 2000 was $16.9 million compared to operating income of $12.5 million in fiscal 1999. The increased operating loss was primarily the result of decreased sales levels and the lower of cost or market reserve for the inventory liquidation under the 2000 store closure program, as explained above. The operating loss, as
a percentage of net sales, was (3.9)% for 2000, an increase of 6.5 percentage points from 2.6% of operating income for 1999.
Restructuring and Asset Impairment Charges. As a result of the Company's operating losses for fiscal 2000 and the filing under Chapter 11, as discussed in "Liquidity and Capital Resources" below, the Company performed an impairment analysis as required under Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed of." The estimated fair value of the impaired assets was determined by comparing expected future cash flows for each store to the combined net property, plant and equipment and allocated goodwill. This analysis and the impact of the Chapter 11 filing, in connection with which the Company rejected store leases relating to a store closing provision from fiscal 1993 and 22 current store leases (subject to Bankruptcy Court approval), resulted in the Company recording a restructuring and asset impairment charge of $127 million for fiscal 2000. The charge consists of $73.6 million for the write-down of goodwill, $46.2 million for the write-down of fixed assets, $14 million for the 2000 store closure program and $.8 million for bankruptcy costs offset by $7.6 million for the elimination of previously recorded store closing liabilities from fiscal 1993 as a result of rejected store leases.
Other Income. Other income for fiscal 2000 was $1 million compared to $3.5 million in fiscal 1999 which included a gain of $2.1 million from the reversion of a noncontributory, defined benefit pension plan which covered former employees of several discontinued operations of Holdings.
Interest and Debt Expense. Interest and debt expense was $23.9 million in fiscal 2000 compared with $22.8 million in fiscal 1999. The increase is the result of a higher level of outstanding borrowings and interest rates under the credit facility during 2000.
Income Taxes. For fiscal 2000 income taxes represent a benefit resulting from the realization of certain net operating losses for which a full valuation allowance had been previously established. The Company reduced its valuation allowance by $.9 million based upon regulatory approval for certain tax matters and immediately realized the related deferred tax asset when the tax refund was received. As of January 28, 2001, the Company's remaining net deferred tax asset position is fully offset with a valuation allowance, due to the Company's historical operating results. Due to the previously unrecognized tax benefits, no income tax provision has been provided for in fiscal 2000 and 1999.
FISCAL 1999 COMPARED TO FISCAL 1998
Net Sales. Sales were $487.3 million for the 1999 fiscal year compared to $512.1 million for the 1998 fiscal year, a decrease of 4.8%. Comparable store sales declined 5.1%. Comparative net sales were negatively impacted by the phasing out of certain craft categories and unfavorable weather patterns in certain key markets including heavy
rainfall in early spring in the midwest and extreme drought conditions and water restrictions in major markets in the east in the summer of 1999. The core lawn and garden business was flat on a same-store basis despite the unfavorable weather patterns.
Cost of Sales Including Buying and Occupancy. Cost of sales including buying and occupancy expenses were $337.2 million in fiscal 1999 compared to $347.5 million in fiscal 1998. This reduction of $10.3 million amounted to a 3% decrease. Cost of sales, as a percentage of net sales, increased by 1.3 percentage points to 69.2% in 1999 compared to 67.9% in 1998. This increase was due primarily to a .3 of a percentage point decrease in merchandise margins and an increase of 1 percentage point in buying and occupancy costs due principally to occupancy costs for new stores and increased depreciation expense. The .3 percentage point decline in merchandise margins resulted primarily from clearance activities in craft classes that had previously been identified by management as noncomplementary to the new floral and home decor category.
Selling, General & Administrative Expense. Selling, general and administrative expense for fiscal 1999 was $137.7 million compared to $135.8 million in fiscal 1998. The increase of $1.9 million was principally due to store related training expense and other costs for new stores. As a percentage of net sales selling, general and administrative expenses increased by 1.7 percentage points to 28.2% in 1999 compared to 26.5% in 1998.
Operating Income (defined as "net sales less cost of sales including buying and occupancy costs, and selling, general and administrative expenses"). Operating income for fiscal 1999 was $12.5 million compared to $28.8 million in fiscal 1998. The decline in operating income was primarily the result of decreased sales levels and increased selling, general and administrative expenses, as explained above. Operating income, as a percentage of net sales, was 2.6% of net sales for 1999, a decrease of 3 percentage points from 5.6% for 1998.
Other Income. Other income for fiscal 1999 was $3.5 million compared with $2.9 million in fiscal 1998. The increase over 1998 was principally the result of a $2.1 million gain from the reversion of a noncontributory, defined benefit pension plan which covered former employees of several discontinued operations of Holdings. The reversion occurred in the 1999 second quarter and was originally included in the change in the net parent investment in the balance sheet. In the 1999 fourth quarter the gain was reclassified to other income. The 1999 increase was partially offset by a higher level of gains from sales of properties during 1998 and a lower level of interest income related to cash equivalents in 1999 of $.6 million compared to $1.1 million in 1998.
Interest and Debt Expense. Interest and debt expense was $22.8 million in fiscal 1999 compared with $21.8 million in fiscal 1998. The increase is the result of a higher level of outstanding borrowings under the credit facility during 1999.
Income (Loss) Before Extraordinary Item and Income Taxes. The loss before extraordinary items for 1999 was $9.3 million compared to income of $7.5 million for 1998. This decline of $16.8 million is directly related to the decline in operating income of $16.3 million as well as changes in other income as explained above.
Income Taxes. Due to the previously unrecognized tax benefits no income tax provision has been provided for in 1999 and 1998.
Extraordinary Item. In the 1998 first quarter the Company recorded an extraordinary charge of $5.1 million as a result of early extinguishment of debt and major modifications to existing credit lines. The early extinguishment of debt resulted in an extraordinary charge of $3.5 million representing the premium of $2.2 million and other costs associated with the retirement of the 11.5% Senior Notes and the 8% Convertible Notes. In addition, costs were incurred for early payment of a term loan and overall credit line refinancing.
