Item 1. Business ------ - ------- --------
Service Merchandise, with 361 stores in 34 states, is a leading retailer of fine jewelry and home products. The Company streamlines its presentation to reflect customer tastes and purchasing habits, grouping merchandise into thematic categories called "worlds" - offering dominant selections of brand name products. In 1997, these "worlds" consisted of: Fine Jewelry, Kitchen and Dining, Furniture and Home Accents, Season to Season, Electronics, Looking Healthy/Staying Healthy (promoting the concept of "wellness" with exercise equipment, personal care items and a bath and body program), Kid Essentials and Travel and Adventure.
General
The Company's franchise is built around selling nationally advertised, brand-name home products and fine jewelry. Customers are made aware of the product offerings through catalogs, direct mail flyers, newspaper inserts and television advertising. While customers may purchase products through mail order, telephone order or via the Company's internet website, the majority of purchases occur directly in a Company store where the customer has physical access to the merchandise.
The typical Service Merchandise store consists of approximately 50,000 square feet of total space and is situated on a stand-alone lot or as an anchor in a suburban mall or strip center. The Company's stores are divided into thematic "worlds" with displays of the products arrayed to support the world concept. In the Fine Jewelry world, merchandise is displayed in showcases and sales associates deliver items to the customers and accept payment. In other worlds, a sample of the merchandise is displayed, and customers select their purchases via a "pull tag" system. The pull tag is taken to a cashier, the product is paid for and the merchandise is delivered to a pick-up station. Additionally, in self-service departments, customers select merchandise from a shelf or display and take it to a check-out counter to finalize the purchase.
The Company is currently testing a "Best of Service" concept which is a scaled-down 10,000 square foot format that carries the full line of jewelry and a limited number of top-selling products from the home product categories. Other new store formats will also be evaluated in 1998. Additionally, in the first quarter of 1998, the Company implemented a new private label credit card program.
Virtually every transaction in the store that involves payment, customer information or inventory is recorded and transmitted, on a daily basis, via satellite to a central information system at the Company's home office. In addition, by use of the computer, the customers may be provided with alternate suggestion items, back-order information, on-line mail orders, gift registry, special orders and layaway information. Most of the Company's stores are equipped with "Service Express", a user-friendly computer which allows customers to verify item availability, place their order, tender payment via credit card, update their address and designate an item as a gift registry purchase.
The Company's computerized daily inventory system tracks the status (on hand, on order, in transit), location and history of inventory in the retail network. The raw data feeds the Company's inventory replenishment system which tracks inventory positions, sales data and sales forecasts and generates either suggested transfers from distribution centers or suggested purchase order quantities. The inventory system also records all sales information to produce daily margin reports, complete with historical comparisons.
Item 1. Business (continued) - ------- --------------------
The Company's information systems enhance the effectiveness of the advertising by tracking customers' purchases and tailoring the Company's mailing lists to meet specific objectives. The Company maintains a 24-million household database of information which is updated with each purchase. This database allows the Company to target customers based on specific criteria, including the categories purchased, the frequency of purchases and the value of those purchases.
Seasonality and Competition
The Company's business is highly seasonal, with the Christmas season being the largest volume selling period of the year. In preparation for the Christmas season, the Company significantly increases its merchandise inventories, which are financed by internally generated funds and short-term borrowings. Fourth quarter net sales accounted for 39.4% of total net sales in fiscal 1997.
The Company is engaged in a highly competitive business and competes with most nationally known jewelry and home retail merchandisers, including department, general merchandise, specialty and discount stores. Many of these competitors are larger and have greater financial resources than the Company. The Company considers quality, value, merchandise mix, service and location to be the most significant competitive factors in its retailing business. The Company's profitability is primarily dependent upon the large sales volume generated during the fourth quarter of its fiscal year.
Suppliers
The Company purchases merchandise from approximately 1,500 suppliers, most of which are manufacturers. In fiscal 1997, the largest vendor accounted for approximately 6.2% of total cash disbursements for inventory items. The Company believes it would experience no difficulty in obtaining quality merchandise from alternate sources. Most merchandise is shipped to the Company's regional distribution centers and transported to the stores by commercial contract carriers.
The Company's direct import program is responsible for sourcing and repackaging many promotional and seasonal items. Direct import purchases, which totaled approximately $265 million in fiscal 1997 (compared to $287 million in fiscal 1996), allow the Company to reduce many traditional cost factors, thereby lowering the cost of merchandise sold in several product lines. In addition to its direct import program, the Company imports diamonds, gemstones and gold which are used by contract fabricators in the manufacture of jewelry items.
