ITEM 1: BUSINESS
GENERAL
Big 5 Corp. (the "Company" or "Big 5") is the leading sporting goods retailer in the Western United States, operating 221 stores under the "Big 5 Sporting Goods" name at January 3, 1999. The Company's core market is California, Washington and Nevada and beginning in 1993, it expanded into Arizona, Idaho, Oregon, New Mexico, Texas and Utah. Big 5 provides a full-line product offering of over 25,000 SKU's in a traditional sporting goods store format that averages 11,000 square feet. The Company's products include athletic shoes and apparel, tennis, golf, ski, snowboard, in-line skating, fitness, outdoor and team sports equipment for the competitive and recreational sporting goods customer. Big 5 offers customers attractive values on recognized brand-name merchandise at a wide variety of price points. Important brand-names offered by the Company include Nike, Reebok, Wilson, K2, Rollerblade, Coleman, Spalding, Adidas, Fila, Speedo, Easton and Columbia, among others. The Company augments its value image by emphasizing merchandise produced exclusively for the Company, and on a selective basis, opportunistic buys comprising first quality items, including overstock and close-out merchandise. These merchandise values are communicated weekly through print advertising created by the Company in order to generate store traffic and drive sales. For the twelve months ended January 3, 1999, the Company generated $491.4 million of revenue, $39.5 million of EBITDA (as defined below) and a same store sales increase of 5.2% over the prior period. Through the period ended January 3, 1999, Big 5 has enjoyed 12 consecutive quarterly increases in same store sales over the comparable prior period.
Big 5 was founded in 1955 by Robert W. Miller, Maurie Liff and Harry Liff, with the establishment of five retail locations in Los Angeles, Burbank, Inglewood, Glendale and San Jose. The Company originally sold World War II surplus items including tents, sleeping bags, air mattresses, housewares, tools and other merchandise. Other sporting goods gradually entered the product mix and as a result, in 1963, the Company decided to become a sporting goods specialist and changed its trade name to "Big 5 Sporting Goods." In 1971, the Company was acquired by Thrifty Corporation ("Thrifty"), which was subsequently purchased by Pacific Enterprises ("PE") in 1986. Throughout these changes in ownership, management remained relatively constant and in 1992, management in conjunction with Leonard Green & Partners, L.P. ("LGP") bought the Company. In October 1997, Big 5 Holdings Corp., the parent corporation of the Company ("Parent"), Robert W. Miller, Steven G. Miller and Green Equity Investors, L.P. ("GEI") agreed to a Plan of Recapitalization and Stock Repurchase Agreement (the "Recapitalization Agreement") which resulted in existing management and employees of the Company (and members of their families) beneficially owning the majority of Parent. Several transactions (collectively referred to as the "Recapitalization") were effected pursuant to the Recapitalization Agreement, including the reincorporation of the Company in Delaware as Big 5 Corp. See "Liquidity and Capital Resources" for a detailed description of the Recapitalization.
MERCHANDISING
Offering approximately 25,000 SKUs, the typical Company store targets the competitive and recreational sporting goods customer with a full-line product offering at a wide variety of price points. The Company believes its long history of success is attributable to its adherence to a consistent merchandising strategy, the key elements of which are summarized below:
Delivering Consistent Value to Consumers. The Company offers consistent value to consumers by offering a distinctive combination of in-line products, "special make-up" merchandise (produced exclusively for the Company under a manufacturer's brand name), private label merchandise and opportunistic buys. The Company offers this consistent value to its customers while maintaining strong
margins as a result of its ability to purchase in large quantities and quickly adjust this combination of merchandise to take advantage of purchasing opportunities. Through its 43 years of operations, the Company has developed specific expertise in selling its particular mix of these products, thereby building the Company's price image, driving its weekly print advertisements and creating retail traffic.
The Company sources its in-line branded merchandise from an extensive list of major sporting goods equipment, athletic footwear and apparel manufacturers. Below is a selection of some of the brands carried by the Company:
The Company also offers a variety of private label merchandise to complement its branded product offerings. The Company's private label items include shoes, apparel, tennis rackets, binoculars, camping equipment and fishing supplies. They are sold under the labels: Fives, Court Casuals, Sports Essentials, Rugged Exposures, Hot Voltage, Golden Bear, Body Glove (licensed), Kemper (licensed) and Pacifica.