Liquidity and Capital Resources
Significant Events. The Company and Holdings each filed a voluntary petition under Chapter 11 within the United States Bankruptcy Court for the District of Maryland, Baltimore Division on February 19, 2001. An Official Committee of Unsecured Creditors, has been appointed in the Chapter 11 cases. In a Chapter 11 case, substantially all liabilities as of the Petition Date are subject to compromise or other treatment under a plan of reorganization. Generally, actions to enforce or otherwise effect payment of all pre-petition liabilities are stayed while the Debtors continue their business operations as debtors-in-possession. In addition, in the Chapter 11 cases, the Debtors may reject executory contracts and lease obligations. In the Chapter 11 cases the Debtors obtained a $100 million debtor-in-possession financing agreement to finance the Company's working capital requirements and retire the Company's pre-petition debt under its credit facility. The Company's financial statements for the year ended January 28, 2001 have been prepared assuming that the Company will continue as a going concern, and not under the liquidation basis of accounting.
2000 Store Closure Program. During the third quarter of fiscal 2000 the Company completed an analysis that targeted 44 stores that no longer fit the Company's long term growth strategy and future capital investment plans. The sale of the stores was subject to lender consent under the Company's credit facility, which was obtained during the fourth quarter. All the 44 stores were closed as of the end of March 2001. The Company anticipates completion of the sale of these stores by the end of fiscal 2001, contingent upon approval by the Bankruptcy Court. In connection with these closures, the Company recorded $17.2 million of charges, of which $3.2 million represents a lower of cost or market reserve for the inventory that was liquidated, which is included in cost of goods sold. The remaining $14 million is included in the restructuring and asset impairment charge of $127 million. Of the $14 million, approximately $.8
million represents termination benefits and severance costs, and the remaining $13.2 million relates primarily to the write-down of fixed assets to the lower of carrying amount or fair value. Fair value was measured by using the estimated net selling price based upon actual bids and appraisals. The estimated fair value of these stores is $33.5 million and is shown in the current asset section of the balance sheet as assets to be disposed of at January 28, 2001.
Operating Activities. Net cash provided by operations for fiscal 2000 was $26.4 million compared to cash used in operations for fiscal 1999 of $15.1 million. The lower level of earnings (net of the restructuring and asset impairment and other noncash charges) was more than offset by the $27.7 million reduction in the balance sheet inventory levels as compared to fiscal 1999. The reduction in inventory occurred in two principal sectors. First, the lawn and garden hardline inventory, including fertilizers, tools and planters, was significantly reduced to bring the inventory levels in line with requirements. Second, the Company's strategy to phase out of certain product classes, especially general and juvenile crafts, reduced the inventory levels of these categories. In addition the 2000 store closure program lessened the cash requirements for the fiscal 2000 Christmas season. Also, at the end of the 2000 fourth quarter the bank's reduction of funding availability under the credit facility contributed to the lower level of accounts payable payments by approximately $13 million when compared to the prior year change.
Investing Activities. Net cash used in investing activities for fiscal 2000 was $16.5 million compared to $28.8 million in fiscal 1999. Capital expenditures in 2000 were $17.6 million and included approximately $7.3 million for new stores, $3.3 million for store refurbishments and new fixtures and $7 million for new information technology systems. Expenditures exclude another $3.9 million of equipment under capital lease for the Company's new POS system.
Financing Activities. Net cash used in financing activities for fiscal 2000 was $8.1 million compared to cash provided by financing activities of $47.6 million for fiscal 1999. The $8.1 million used in fiscal 2000 related to payment of bank debt offset by an increase in the net parent investment for a $15 million equity contribution from Cypress. On April 27, 2000 Cypress contributed $15 million and received 2,801,204 shares of Holdings common stock. The capital contribution is intended for the funding of the Company's new POS system for $12.5 million and $2.5 million for general corporate purposes. The $47.6 million provided in 1999 was due primarily to a net increase in short-term borrowings under the Senior Secured Credit Facility of $42 million. In addition, Holdings completed the reversion of a noncontributory, defined benefit pension plan which covered former employees of several discontinued operations. The net surplus after the purchase of annuities reverted back to Holdings which in turn transferred the funds to the Company. The gross cash proceeds were $11.2 million, which were used to fund a $2.8 million investment in the Company's 401(k) program for future company match contributions, payment of $1.7 million in excise taxes and $6.7 million used for general corporate purposes.
At January 28, 2001 the Company had a Senior Secured Credit Facility (the "credit facility") with various banks and financial institutions providing for total borrowings of up to $125 million. The Company had borrowings outstanding of $62.3 million and outstanding letters of credit of $2.8 million at January 28, 2001. During the fiscal 2000 fourth quarter the Company, although having borrowing availability under the credit facility, was unable to draw sufficient funding to meet its working capital needs. The Company did not make the quarterly term loan payment on January 29, 2001 as it was unable to secure alternative funding. These factors contributed to the Chapter 11 filing. The credit facility requires the Company to maintain certain financial ratios. As of the close of business on January 28, 2001 the Company was in default of its financial covenants under the credit facility.
The Company's subordinated notes contain cross defaults that were violated when the Company defaulted on covenants under the credit facility. In addition the Company defaulted on the interest payment due in March, 2001; therefore, the $115 million of subordinated notes has been classified as current at January 28, 2001.
Total debt at January 28, 2001 was $214 million including borrowings under the credit facility, mortgages, capital leases, and subordinated notes. As a result of the debt covenant defaults and the Chapter 11 filing all the debt, except for $5.4 million of capital leases, has been classified as current as of January 28, 2001. Cash and cash equivalents were $10.6 million at the end of fiscal 2000.
The Company negotiated a $100 million debtor-in-possession agreement (the "DIP Financing") dated February 19, 2001 for two years to finance the Company's working capital requirements. The Company utilized $62.1 million (including interest and fees) of the DIP financing to pay off the existing debt under the credit facility on February 21, 2001.
The Company's most significant cash requirements for the next fiscal year are for seasonal buildup of merchandise inventories and bankruptcy related expenditures. In fiscal 2001 the Company anticipates spending $4 million for capital expenditures, including fixtures for one new store that opened on April 7, 2001, the remaining implementation of the POS system that will be fully operational in all stores as of the end of April, 2001 and general store capital expenditures.