Employees
The number of persons employed by the Company fluctuates seasonally. During the fiscal year ended December 28, 1997, the number of active employees varied from approximately 26,800 to approximately 42,700 including both permanent and temporary employees. As of December 28, 1997, the Company had 24,168 permanent employees, of whom 84% were hourly-paid personnel engaged in non-supervisory activities; the balance consisted of administrative, executive, distribution center and store management personnel. None of the Company's employees are covered by a collective bargaining agreement. The Company has never experienced a work stoppage due to a labor disagreement and regards its employee relations as satisfactory.
Certain Factors that may affect Operating Results
On March 25, 1997, the Company announced a corporate restructuring and repositioning plan ("1997 Restructuring Plan"). See the Notes to Consolidated Financial Statements, which are incorporated herein by reference to the Registrant's 1997 Annual Report to Shareholders, for a description of this plan.
Item 1. Business (continued) - ------- --------------------
The Company's liquidity, capital resources and results of operations may be affected from time to time by a number of factors and risks, including, but not limited to, trends in the economy as a whole, which may affect consumer confidence and consumer demand for the types of goods sold by the Company; competitive pressures from other retailers, including specialized retailers and discount stores which may affect the nature and viability of the Company's business strategy; availability and cost of labor employed; real estate occupancy and development costs, including the substantial fixed investment costs associated with opening, maintaining or closing a Company store; the ability to advertise effectively and control advertising costs; availability, costs and terms of financing, including the risk of rising interest rates; availability of trade credit and terms with vendors; the Company's use of substantial financial leverage and the potential impact of such leverage on the Company's ability to execute its operating strategies, to withstand significant economic downturns and to repay its indebtedness; the ability to maintain gross profit margins and to achieve future cost savings; the seasonal nature of the Company's business and the ability of the Company to predict consumer demand as a whole, as well as demand for specific goods; the ability of the Company to attract and retain customers by executing the Company's remerchandising strategy and improving customer service; costs associated with the shipping, handling and control of inventory and the Company's ability to optimize its supply chain; potential adverse publicity; the ability and success in completing the disposition of store locations closed and designated to be closed pursuant to the 1997 Restructuring Plan; the ability and success in completing and implementing plans regarding the Company's credit card program and alternative store formats; the ability to execute a strategic repositioning of the Company; and the ability to effect conversions to new technological systems including, becoming year 2000 compliant.
This report includes, and other reports and statements issued on behalf of the Company may include, certain forward-looking information that is based upon management's beliefs as well as on assumptions made by and data currently available to management. This information, which has been or in the future may be, included in reliance on the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995, is subject to a number of risks and uncertainties, including but not limited to the factors identified above. Actual results may differ materially from those anticipated in any such forward-looking statements. The Company undertakes no obligation to update or revise any such forward-looking statements to reflect subsequent events or circumstances.
Item 2.
Item 2. Properties - ------- ----------
The Company leases and owns retail store facilities, warehouses and office space. The Company has financed a number of its owned facilities out of internally generated funds. Some owned facilities have ground leases on a long-term basis, some are financed through industrial development financing under which the Company either has ownership or a right to obtain ownership and others are financed by real estate mortgages. The Company occupies office space in two locations in greater Nashville, Tennessee, both of which are owned by the Company.
The Company operated four major distribution centers and one return center (Bowling Green, Kentucky) as of December 28, 1997. These distribution centers are located in Florida, New York, Tennessee, and Texas and contain an aggregate of approximately 3,102,000 square feet as set forth below:
The Company anticipates that it would be able to obtain suitable replacement facilities should it not be able to renew the above leases.
Item 2. Properties (continued) - ------- ----------------------
As of December 28, 1997, the Company operated 361 retail stores (typically consisting of approximately 50,000 square feet) as follows:
Most of the leases contain renewal or purchase options. See the Notes to Consolidated Financial Statements, which are incorporated herein by reference to the Registrant's 1997 Annual Report to Shareholders, for information concerning the Company's lease commitments.
For a listing of store locations, see page 8. The numbers in parentheses show the number of stores per state and where there is more than one store in any city, the number of stores in such city.
Item 2. Properties (continued) - ------- ----------------------
Item 3.
Item 3. Legal Proceedings - ------- -----------------
No reportable items.
Item 4.
Item 4. Submission of Matters to a Vote of Security-Holders - ------- ---------------------------------------------------
There were no reportable items during the Company's fourth quarter.
Executive Officers of the Registrant (1) - -----------------------------------------
The following is a list of executive officers, their ages, positions and business experience during the past five years as of the date hereof:
PART II
Item 5.
Item 5. Market for the Registrant's Common Stock and Related Stockholder Matters
The Company's Common Stock trades on the New York Stock Exchange (NYSE) under the symbol SME. The number of record holders of Common Stock at March 2, 1998 and February 28, 1997 were 5,844 and 6,076, respectively.