Offering a Customized Product Assortment. Through its 43 years of experience across different demographic, economic and competitive markets, the Company's management has refined its merchandising strategy to increase sales by offering a selection of goods that meets customer demands while managing inventory levels. The Company believes it provides consumers with a merchandise offering that compares favorably to its competitors, including the superstores, in terms of category selection. A goal of the Company's merchandising strategy is to offer a customized and selected assortment of products which enables the consumer to comparison shop at a Big 5 store without being overwhelmed by a large number of different products in any one category. The Company tailors its merchandise selection and quantity on a store-by-store basis in order to satisfy each region's specific needs and buying habits.
The Company's buyers work closely with senior management to determine the product selection, promotion and pricing of the merchandise mix. The Company utilizes an integrated merchandising, distribution and financial information system. Management uses the information provided to continually refine its merchandise mix, pricing strategy, advertising effectiveness and inventory levels.
Market Leader in Core Market Served. The Company has built a recognized franchise by establishing a strong presence in its core market of California, Washington and Nevada and by consistently promoting quality brand-name products at attractive prices. The Company has over triple the number of stores as its closest full-line sporting goods competitor in such core market. This concentration of stores provides economies of scale in advertising and distribution as well as increased customer awareness of the Big 5 name.
ADVERTISING
The Company believes that the consistency and reach of Big 5's print advertising programs have created high customer awareness of Big 5. Through years of focused advertising, Big 5 has reinforced its reputation for providing quality products at attractive prices. The Company attempts to highlight a broad range of merchandise categories in every advertisement to maintain customer awareness of its full-line product offering. The Company's advertising message is reinforced 52 weeks a year in the form of newspaper inserts or mailers, typically consisting of four standard pages using color photography. The Company believes that its print advertising consistently reaches more households in its core market than does
the print advertising of its competitors. The Company's effectiveness in communicating the product values it offers is evidenced by the fact that typically 40% of sales have been products included in these weekly advertisements.
The Company uses its professional in-house advertising staff rather than an outside advertising agency. The staff centrally handles all of its advertising, including design, layout, production and media management. This approach has been in place since its founding. Big 5's in-house advertising enables management the flexibility to react quickly to merchandise trends and maximize the effectiveness of its weekly inserts and mailers.
EXPANSION AND STORE DEVELOPMENT
The Company's expansion within and beyond its core market has been systematic and designed to take advantage of Big 5's name recognition and to capitalize on the Company's economical store format and distinctive merchandise mix. Throughout the Company's history, management has emphasized careful site selection and controlled growth. Over the past five fiscal years, 64 stores have opened (13 new stores annually on average), of which 52% were outside of the Company's core market of California, Washington and Nevada. These non-core stores have grown to 17% of the Company's store base at the end of 1998. The following table sets forth certain information regarding the Company's expansion program during the periods indicated:
The Company has identified numerous expansion opportunities to further penetrate its core market, develop recently entered markets and expand into new market areas with similar demographic, competitive and economic profiles as its existing markets. The typical Big 5 store size provides the Company with a large selection of locations for new store placement which, in turn, allows the Company to open stores conveniently located to the customer. Continuing its controlled growth strategy, the Company plans on opening approximately 15-20 stores annually over the next five years. This expansion plan is designed to take advantage of the growing economies of the Company's existing and recently entered markets and to capitalize on opportunities in fast growing new markets.
Big 5's store format requires a low investment in fixtures and equipment (approximately $275,000), working capital (approximately $500,000, of which one-third is typically financed by vendors) and real estate (leased, "built-to-suit" locations). The Company's leases generally require the lessor, rather than the Company, to fund all or a significant portion of the capital expenditures related to new store construction and costs of improvements. The Company expects that the net cash generated from operations, together with borrowings under the CIT Credit Facility (as defined below), will enable the Company to finance the expenditures related to its planned expansion.