As previously discussed, the Company will operate its business as debtor-in-possession, but may not engage in transactions outside of the ordinary course of business without approval of the Bankruptcy Court. The Company is planning to implement a reorganization plan that would include cost reductions, improved operating efficiencies and increased financial flexibility. In addition, the Company's DIP Financing imposes certain operating and financial covenant restrictions that are dependent on the Company achieving satisfactory levels of profitability and cash flow from operations. Additionally, the Company's business depends, in part, on normal weather patterns across its markets. Any unusual weather patterns in the Company's markets can have a material and adverse impact on the
Company's business and financial condition, particularly the lawn and garden sector. The ability of the Company to continue as a going concern is dependent upon, among other things, confirmation of a plan of reorganization, future profitable operations, the ability to comply with the DIP financing covenants and the ability to generate sufficient cash from operations and financing sources to meet obligations. There can be no assurances that the Company will be successful in reorganizing under Chapter 11, which could result in liquidation. The accompanying financial statements do not include any adjustments that would be required if the Company were in liquidation.
Inflation
Inflation has been modest in recent years and has not had a significant effect on the Company. If merchandise costs were to increase because of inflation, management believes such increases could be recovered through higher selling prices, since virtually all retailers would be similarly affected.
SAFE HARBOR STATEMENT under the Private Securities Litigation Reform Act of 1995: Except for the historical information contained herein, the matters discussed in this Annual Report are forward-looking statements that involve risks and uncertainties, including but not limited to economic, competitive, governmental and technological factors affecting the Company's operations, markets, products, services and prices, and other factors discussed in the Company's filings with the Securities and Exchange Commission.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company perceives its only market interest rate risk to be limited to borrowings under the credit facility. These borrowings are at variable interest rates; and therefore, the related interest expense is sensitive to changes in the general level of U.S. interest rates and the LIBOR (London Interbank Offering Rate). The Company had borrowings outstanding under this credit facility of $62.3 million at January 28, 2001 with a weighted average interest rate of approximately 10% compared with $80.9 million at January 30, 2000 with a weighted average interest rate of approximately 9.7%. A significant portion of the Company's interest expense has been fixed through issuance of the Company's $115 million Senior Subordinated Notes due March 2008. The fixed interest rate on the Senior Subordinated Notes is 10 1/4%.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Financial Statements
The Company's financial statements and supplementary data are listed in Item 14 of this Report.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Set forth below are the names, ages and positions of the persons serving as the directors and executive officers of the Company. Each director will hold office until the next annual meeting of shareholders and until the director's successor is elected and qualified or until the earlier of the director's death, resignation or removal.
Joseph R. Baczko is Chairman of the Board and Chief Executive Officer and has been in these positions since December 1997 after having been a private investor and consultant since 1993. He was also President from December 1997 to April 1999.
Adam Szopinski is President, Chief Operating Officer and director since April 1999. Prior thereto he was Executive Vice President, Chief Operating Officer and director since December 1997 after having served as the Vice President of Operations of Toys "R" Us International since 1989.
Larry T. Lakin is Vice Chairman, Chief Financial Officer and director since April 1999. In June 1998 Mr. Lakin was named Treasurer. Prior thereto he was Executive Vice President, Chief Financial Officer and director since December 1997. Mr. Lakin previously served as the Chief Financial Officer and a principal of Shiara, Inc. ("Shiara"), a private fragrance company and cosmetic venture, from April 1994 to December 1997.
David P. Spalding became a director in December 1997 and has served as Vice Chairman of Cypress since its formation in April 1994. Prior to joining Cypress, he was a Managing Director in the Merchant Banking Group
at Lehman Brothers Inc. Mr. Spalding is also a director of Lear Corporation, AMTROL Inc. and Williams Scotsman, Inc.
James A. Stern became a director in December 1997 and has been Chairman of Cypress since its formation in April 1994. Prior to joining Cypress, Mr. Stern spent his entire career with Lehman Brothers Inc., most recently as head of the Merchant Banking Group. Mr. Stern is also a director of AMTROL Inc., Cinemark USA, Inc., Lear Corporation, WESCO International, Inc., and a trustee of Tufts University.
Bahram Shirazi became a director in December 1997. Mr. Shirazi has been a managing director of Cypress since 1998. Prior to 1998 he was a principal of Cypress since its formation in April 1994. Prior to joining Cypress, he was a Vice President in the Merchant Banking Group at Lehman Brothers Inc from 1992 to 1994. Mr. Shirazi is also a director of Clubcorp, Inc. and Homeruns.com, Inc.
Jeffrey P. Hughes became a director in February 2001 and has been Vice Chairman of Cypress since its formation in April 1994. Prior to joining Cypress, Mr. Hughes spent 26 years at Lehman Brothers as a senior investment banker and merchant banker and became a partner in 1976. Mr. Hughes is also on the Board of Duke University Law School.
COMPENSATION OF DIRECTORS
The Company currently pays no compensation to its non-employee directors, nor does it pay any additional remuneration to employees or executive officers of the Company for serving as directors.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The following table sets forth information concerning the compensation for services rendered in all capacities to the Company for the fiscal years ended January 31, 1999 (fiscal year 1998), January 30, 2000 (fiscal year 1999) and January 28, 2001 (fiscal year 2000) for those persons who were at January 28, 2001, the Chief Executive Officer and the other two most highly compensated executive officers of the Company. The Chief Executive Officer and the two most highly compensated officers will be referred to collectively as the "Named Officers".
SUMMARY COMPENSATION TABLE
(1) Amounts earned under the Executive Officer Incentive Program of the Company for services rendered in the respective fiscal years.
(2) Represents living expenses paid by the Company including the tax effect.
(3) Of this amount, $294,770 represents relocation paid to Mr. Baczko including the tax effect.
(4) Includes insurance premiums paid by the Company on behalf of the Named Officers for term and supplemental life insurance for 1998. For 1999 and 2000 also includes short-term disability and medical insurance.
(5) Includes the Company match under the Company's 401(k) plan on behalf of Mr. Szopinski of $3,461 for 2000 and $5,000 for 1999.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
For the Company's 2000 fiscal year, Mr. Spalding, Mr. Stern and Mr. Shirazi were the members of the Company's Compensation Committee.
COMPENSATION COMMITTEE REPORT ON EXECUTIVE COMPENSATION
COMPENSATION POLICIES
The Compensation Committee (the "Committee"), which is comprised of three non-employee directors, is responsible for establishing the Company's executive compensation policies, reviewing the compensation of officers and key employees, recommending and approving changes in compensation and reviewing and recommending changes in the Company's employee benefit programs and management succession plans.