High and low closing sales prices as reported by the NYSE for fiscal 1997 and 1996 were as follows:
1997 High Low - ---- ----- ----- First Quarter 4 3/4 3 3/8 Second Quarter 3 5/8 2 5/8 Third Quarter 4 1/2 2 7/8 Fourth Quarter 4 7/8 1 7/8
1996 High Low - ---- ----- ----- First Quarter 6 4 1/2 Second Quarter 6 1/4 4 5/8 Third Quarter 5 3/4 4 1/2 Fourth Quarter 6 3/8 4 1/4
The Company's Amended and Restated Credit Facility contains certain restrictive covenants, including limitations on the ability to pay dividends. The Company has not declared any cash dividends to shareholders for fiscal 1997 or 1996. The Company's amended and restated Credit Facility permits the payment of dividends with respect to the Company's common stock, $0.50 par value (a) payable solely in securities of the Company, and (b) after June 30, 1999, payable in cash (if no Default or Event of Default exists) in an aggregate amount by which the following, when added to the amount
Item 5. Market for the Registrant's Common Stock and Related Stockholder Matters (continued)
of any cash dividends paid or declared would exceed 25% of Consolidated Net Income of the Company for the period of September 30, 1997 through the last day of the fiscal quarter prior to the dividend payment date: (i) Acquisitions and Investments under Section 8.8(m) of the Credit Facility in excess of $80 million, or (ii) Investments (other than Acquisitions under Section 8.8(m) of the Credit Facility in excess of $30 million).
Item 6.
Item 6. Selected Financial Data
Page 6 under the caption "Selected Financial Information" of the Registrant's 1997 Annual Report to Shareholders for the year ended December 28, 1997 is herein incorporated by reference.
Item 7.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Pages 7 through 11 of the Registrant's 1997 Annual Report to Shareholders for the year ended December 28, 1997 under the caption "Management's Discussion and Analysis" are herein incorporated by reference.
Item 8.
Item 8. Financial Statements and Supplementary Data
As set forth in the Registrant's 1997 Annual Report to Shareholders for the year ended December 28, 1997, the following are incorporated herein by reference:
PART III
Item 10.
Item 10. Directors and Executive Officers of the Registrant
Pages 2 through 5 under the caption "Election of Directors" and page 20 under the caption "Section 16(a) Beneficial Ownership Reporting Compliance" of the Registrant's Proxy Statement dated March 13, 1998 filed with the Commission pursuant to Rule 14a-6(b) are incorporated herein by reference.
Pursuant to General Instruction G(3), information concerning Executive Officers of the Registrant is included in Part I, Item 4, under the caption "Executive Officers of the Registrant" of this Form 10-K.
Item 11.
Item 11. Executive Compensation
Reference is made to the information on pages 8 through 18 of the Registrant's Proxy Statement dated March 13, 1998 filed with the Commission pursuant to Rule 14a-6(b), concerning executive compensation, which is herein incorporated by reference.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management
Reference is made to the information on pages 6 and 7 of the Registrant's Proxy Statement dated March 13, 1998 filed with the Commission pursuant to Rule 14a-6(b), concerning the beneficial ownership of Registrant's common stock, which is herein incorporated by reference.
Item 13.
Item 13. Certain Relationships and Related Transactions
Reference is made to the information on page 20 of the Registrant's Proxy Statement dated March 13, 1998 filed with the Commission pursuant to Rule 14a-6(b), concerning certain relationships and related transactions, which is herein incorporated by reference.
PART IV
3. Exhibits and Index to Exhibits
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.
SERVICE MERCHANDISE COMPANY, INC.
By: /s/ S. Cusano ------------- S. Cusano Executive Vice President and Chief Financial Officer
March 27, 1998
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.
/s/ James E. Poole /s/ Gary M. Witkin - ------------------- ------------------- James E. Poole Gary M. Witkin Chairman of the Board President, Chief Executive Officer March 27, 1998 and Director (Principal Executive Officer) March 27, 1998
INDEPENDENT AUDITORS' REPORT
Board of Directors and Shareholders Service Merchandise Company, Inc. Brentwood, Tennessee
We have audited the consolidated financial statements of Service Merchandise Company, Inc. and subsidiaries as of December 28, 1997 and December 29, 1996, and for each of the three years in the period ended December 28, 1997, and have issued our report thereon dated February 6, 1998; such consolidated financial statements and report are included in your 1997 Annual Report to Shareholders and are incorporated herein by reference. Our audits also included the consolidated financial statement schedule of Service Merchandise Company, Inc., listed in Item 14.