MANAGEMENT INFORMATION SYSTEMS
Big 5 believes its ability to generate an efficiently stocked merchandise selection and store inventory level that satisfies customer demands while effectively managing inventory levels is a critical component of its merchandising strategy and serves to differentiate the Company from its competition. The
Company is able to execute this strategy as a result of its effective use of its integrated management information systems, called the COACH (Customer Oriented Approach for Continued High-Performance) system.
The COACH system is a low maintenance data processing environment capable of supporting Big 5's future growth (see "Year 2000"). The COACH system provides the Company with valuable inventory tracking information through the implementation of store-level perpetual inventories. Each store has a unique inventory model that allows the Company to maximize inventory mix at the store level. The COACH system also includes a local area network that connects all corporate users to electronic mail, scheduling and the host AS/400 system. The host system and the Company's stores are linked by a network that provides satellite communications for credit card, in-house tender authorization, and daily polling of sales at the store level. In Big 5's distribution center, radio frequency terminals are used in the areas of receiving, stock putaway, stock movement, order filling, cycle counting and inventory management. Store processes have been streamlined by implementing radio frequency, hand-held terminals to assist in store ordering, receiving transfers and perpetual inventories. The COACH system also helps the Company to control shrink. Management believes its use of these systems is more extensive, disciplined and sophisticated than that of many of its competitors.
DISTRIBUTION
The Company maintains a 440,000 square foot leased distribution center in Fontana, California that serviced all 221 of its stores at January 3, 1999. The Fontana facility is fully integrated with the COACH management information system that provides warehousing and distribution capabilities. The COACH system enhances the Company's distribution process and aids in controlling distribution costs. Big 5 believes that its Fontana distribution facility can readily support the Company's expansion plans discussed above.
The distribution facility was constructed in 1990 and warehouses the majority of the merchandise carried in the Company's stores. Big 5 estimates that 98% of all store merchandise is received from its distribution center. The Company distributes merchandise from the facility to its stores at least once a week, Monday through Saturday, using a fleet of 23 leased tractors, 12 leased trailers, two Company-owned tractors, 49 Company-owned trailers as well as contract carriers.
On March 5, 1996, the Company purchased the Fontana facility building and improvements from MLTC Funding, Inc. ("MLTC"), which previously owned and leased such property to the Company, and then entered into a sale and leaseback agreement with regard to the Fontana facility. Prior to this transaction, the Company owned the land associated with the facility and leased the buildings and improvements.
INDUSTRY AND COMPETITION
Sporting goods are marketed through various retail entities, including sporting goods stores, department stores, discount retailers, specialty stores, electronic commerce and mail order. According to the National Sporting Goods Association, total U.S. retail sales of sporting goods were approximately $44.3 billion in 1998. In general, the Company's competitors tend to fall into four basic categories: traditional sporting goods stores, mass merchandisers, specialty sporting goods stores and sporting goods superstores.
Traditional Sporting Goods Stores. This category consists of traditional sporting goods chains, including the Company. These stores range in size from 5,000 to 20,000 square feet and are frequently located in regional malls and multi-store shopping centers. The traditional chains typically carry a varied assortment of merchandise and attempt to position themselves as convenient neighborhood stores. Sporting goods retailers operating stores within this category include Oshman's, Hibbett's and Copeland's.
Mass Merchandisers. This category includes discount retailers such as Wal-Mart and Kmart and department stores such as JC Penney and Sears. These stores range in size from approximately 50,000 to
200,000 square feet and are primarily located in regional malls, shopping centers or free-standing sites. Sporting goods merchandise and apparel represent a small portion of the total merchandise in these stores and the selection is often more limited than in other sporting goods retailers. Although generally price competitive, discount and department stores typically have limited customer service in their sporting goods departments.
Specialty Sporting Goods Stores. This category consists of two groups. The first group generally includes athletic footwear specialty stores, which are typically 2,000 to 20,000 square feet in size and are located in shopping malls. Examples include such retail chains as Foot Locker, Lady Foot Locker and Just for Feet. These retailers are highly focused, with most of their sales coming from athletic footwear and team licensed apparel. The second group consists of pro shops and stores specializing in a particular sport or recreation. This group includes backpacking and mountaineering specialty stores and specialty skate shops and golf shops. Typically, prices at specialty stores tend to be higher than prices at the sporting goods superstores and traditional sporting goods stores.