In connection with its responsibility to guide the Company's policies, plans and programs, the Committee approves the annual compensation of the Company's executive officers and other key employees, which consists primarily of base salary and bonus.
ELEMENTS OF EXECUTIVE OFFICER COMPENSATION
Base Salaries The Company maintains salary ranges for its executive officers based on the practices of other companies with revenues and operating characteristics similar to those of the Company, geographic criteria and responsibility level. Using the ranges as a guideline, the Company establishes salaries at levels necessary to attract and retain talented executive officers and other key employees.
The Committee's approval of salary increases for executive officers depends on the Company's performance in the prior fiscal year, achievement of non-financial objectives and overall personal performance.
Bonuses The program provides that the executive officers of the Company are eligible to receive bonus payments based on the achievement of profit levels that are determinable at the discretion of the Committee and personal performance. The Committee has the authority to waive performance or profitability criteria under the program when awarding salary increases or when granting bonuses.
Committee Members: David P. Spalding James A. Stern Bahram Shirazi
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
All of the outstanding capital stock of the Company is owned by Holdings. The authorized capital stock of Holdings consists of 100,000,000 shares of Holdings Common Stock and 1,000,000 shares of preferred stock, par value $1.00 per share. As of April 30, 2001, 33,801,204 shares of Holdings Common Stock and no shares of preferred stock were issued and outstanding on a fully diluted basis.
The following table sets forth certain information as to the beneficial ownership of Holdings Common Stock as of April 30, 2001 by (i) owners of more than 5% of the outstanding shares of Holdings Common Stock, (ii) each executive officer and director of Holdings, and (iii) all executive officers and directors of Holdings, as a group. Except as indicated in the footnotes to this table, the Company believes that the persons named in the table have sole voting and investment power with respect to all shares shown as beneficially owned by them.
- -------------------
* Represents holding of less than 1%.
(a) Cypress Offshore and CMBP are affiliates of Cypress. Messrs. Spalding and Stern are members of Cypress and may be deemed to share beneficial ownership of the shares of Holdings Common Stock shown as beneficially owned by the Cypress Funds. Both of such individuals disclaim beneficial ownership of such shares.
(b) Cypress Offshore owns its interest in Holdings through its wholly owned subsidiary Cypress Garden Ltd.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The summary of the following agreement does not purport to be complete and, while the Company believes that the summary of the material provisions of such agreement is accurate and a complete summary of all material terms, such summary is subject to, and qualified in its entirety by reference to, the agreement summarized below, including the definitions therein of certain terms.
EMPLOYMENT AGREEMENTS
The Company entered into employment agreements with the following executive officers on January 18, 2001:
Joseph R. Baczko, Chairman of the Board and Chief Executive Officer
Adam Szopinski, President and Chief Operating Officer
Larry T. Lakin, Vice Chairman and Chief Financial Officer
These agreements provide for continued employment of these individuals in their current positions for the period commencing on January 18, 2001 and ending on January 31, 2003.
These executives will be paid at their current annual salary with any increases to be determined at the sole discretion of the Compensation Committee of the Board of Directors.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
A. List of documents filed as part of this report:
1. FINANCIAL STATEMENTS Page No.
- Report of Independent Auditors to
- Balance Sheets - as of January 28, 2001 and January 30, 2000.
- Statements of Operations - for the years ended January 28, 2001, January 30, 2000 and January 31, 1999.
- Statements of Changes in Shareholder's Equity - for the years ended January 28, 2001, January 30, 2000, and January 31, 1999.
- Statements of Cash Flows - for the years ended January 28, 2001, January 30, 2000 and January 31, 1999.
- Notes to Financial Statements to
2. FINANCIAL STATEMENT SCHEDULES
Schedules not included have been omitted because they are not applicable or the required information is shown in the financial statements or notes thereto.
II - Valuation and qualifying accounts- to years ended January 28, 2001, January 30, 2000 and January 31, 1999.
3. EXHIBITS
Exhibit No. Description of Exhibit
2.1 Agreement and Plan of Merger dated as of November 22, 1997, between FNC Holdings Inc. (formerly General Host Corporation) and Cyrus Acquisition Corp. (Incorporated by reference to the
Company's Registration Statement (Form S-4), Registration No. 333-50815 ("the Form S-4"), Exhibit 2.1.)
3.1 Restated Articles of Incorporation of the Company (Incorporated by reference to the Form S-4, Exhibit 3.1.)
3.2 Bylaws of the Company (Incorporated by reference to the Form S-4, Exhibit 3.2.)
4.1 Indenture dated as of February 26, 1998 between the Company and Bankers Trust Company (Incorporated by reference to the Form S-4, Exhibit 4.1.)
10. Material Contracts
10.1 Credit Agreement dated as of December 24, 1997 among the Company, Cyrus Acquisition Corp., General Host Corporation, the lenders party thereto, The Chase Manhattan Bank and Goldman Sachs Credit Partners LLP (Incorporated by reference to the Form S-4, Exhibit 10.1.)
10.2 Amendment No. 2 and Waiver, dated as of December 20, 1999, to the Credit Agreement dated as of December 24, 1997, as amended by Amendment No. 1, dated as of April 15, 1998, among Frank's Nursery & Crafts, Inc., FNC Holdings Inc., the lenders party thereto, The Chase Manhattan Bank and Goldman Sachs Credit Partners L.P. (Incorporated by reference to the 1999 Form 10-Q filed December 22, 1999 Exhibit 10.2., File No. 1-5364)
10.3 Amendment No. 3, dated as of April 20, 2000, to the Credit Agreement dated as of December 24, 1997, as amended by Amendment No. 2, dated as of December 25, 1999 and Amendment No. 1, dated as of April 15, 1998, among Frank's Nursery & Crafts, Inc., FNC Holdings Inc., the lenders party thereto, The Chase Manhattan Bank and Goldman Sachs Credit Partners L.P. (Incorporated by reference to the 1999 Form 10-K filed April 28, 2000)
10.4 Stock Purchase Agreement dated as of April 27, 2000, between FNC Holdings Inc., Cypress Merchant Banking Partners, L.P. and Cypress Gardens Ltd. (Incorporated by reference to the 1999 Form 10-K filed April 28, 2000)
10.5 Amended and Restated Debtor In Possession Loan and Security Agreement dated as of February 19, 2001, by and among Frank's Nursery & Crafts, Inc., the lenders that are signatories thereto, Wells Fargo Retail Finance, LLC, as agent (Filed herewith)
10.6 Employment Agreement dated as of January 18, 2001 by and between the Company and Joseph R. Baczko (Filed herewith)
10.7 Employment Agreement dated as of January 18, 2001 by and between the Company and Larry T. Lakin (Filed herewith)
10.8 Employment Agreement dated as of January 18, 2001 by and between the Company and Adam Szopinski (Filed herewith)
B. Reports on Form 8-K
During the last quarter of the period covered by this report, the Company did not file a report on Form 8-K.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.