Sporting Goods Superstores. Stores in this category typically are larger than 35,000 square feet and tend to be free-standing locations. These stores emphasize high volume sales and a large number of SKU's. Examples include Oshman's Super Sports, The Sports Authority, Jumbo Sports, Sport Chalet, Gart Sports and Sportmart.
The Company believes that it competes successfully with each of the competitors discussed above by focusing on what the Company believes are the primary factors of competition in the sporting goods industry. These factors include experienced and knowledgeable personnel, personal attention given to customers, breadth, depth, price and quality of merchandise offered, advertising, purchasing and pricing policies, effective sales techniques, direct involvement of senior officers in monitoring store operations, management information systems and store location and format.
DESCRIPTION OF SERVICE MARKS AND TRADEMARKS
The Company uses "Big 5 Sporting Goods" name as a service mark in connection with its business operations and has registered this name as a federal service mark. The Company has also registered federally and/or locally as trademarks and service marks certain private labels under which it sells a variety of merchandise, including apparel.
EMPLOYEES
As of January 3, 1999, Big 5 had approximately 5,248 full and part-time employees. The General Warehousemen Union, Local 598, International Brotherhood of Teamsters ("Local 598") currently represents 398 hourly employees (or approximately 7.6%) in the Company's distribution center and certain stores. In September 1997, the Company negotiated two contracts with Local 598 covering these employees, which expire on August 31, 2000. The Company has not had a strike or work stoppage in the last 19 years. The Company believes that it provides working conditions and wages that are comparable to those offered by other retailers in the industry, and that its employee relations are good.
The Company emphasizes friendly and knowledgeable customer service at its stores. To provide the proper incentives, the Company has established various advancement and compensation programs. Store managers and first assistant managers receive a commission based on their store's gross sales. In addition, full-time employees are given opportunities for career advancement, and part-time employees are eligible to receive merit-based pay increases. Periodic store sales contests are held throughout the year.
EMPLOYEE TRAINING
The Company has developed an extensive training program for all store employees, including salespeople, cashiers and management trainees. An introductory program for all full-time retail employees stresses excellence in customer service as well as effective selling skills. The Company's InfoWindow, an interactive, multimedia training system, provides a cost-effective, consistent method of training employees, which is designed to improve performance, customer service and on-the-job safety. Store employees gain hands-on practice using a touch-screen monitor and simulated keyboard to learn how to provide high quality customer service and use the Company's in-store systems. In addition, cashiers receive additional training relating to the Company's point-of-sale system and cash handling. Management trainees receive additional training throughout their careers, including seminars that focus on advanced management and sales skills, and store specific information relating to loss prevention, scheduling and merchandising strategy.
ITEM 2:
ITEM 2: PROPERTIES
As of January 3, 1999, Big 5 operated 221 stores in nine western states. All but one of the Company's store sites are leased. Only six, or approximately 3%, of the Company's leases are due to expire in the next five years without renewal options, and most of the Company's long-term leases contain renewal options. The average lease expiration term of the Company's existing leases, taking into account renewal options, is approximately 20 years. The Company believes that it benefits from long-term below-market leases in many of its locations. The Company's stores average approximately 11,000 square feet in size typically ranging from 8,000 to 15,000 square feet and are located primarily in multi-store shopping centers or as free standing units. Specific store locations are selected based on market demographics, competitive factors and site economics. The Company currently leases its Fontana warehouse facility from the State of Wisconsin Investment Board. The lease for the facility has an initial term of ten years and commenced on March 5, 1996. The Company also has the right to exercise three five-year options beyond the initial ten-year term.
The chart below sets forth information with respect to Big 5's geographic markets:
ITEM 3:
ITEM 3: LEGAL PROCEEDINGS
The Company is from time to time involved in routine litigation incidental to the conduct of its business. The Company regularly reviews all pending litigation matters in which it is involved and establishes reserves deemed appropriate by management for such litigation matters. The Company believes that no litigation currently pending against it will have a material adverse effect on its financial position or results of operations.
ITEM 4:
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of security holders during the year ended January 3, 1999.
PART II
ITEM 5:
ITEM 5: MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS.
The Company is a wholly-owned subsidiary of Parent. Neither the Company's nor Parent's capital stock is publicly traded. Restrictive covenants in the Company's revolving credit facility generally restrict the declaration or payment of dividends on the Company's common stock other than to enable Parent to pay operating and overhead expenses and certain other limited types of expenses. The Senior Notes (as defined below) restrict the declaration and payment of dividends unless the Company satisfies certain financial covenants, among other things.
ITEM 6:
ITEM 6: SELECTED HISTORICAL FINANCIAL DATA
The following selected historical financial data have been prepared by the Company's management from the audited financial statements and the notes thereto of United Merchandising Corp. (which was reincorporated in Delaware as Big 5 Corp. in connection with the Recapitalization) and Big 5 Corp. With respect to the selected historical financial data, the Company means United Merchandising Corp. for fiscal years 1994 through 1996, and Big 5 Corp. for fiscal years 1997 and 1998. The selected historical financial data should be read in conjunction with, and are qualified in their entirety by, "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the historical financial statements of the Company and the related notes thereto.
(Notes to table on previous page and this page) - -------------------------------------------------------
(a) The Company's fiscal year is a 52 or 53 week year ending on the Sunday closest to the calendar year end. Fiscal years 1994 through 1997 consist of 52 weeks and fiscal year 1998 consists of 53 weeks.
(b) EBITDA represents net earnings (loss) before taking into consideration net interest expense, income tax expense, depreciation expense, amortization expense, and non-cash rent expense (see Footnote 5 in "Notes to Financial Statements"), and where relevant to the period referenced, extraordinary loss from early extinguishment of debt. While EBITDA is not intended to represent cash flow from operations as defined by generally accepted accounting principles ("GAAP") and should not be considered as an indicator of operating performance or an alternative to cash flow (as measured by GAAP) as a measure of liquidity, it is included herein to provide additional information with respect to the ability of the Company to meet its future debt service, capital expenditure and working capital requirements. See "Management's Discussion and Analysis of Financial Condition and Results of Operations."
(c) For the purpose of calculating the ratio of earnings to fixed charges, "earnings" represents income before provisions for income taxes and fixed charges. "Fixed charges" consist of interest expense, amortization of debt financing costs, and one third of lease expense, which management believes is representative of the interest component of lease expense. Earnings were insufficient to cover fixed charges by approximately $6,383 for fiscal year 1995.
(d) Same store sales data for a fiscal year reflects stores open throughout that fiscal year and the prior fiscal year.
(e) Inventory turns equal fiscal year cost of goods sold, buying and occupancy costs divided by 4 quarter average FIFO inventory balances adjusted to exclude overhead costs capitalized into inventory balances.
(f) Net working capital is defined as current assets less current liabilities excluding current maturities of long-term debt.
ITEM 7:
ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following should be read in conjunction with the historical financial statements of United Merchandising Corp. (reincorporated in Delaware as Big 5 Corp.) and the related notes thereto. The Company's fiscal year ends on the Sunday closest to December 31. Accordingly, fiscal years 1996, 1997 and 1998 ended on December 29, 1996, December 28, 1997 and January 3, 1999, respectively. Certain information in this Management's Discussion and Analysis section includes forward-looking statements. Such forward-looking statements relate to the Company's financial condition, results of operations, expansion plans, and business (see "Forward-Looking Statements").
RESULTS OF OPERATIONS
The Company operates in one business segment, as a sporting goods retailer under the Big 5 Sporting Goods name. The table below sets forth certain statement of operation components as a percentage of net sales.
(The fiscal years ended January 3, 1999, December 28, 1997 and December 29, 1996 are referred to below as "Fiscal 1998", "Fiscal 1997" and "Fiscal 1996", respectively.)
FISCAL 1998 VERSUS FISCAL 1997
Fiscal 1998 was a 53-week period for the Company. As a result, the following discussion of Fiscal 1998 versus Fiscal 1997 reflects a comparison of a 1998 53-week period to a 1997 52-week period. Exceptions to this comparison are noted where appropriate.