FRANK'S NURSERY & CRAFTS, INC.
Date: April 30, 2001 By /s/Joseph R. Baczko ------------------------------ Joseph R. Baczko Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
Date: April 30, 2001 /s/Joseph R. Baczko ------------------------------ Joseph R. Baczko Chairman of the Board of Directors and Chief Executive Officer (Principal Executive Officer)
Date: April 30, 2001 /s/Adam Szopinski ------------------------------ Adam Szopinski President, Chief Operating Officer and Director
Date: April 30, 2001 /s/ Larry T. Lakin ------------------------------ Larry T. Lakin Vice Chairman, Chief Financial Officer, Treasurer and Director (Principal Financial and Accounting Officer)
Date: April 30, 2001 /s/ David P. Spalding ------------------------------ David P. Spalding Director
Date: April 30, 2001 /s/James A. Stern ------------------------------ James A. Stern Director
Date: April 30, 2001 /s/Bahram Shirazi ------------------------------ Bahram Shirazi Director
Date: April 30, 2001 /s/Jeffrey P. Hughes ------------------------------ Jeffrey P. Hughes Director
Report of Independent Auditors
The Board of Directors and Shareholder Frank's Nursery & Crafts, Inc.
We have audited the accompanying balance sheets of Frank's Nursery & Crafts, Inc. (the "Company") as of January 28, 2001 and January 30, 2000, and the related statements of operations, changes in shareholder's equity, and cash flows for each of the three years in the period ended January 28, 2001. Our audits also included the financial statement schedule listed in the Index at Item 14(A) for 2000, 1999 and 1998. These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Frank's Nursery & Crafts, Inc. at January 28, 2001 and January 30, 2000, and the results of its operations and its cash flows for each of the three years in the period ended January 28, 2001, in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
The accompanying financial statements have been prepared assuming that Frank's Nursery & Crafts, Inc. will continue as a going concern. As more fully described in Notes 7 and 13, the Company has incurred operating losses, has a working capital deficiency and is in default of certain covenants under the terms of the agreement for its senior subordinated notes and its senior credit facility. The Company also voluntarily filed for reorganization under Chapter 11 of the United States Bankruptcy Code. These conditions raise substantial doubt about the Company's ability to continue as a going concern. The financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the outcome of this uncertainty.
/s/ Ernst & Young LLP
Detroit, Michigan March 30, 2001
FRANK'S NURSERY & CRAFTS, INC. BALANCE SHEETS (IN THOUSANDS)
See accompanying notes.
FRANK'S NURSERY & CRAFTS, INC. STATEMENTS OF OPERATIONS (IN THOUSANDS)
See accompanying notes.
FRANK'S NURSERY & CRAFTS, INC.
STATEMENTS OF CHANGES IN SHAREHOLDER'S EQUITY FOR THE FISCAL YEARS ENDED JANUARY 28, 2001, JANUARY 30, 2000, AND JANUARY 31, (IN THOUSANDS)
See accompanying notes.
FRANK'S NURSERY & CRAFTS, INC. STATEMENTS OF CASH FLOWS (IN THOUSANDS)
See accompanying notes.
FRANK'S NURSERY & CRAFTS, INC. NOTES TO FINANCIAL STATEMENTS (IN THOUSANDS, EXCEPT WHERE INDICATED)
NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
DESCRIPTION OF OPERATIONS
Frank's Nursery & Crafts, Inc. ("Frank's" or the "Company") is a wholly-owned subsidiary of FNC Holdings Inc. ("Holdings"). Holdings is principally owned by The Cypress Group LLC ("Cypress").
The Company operates a chain of specialty retail stores devoted to the sale of lawn and garden, Christmas and floral and home decor in the United States. As of January 28, 2001 the Company operated 218 retail stores located in 14 states primarily in the East, Middle Atlantic and Midwest regions of the country.
FISCAL YEAR
The fiscal year is normally comprised of 52 or 53 weeks, ending on the last Sunday in January. The 2000 fiscal year reflects a 52- week period ended January 28, 2001. The 1999 fiscal year reflects a 52-week period ended January 30, 2000 and the 1998 fiscal year reflects a 53-week period ended January 31, 1999.
USE OF ESTIMATES
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements. Estimates also affect reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
RECLASSIFICATIONS
Certain reclassifications have been made to prior year's financial statements to conform to the 2000 presentation.
REVENUE RECOGNITION
The Company recognizes revenue when the customer takes possession of the merchandise.
FAIR VALUE OF BALANCE SHEET FINANCIAL INSTRUMENTS
The carrying amounts reported in the balance sheets for cash and cash equivalents, marketable securities, notes receivable, accounts receivable and accounts payable approximate fair value because of the immediate or short-term maturity of these financial instruments. Due to the Company filing Chapter 11 (Note 13) and its potential impact on final settlement of all pre-petition liabilities, it is not practicable to measure the fair value of the Company's debt at January 28, 2001.
FRANK'S NURSERY & CRAFTS, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED)
NOTE 1 (CONTINUED)
CASH EQUIVALENTS
Cash equivalents consist of highly liquid investments, such as U.S. government securities and bank certificates of deposit having original maturities of three months or less, and are carried at cost plus accrued interest.
MARKETABLE SECURITIES
Marketable securities represent an investment in a guaranteed fund restricted for the funding of the Company's 401(k) match program (Note 10). The securities are classified as held-to-maturity in accordance with Financial Accounting Standards No. 115 "Accounting for Certain Investments in Debt and Equity Securities" and are reported at amortized cost. The fair value of these securities approximate their costs at January 28, 2001.