Net sales. Net sales increased 10.8% (or $47.9 million) from $443.5 million for 52 weeks in Fiscal 1997 to $491.4 million for 53 weeks in Fiscal 1998. Same store sales increased 5.2% for Fiscal 1998 versus a comparable period in 1997. Sales generated from new stores opened in Fiscal 1997 and Fiscal 1998 and the extra week of sales in Fiscal 1998 versus Fiscal 1997 created the remainder of the Fiscal 1998 net sales increase. Store count at the end of Fiscal 1998 was 221 versus 210 at the end of Fiscal 1997 as the Company opened twelve new stores and closed one during the year. The Company achieved positive same store sales of 4.1% during the fourth quarter of Fiscal 1998, representing the twelfth consecutive quarter of positive quarterly same store sales results.
Gross Profit. Gross profit increased 11.4% (or $16.5 million) from $144.6 million in Fiscal 1997 to $161.2 million in Fiscal 1998, reflecting increased sales (as discussed above) and improved gross profit margin. Gross profit margin increased from 32.6% in Fiscal 1997 to 32.8% in Fiscal 1998. The improvement is primarily the result of improved productivity and leveraging of fixed costs at the Company's distribution center while maintaining overall gross profit margins for product sales and store inventory shrink results.
Operating Expenses. Selling and administrative expenses increased 10.5% (or $11.5 million) from $110.1 million in Fiscal 1997 to $121.6 million in Fiscal 1998. As a percentage of sales, selling and administrative expenses remained unchanged at 24.8% in Fiscal 1998 compared with Fiscal 1997.
Depreciation and Amortization Expense. Depreciation and amortization expense increased 8.7% (or $0.7 million) from $8.2 million in Fiscal 1997 to $8.9 million in Fiscal 1998. The increase was due primarily to added depreciation and amortization related to expenditures for the growth in the Company's store base during Fiscal 1998, with store count growing from 210 at the end of Fiscal 1997 to 221 at the end of Fiscal 1998.
Interest Expense. Interest expense increased 55.0% (or $6.8 million) from $12.4 million in Fiscal 1997 to $19.3 million in Fiscal 1998. The variance in interest expense versus last year reflected the impact of increased debt due to the Company's Recapitalization which took place in November of 1997. This variance was partially offset by a decrease in the Company's average borrowings under the CIT Credit Facility which totaled $20.9 million at the end of Fiscal 1998 versus $43.3 million at the end of Fiscal 1997.
Income Taxes. There was an income tax provision of $4.7 million in Fiscal 1998 versus $1.4 million in Fiscal 1997. Income tax expense in Fiscal 1998 and 1997 was impacted by a $0.2 million and $3.9 million, respectively, reduction of the valuation allowance on the Company's deferred tax assets.
Extraordinary Loss from Early Extinguishment of Debt. There was no extraordinary loss reported for Fiscal 1998. In the fourth quarter of Fiscal 1997, an extraordinary loss of $1.6 million, net of taxes, was incurred in connection with the repayment of the Company's previously outstanding subordinated debt. The extraordinary loss consisted of a redemption premium of $2.1 million and a $0.6 million write-off of unamortized deferred financing fees.
Net Income. Net income for Fiscal 1998 decreased $4.1 million from $10.9 million in Fiscal 1997 to $6.8 million in Fiscal 1998. This variance reflects higher operating income in Fiscal 1998 which was more than offset by the impact of the Recapitalization on interest expense combined with increased income tax expense recorded in Fiscal 1998.
EBITDA. EBITDA increased 14.6% (or $5.0 million) from $34.5 million in Fiscal 1997 to $39.5 million in Fiscal 1998. Strong sales along with improved gross profit margins were the primary factors creating Fiscal 1998's positive operating results versus Fiscal 1997.
FISCAL 1997 VERSUS FISCAL 1996
Net sales. Net sales increased 9.7% (or $39.2 million) from $404.3 million in Fiscal 1996 to $443.5 million in Fiscal 1997. Same store sales increased 6.6% compared with the same period last year, reflecting improved economic conditions in the regions in which the Company operates, together with continuing refinements in advertising and merchandising programs partially resulting from improved utilization of the management tools derived from the Company's information systems. Sales attributable to an increase in store count from 196 in Fiscal 1996 to 210 in Fiscal 1997 constituted the remainder of the 9.7% increase for Fiscal 1997.
Gross Profit. Gross profit increased 13.8% (or $17.5 million) from $127.1 million in Fiscal 1996 to $144.6 million in Fiscal 1997, reflecting increased sales (as discussed above) and improved gross profit margin. Gross profit margin increased from 31.5% in Fiscal 1996 to 32.6% in Fiscal 1997. The improvement is a result of positive comparisons of gross profit margins in the majority of the Company's product categories and improved store inventory shrink results, both of which were aided by the Company's enhanced information systems.
Operating Expenses. Selling and administrative expenses increased 9.0% (or $9.0 million) from $101.1 million in Fiscal 1996 to $110.1 million in Fiscal 1997. As a percentage of sales, selling and
administrative expenses decreased from 25.0% in Fiscal 1996 to 24.8% in Fiscal 1997, reflecting management's continued focus on controlling expenses and its leveraging fixed costs due to increased sales.
Depreciation and Amortization Expense. Depreciation and amortization expense decreased 14.6% (or $1.4 million) from $9.6 million in Fiscal 1996 to $8.2 million in Fiscal 1997. The decrease reflected primarily a reduction in leasehold improvements amortization resulting from the sale/leaseback of the Company's Fontana distribution center in the prior year and an increase in the amortization term of the Company's leasehold interests.
Interest Expense. Interest expense increased 7.8% (or $0.9 million) from $11.5 million in Fiscal 1996 to $12.4 million in Fiscal 1997. This increase reflected the impact of the Company's Recapitalization which resulted in increased debt levels in the fourth quarter of Fiscal 1997.
Income Taxes. The Company recorded an income tax provision, net of a $3.9 million reduction of the valuation allowance on the Company's deferred tax assets, against operations of $1.4 million in Fiscal 1997 versus $1.0 million in Fiscal 1996.
Extraordinary Loss from Early Extinguishment of Debt. In the fourth quarter of Fiscal 1997, an extraordinary loss of $1.6 million, net of taxes, was incurred in connection with the repayment of the Company's previously outstanding subordinated debt. The extraordinary loss consisted of a redemption premium of $2.1 million and a $0.6 million write-off of the unamortized deferred financing fees. During Fiscal 1996, an extraordinary loss of $1.3 million net of taxes reflects prepayment premiums of $1.2 million and a $1.0 million write-off of unamortized deferred financing fees related to the refinancing of its indebtedness under a prior credit facility.
Net Income (Loss). Net income for Fiscal 1997 increased $8.1 million from income of $2.8 million in Fiscal 1996 to income of $10.9 million in Fiscal 1997. This improvement reflects the positive sales and gross profit results achieved during Fiscal 1997.
EBITDA. EBITDA increased 32.2% (or $8.4 million) from $26.1 million in Fiscal 1996 to $34.5 million in Fiscal 1997. Increased same store sales, gross profit margin and operating efficiencies were the primary factors contributing to the significant improvement.
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary sources of liquidity are cash flow from operations and borrowings under the Company's five year, non-amortizing, $125.0 million revolving credit facility (the "CIT Credit Facility"). The Company amended its then-current Credit Facility effective November 13, 1997, to provide for the CIT Credit Facility. The CIT Credit Facility is secured by the Company's trade accounts receivable, merchandise inventories and general intangible assets. The Company intends to use net cash provided by operating activities and borrowings under the CIT Credit Facility to fund its anticipated capital expenditures and working capital requirements. However, if additional cash is required, it may be difficult for the Company to obtain because the Company is highly leveraged.