MERCHANDISE INVENTORIES
Merchandise inventories are stated at the lower of cost or market, with cost being determined under the first-in, first-out method.
PRE-OPENING COSTS
Pre-opening costs are expensed as incurred.
ADVERTISING COSTS
Advertising costs are expensed when the advertising first takes place. Advertising expenditures were $22,707 for 2000, $22,300 for 1999 and $23,847 for 1998.
STORE CLOSING COSTS
Provisions for store closing costs are charged to operations in the period when the decision is made to close a retail unit.
PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment, including significant improvements thereto, are recorded at cost. Expenditures for repairs and maintenance are charged to expense as incurred. The cost of plant and equipment is depreciated over the estimated useful lives of the related assets using the straight-line method. Estimated useful lives, including capital leases, are: buildings, 10-40 years or, if shorter, the terms of the lease; equipment, 3-20 years. Leasehold improvements are depreciated over the lease terms of the respective leases or the estimated useful lives. Upon sale or other disposition of assets, the cost and related accumulated depreciation are removed from the accounts and the resulting gain or loss, if any, is recognized in the statement of operations.
FRANK'S NURSERY & CRAFTS, INC NOTES TO FINANCIAL STATEMENTS (CONTINUED)
NOTE 1 (CONTINUED)
GOODWILL
Goodwill represents the costs in excess of the fair value of identifiable assets for acquired businesses is amortized on a straight-line basis over the estimated future period benefitted, not to exceed forty years. As a result of the change in circumstances related to the Chapter 11 filing (Notes 3 and 13), the Company changed the prospective life of the remaining goodwill to ten years.
IMPAIRMENT OF LONG-LIVED ASSETS
Impairment of long-lived assets, including goodwill, is reviewed annually or when events and circumstances warrant such a review by the Company in accordance with Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of," (FAS 121) by comparing estimated future undiscounted cash flows associated with the asset to the asset's carrying value to determine if an impairment exists. If the expected future cash flows are less than the carrying amount of such assets, the Company recognizes an impairment loss for the difference between the carrying amount and the estimated fair value. Fair value is estimated using discounted future cash flows.
LEASES
Leases that meet the accounting criteria for capital leases are recorded as property, plant and equipment, and the related capital lease obligations (the aggregate present value of minimum future lease payments, excluding executory costs such as taxes, maintenance and insurance) are included in debt. Depreciation and interest are charged to expense, and rent payments are treated as payments of long-term debt, accrued interest and executory costs. All other leases are accounted for as operating leases and rent payments are charged to expense as incurred.
INCOME TAXES
Income taxes for Frank's are included in the consolidated U.S. federal income tax return of Holdings. In preparing its financial statements, Frank's has determined its tax provision on a separate return basis. Deferred tax assets and liabilities are determined based on differences between the financial reporting and income tax bases of assets and liabilities using enacted tax rates and laws in effect when the differences are expected to reverse.
FRANK'S NURSERY & CRAFTS, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED)
NOTE 2: STORE CLOSURE PROGRAM
During the third quarter of fiscal 2000 the Company completed an analysis that targeted 44 stores that no longer fit the Company's long term growth strategy and future capital investment plans. The size and age of the stores and lack of market penetration weighed heavily in the decision for closure despite the fact that the stores were marginally profitable. The sale of the stores was subject to lender consent under its credit facility, which was obtained during the fourth quarter. All the stores were closed as of the end of March 2001. The Company anticipates completion of the sale of these stores by the end of fiscal 2001, contingent upon approval by the Bankruptcy Court. In connection with these closures, the Company recorded $17.2 million of charges, of which $3.2 million represents a lower of cost or market reserve for the inventory that was liquidated which is included in cost of goods sold. The remaining $14 million is included in the restructuring and asset impairment charge of $127 million (Note 3). Of the $14 million, approximately $.8 million represents termination benefits and severance costs, and the remaining $13.2 million relates primarily to the write-down of fixed assets to the lower of carrying amount or fair value. Fair value was measured by using the estimated net selling price based upon actual bids and appraisals. The estimated fair value of these stores is $33.5 million and is shown in the current asset section of the balance sheet as assets to be disposed of at January 28, 2001.
FRANK'S NURSERY & CRAFTS, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED)
NOTE 3: RESTRUCTURING AND ASSET IMPAIRMENT CHARGES
As a result of the Company's operating losses for fiscal 2000 and the filing under Chapter 11 (Note 13), the Company performed an impairment analysis as required under FAS 121. The estimated fair value of the impaired assets was determined by comparing expected future cash flows for each store to the combined net property, plant and equipment and allocated goodwill. In connection with its Chapter 11 case, the Company rejected store leases and reversed a provision related to a store closing provision that originated in fiscal 1993. Additionally, the Company will seek to reject 22 current store leases (subject to Bankruptcy Court approval), resulting in a fixed asset impairment charge. The impairment analysis and the result of the store lease rejections resulted in the Company recording a charge of $127 million for fiscal 2000, consisting of the following:
NOTE 4: OTHER INCOME
The gain of $2,094 in fiscal 1999 resulted from the reversion of a noncontributory, defined benefit pension plan which covered former employees of several discontinued operations of Holdings.
FRANK'S NURSERY & CRAFTS, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED)
NOTE 5: INCOME TAXES
The reconciliation of income taxes computed at the federal statutory tax rate to income tax benefit is:
Deferred tax assets and liabilities are composed of the following:
FRANK'S NURSERY & CRAFTS, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED)
NOTE 5 (CONTINUED)
Income taxes for fiscal 2000 represent a benefit resulting from the realization of certain net operating losses for which a full valuation allowance has been previously established. The Company reduced their valuation allowance by $.9 million based upon regulatory approval for certain tax matters and immediately realized the related deferred tax asset when the tax refund was received.
Due to the Company's historical operating results, a valuation allowance for the net deferred tax asset balance is recorded at January 28, 2001 and January 30, 2000.
As discussed in Note 1, Frank's files a consolidated tax return with Holdings. At January 28, 2001 the federal tax NOL carryforwards, for Holdings, on a consolidated basis, approximated $141,000, the federal tax NOL carryforwards attributable to Frank's on a separate return basis approximated $116,000. The net operating loss will expire as follows: in January 2009 - $30,000, January 2010 - $2,000, January 2011 - $4,000, January 2012 - $8,000, January 2013 - $27,000, January 2020 - $3,000 and January 2021 - $42,000.
Holdings underwent an ownership change on December 24, 1997. Net operating losses incurred prior to the ownership change will be subject to usage limitations imposed by Internal Revenue Code Section 382. Of Holdings total net operating loss carryforward of $141,000, approximately $45,000 is not subject to these limitations. Approximately $7,200 of the NOL subject to limitations may be utilized each tax year.
FRANK'S NURSERY & CRAFTS, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED)
NOTE 6: PROPERTY, PLANT AND EQUIPMENT
NOTE 7: NOTE PAYABLE AND LONG-TERM DEBT
At January 28, 2001 the Company had a Senior Secured Credit facility (the "credit facility") with various banks and financial institutions which provides for (i) a term loan facility of up to $20.3 million (the "Term Loan Facility") and (ii) a revolving credit facility of up to $110 million (the "Revolving Credit Facility") in revolving credit loans and letters of credit.
FRANK'S NURSERY & CRAFTS, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED)
NOTE 7: CONTINUED
The facility has a borrowing base tied to inventories and company- owned real estate, which determines the borrowing availability at any given time based on the seasonality of the business. Term loans mature seven years after the closing date of the credit facility - December 24, 1997, in equal quarterly installments beginning in fiscal 1999 in an aggregate amount equal to 8.8% of the aggregate Term Loan Facility amount and increasing at each anniversary to 10.6%, 12.9%, 14.7%, 20.6% and 32.4% for fiscal years 2000, 2001, 2002, 2003, and 2004, respectively. Revolving credit loans mature in December, 2003. In addition, the Company must repay all borrowings under the Revolving Credit Facility for a period of at least 30 consecutive days in each fiscal year. The Company had borrowings outstanding of $15 million under the Term Loan Facility and $47.4 million under the Revolving Credit Facility at January 28, 2001. In addition the Company had outstanding letters of credit of $2.8 million.
Term loans provided pursuant to the Term Loan Facility bear interest, at the Company's election, at an annual rate equal to the Adjusted LIBOR (London Interbank Offering Rate) plus 3.25% or Alternative Base Rate (as defined therein) plus 2.5%, provided that such margins may be reduced if the Company meets certain senior leverage ratio tests. Revolving credit loans obtained pursuant to the Revolving Credit Facility bear interest, at the Company's election, at an annual rate equal to the Adjusted LIBOR plus 3.25% or Alternative Base Rate plus 2.25%, provided that such margins may be reduced if the Company meets certain senior leverage ratio tests. The Alternative Base Rate is the highest of the bank's Prime Rate, the Federal Funds Effective Rate plus 0.50% and the base CD Rate plus 1.00%. In addition, there is a commitment fee equal to 0.50% per annum on the total undrawn portion of the Term Loan Facility and the Revolving Credit Facility.
Among other obligations, the credit facility requires the Company to satisfy certain tests and maintain specified financial ratios, including a minimum interest coverage ratio and a maximum leverage ratio. In addition, the credit facility restricts, among other things, the Company's ability to incur additional indebtedness and to make acquisitions, investments and capital expenditures beyond a certain level. As of the close of business on January 28, 2001 the Company was in default of the financial covenants under the credit facility. Additionally, the Company did not make the quarterly term loan payment on January 29, 2001. The lender did not provide a waiver or amendment for the defaults; therefore the entire amount of the credit facility is classified as current.
FRANK'S NURSERY & CRAFTS, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED)
NOTE 7: CONTINUED
In March 1998 the Company issued $115 million of 10 1/4% Senior Subordinated Notes due March 21, 2008 (the "Subordinated Notes") and utilized approximately $110.7 million to pay down $17.2 million of indebtedness under the Term Loan Facility and to repay the remaining outstanding 11 1/2% Senior Notes of $25.2 million and the $65 million of 8% Convertible Subordinated Notes. This resulted in an extraordinary charge of $5.1 million, which included premium of $2.2 million, debt issue costs of $1.3 million and $1.6 million incurred for early payment of the Term Loan Facility and overall credit line refinancing.
The Subordinated Notes contain cross defaults that were triggered when the Company violated covenants under the credit facility. In addition the Company defaulted on the interest payment due in March, 2001; therefore the $115 million of Subordinated Notes has been classified as current at January 28, 2001.
The mortgage notes have interest rates varying from 7.8% to 9.625%, and the notes mature with balloon payments on varying dates from February 1, 2001 to September 1, 2007. The mortgage notes are secured by retail properties owned by the Company.
Aggregate scheduled maturities of debt for the five years subsequent to 2000, excluding capital lease obligations (Note 9), are $66,977 in 2001, $831 in 2002, $906 in 2003, $990 in 2004 and $2,861 in 2005.
NOTE 8: NET PARENT INVESTMENT
On April 27, 2000 Cypress contributed $15 million and received 2,801,204 shares of Holdings common stock. The capital contribution is intended to fund the Company's new POS system for $12.5 million and $2.5 million for general corporate purposes. As a result of the capital contribution, the Company's net parent investment increased by $15 million due to the cash transfer from Holdings to the Company.
In addition the Company is responsible for certain liabilities of discontinued operations for businesses that Holdings had sold in prior years. These liabilities are included in the net parent investment account. The remaining liability was $1.2 million at January 28, 2001.
FRANK'S NURSERY & CRAFTS, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED)
NOTE 9: LEASES
The Company's capital leases are principally for retail store locations, for periods ranging up to 25 years. The Company's operating leases are principally for retail store locations, some of which include renewal, purchase or escalation clauses.
Annual minimum lease payments under all capital and operating leases with lease terms longer than one year at January 28, 2001, are as follows:
Rent expense was $23,031 in 2000, $22,399 in 1999 and $22,684 in 1998. Rent expense includes additional rentals based on retail store sales (in excess of the minimums specified in leases) of $170 in 2000, $322 in 1999 and $446 in 1998 and is reduced by sublease rental income of $581 in 2000, $547, in 1999 and $679 in 1998.
NOTE 10: 401(K) PLAN
The Company provides a 401(k) Plan permitting employees to invest from 1% to 15% of their salary in outside mutual funds. The plan provides an employer match of 50% of the employee contribution. The Company's contribution is limited to 3% of salary and became effective November 1998.
FRANK'S NURSERY & CRAFTS, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED)
NOTE 11: LITIGATION AND OTHER CONTINGENCIES
In the normal course of business the Company is subject to various claims. These claims should be resolved in connection with the Company's Chapter 11 cases. In the opinion of management, any ultimate liability arising from or related to these claims should not have a material adverse effect on future results of operations or the consolidated financial position of the Company.
NOTE 12: SUPPLEMENTAL CASH FLOW INFORMATION
Interest payments were $21,281 in 2000, $20,436 in 1999 and $18,841 for 1998. No income tax payments were made in 2000, 1999, or 1998.
NOTE 13: SUBSEQUENT EVENT
On February 19, 2001 (the "Petition Date"), the Company and Holdings (the "Debtors") each filed a voluntary petition under Chapter 11 of the United States Bankruptcy Code ("Chapter 11") within the United States Bankruptcy Court for the District of Maryland, Baltimore Division (the "Court"). An Official Committee of Unsecured Creditors has been appointed in the Chapter 11 cases. In a Chapter 11 case, substantially all liabilities as of the Petition Date are subject to compromise or other treatment under a plan of reorganization. Generally, actions to enforce or otherwise effect payment of all pre-petition liabilities are stayed while the Debtors continue their business operations as debtors-in- possession. In addition, in the Chapter 11 cases, the Debtors may seek to reject executory contracts and lease obligations. In connection with the Chapter 11 cases, the Debtors obtained a $100 million debtor-in-possession financing agreement for two years with a lender (the DIP financer") to finance the Company's working capital requirements and retire the Company's outstanding obligations under the existing credit facility. On February 21, 2001 the debt and associated fees totaling $62.1 million under the credit facility was paid by the DIP financer. This resulted in an extraordinary charge of $4.3 million primarily for debt issue costs.
Schedule II
FRANK'S NURSERY & CRAFTS, INC. VALUATION AND QUALIFYING ACCOUNTS FISCAL YEAR ENDED JANUARY 28, 2001 (In thousands)
(1) Represents reduction against cost of goods sold. (2) Represents severance and taxes for the 2000 Store Closure Program. (3) Reclassification from noncurrent portion of reserve. (4) Represents payments of liabilities and loss on sale of property. (5) Represents charge for restructuring and asset impairment. (6) Reclassification to current portion of reserve.
Schedule II
FRANK'S NURSERY & CRAFTS, INC. VALUATION AND QUALIFYING ACCOUNTS FISCAL YEAR ENDED JANUARY 30, 2000 (In thousands)
(1) Represents reduction against cost of goods sold. (2) Represents payments of liabilities and loss on sale of property. (3) Reclassification from noncurrent portion of reserve. (4) Reclassification to current portion of reserve.
Schedule II
FRANK'S NURSERY & CRAFTS, INC. VALUATION AND QUALIFYING ACCOUNTS FISCAL YEAR ENDED JANUARY 31, 1999 (In thousands)
(1) Additions to Goodwill resulting from the Acquisition. (2) Represents reduction against cost of goods sold. (3) Represents payments of liabilities. (4) Reclassification to current portion of reserve. (5) Reclassification from noncurrent portion of reserve.
Exhibit Index
2.1 Agreement and Plan of Merger dated as of November 22, 1997, between FNC Holdings Inc. (formerly General Host Corporation) and Cyrus Acquisition Corp. (Incorporated by reference to the Company's Registration Statement (Form S-4), Registration No. 333-50815 ("the Form S-4"), Exhibit 2.1.)
3.1 Restated Articles of Incorporation of the Company (Incorporated by reference to the Form S-4, Exhibit 3.1.)
3.2 Bylaws of the Company (Incorporated by reference to the Form S-4, Exhibit 3.2.)
4.1 Indenture dated as of February 26, 1998 between the Company and Bankers Trust Company (Incorporated by reference to the Form S-4, Exhibit 4.1.)
10. Material Contracts
10.1 Credit Agreement dated as of December 24, 1997 among the Company, Cyrus Acquisition Corp., General Host Corporation, the lenders party thereto, The Chase Manhattan Bank and Goldman Sachs Credit Partners LLP (Incorporated by reference to the Form S-4, Exhibit 10.1.)
10.2 Amendment No. 2 and Waiver, dated as of December 20, 1999, to the Credit Agreement dated as of December 24, 1997, as amended by Amendment No. 1, dated as of April 15, 1998, among Frank's Nursery & Crafts, Inc., FNC Holdings Inc., the lenders party thereto, The Chase Manhattan Bank and Goldman Sachs Credit Partners L.P. (Incorporated by reference to the 1999 Form 10-Q filed December 22, 1999 Exhibit 10.2., File No. 1-5364)
10.3 Amendment No. 3, dated as of April 20, 2000, to the Credit Agreement dated as of December 24, 1997, as amended by Amendment No. 2, dated as of December 25, 1999 and Amendment No. 1, dated as of April 15, 1998, among Frank's Nursery & Crafts, Inc., FNC Holdings Inc., the lenders party thereto, The Chase Manhattan Bank and Goldman Sachs Credit Partners L.P. (Incorporated by reference to the 1999 Form 10-K filed April 28, 2000)
10.4 Stock Purchase Agreement dated as of April 27, 2000, between FNC Holdings Inc., Cypress Merchant Banking Partners, L.P. and Cypress Gardens Ltd. (Incorporated by reference to the 1999 Form 10-K filed April 28, 2000)
10.5 Amended and Restated Debtor In Possession Loan and Security Agreement dated as of February 19, 2001, by and among Frank's Nursery & Crafts, Inc., the lenders that are signatories thereto, Wells Fargo Retail Finance, LLC, as agent (Filed herewith)
10.6 Employment Agreement dated as of January 18, 2001 by and between the Company and Joseph R. Baczko (Filed herewith)
10.7 Employment Agreement dated as of January 18, 2001 by and between the Company and Larry T. Lakin (Filed herewith)
10.8 Employment Agreement dated as of January 18, 2001 by and between the Company and Adam Szopinski (Filed herewith)