In October 1997, Parent, Robert W. Miller, Steven G. Miller and Green Equity Investors, L.P. ("GEI") agreed to the Recapitalization Agreement. The following transactions (collectively constituting the Recapitalization) were effected pursuant to the Recapitalization Agreement: (i) the Company issued the Senior Notes (as defined below) ($130.4 million gross proceeds); (ii) the Company defeased and repaid all of its outstanding 13 5/8% Senior Subordinated Notes due 2002 (the "Old Subordinated Notes"); (iii) Parent issued Senior Discount Notes in an aggregate principal amount at maturity of $48.2 million maturing on November 30, 2008 (the "Parent Discount Notes") with a warrant to purchase approximately three percent of the Common Stock of Parent, par value $.01 per share (the "Common Stock") at a nominal exercise price (the "Warrant") ($24.5 million proceeds); (iv) Parent accelerated vesting of substantially all outstanding options and restricted stock held by management and employees of the Company; (v) Parent redeemed for
cash its existing Series A 9% Cumulative Redeemable Preferred Stock (the "Parent Old Preferred") for approximately $21.9 million in the aggregate, including accrued dividends; (vi) Parent paid a cash distribution of $15 per share on its outstanding shares of Common Stock (approximately $63.2 million in the aggregate); (vii) Parent repurchased from Pacific Enterprises ("PE") its warrant respecting 397,644 shares of Common Stock and 16,667 shares of Parent Old Preferred (the "PE Warrant") and approximately 2,737,310 shares of Common Stock from the Selling Stockholders (as defined below) (of which GEI owned 86.8%) for an aggregate of $17.6 million in cash and $35.0 million of Parent Senior Exchangeable Preferred Stock (the "Parent New Preferred"); (viii) Parent sold additional Common Stock to middle and senior level management of the Company (approximately $2.3 million gross proceeds), increasing the beneficial ownership of management and employees (and members of their families) from 14.0% to 55.3% (in each instance on a fully diluted basis); and (ix) other transactions occurred, including a distribution of $81.5 million from the Company to Parent, so that the above referenced transactions could be effected. The Recapitalization is accounted for as a recapitalization for accounting purposes. As a result of the Recapitalization, existing management and employees of the Company (and members of their families) beneficially own the majority of Parent. Chairman and Chief Executive Officer Robert W. Miller, who co-founded the Company in 1955, and his son Steven G. Miller, President and Chief Operating Officer, who has been with the Company for 29 years, significantly increased their ownership in Parent and control the Board of Directors of Parent and thus the Company. See "Principal Stockholders."
In connection with the Recapitalization, the Company issued $131.0 million in aggregate principal amount of 10 7/8% Senior Notes due 2007 (the "Senior Notes"), requiring semi-annual interest payments. The Company has no mandatory payments of principal on the Senior Notes prior to their final maturity in 2007.
As a result of borrowings relating to the Recapitalization, the Company's interest expense increased from $12.4 million in Fiscal 1997 to $19.3 million in Fiscal 1998. The Company believes that cash flow from operations will be sufficient to cover the interest expense arising from the CIT Credit Facility and the Senior Notes. However, the Company's ability to meet its debt service obligations depends upon its future performance, which, in turn, is subject to general economic conditions and regional risks, and to financial, business and other factors affecting the operations of the Company, including factors beyond its control. Accordingly, there can be no assurance that cash flow from operations will be sufficient to meet the Company's debt service obligations.
Net cash provided by operating activities was $29.7 million in Fiscal 1998 versus $3.6 million in Fiscal 1997. The change between periods reflected management's focus on working capital during Fiscal 1998. Inventory levels improved during the year such that additional inventory levels were not required to support increased store count, and in fact there was a total inventory per store reduction of 5% when comparing January 3, 1999 to December 28, 1997. In addition to inventories, management successfully managed payable levels to improve the Company's working capital position. This payables increase added an additional $9.6 million to net cash provided by operating activities during Fiscal 1998.
Net cash used in financing activities was $20.0 million in Fiscal 1998 versus $1.9 million in Fiscal 1997, reflecting the significant reduction in borrowings under the CIT Credit Facility during Fiscal 1998. As of January 3, 1999, the Company had borrowings of $20.9 million and letter of credit commitments of $3.7 million outstanding under the CIT Credit Facility compared to $43.3 million and $4.5 million at December 28, 1997, with no cash and cash equivalents at January 3, 1999 compared to $1.4 million at December 28, 1997.
Capital expenditures for Fiscal 1998 were $8.5 million as the Company opened a total of 12 new stores. Management expects capital expenditures for Fiscal 1999 will range from $10 to $11 million and will be used primarily to fund the opening of approximately 15 to 20 new stores as well as a one-time expenditure of approximately $3.8 million for new point-of-sale hardware and software. The Company's store format requires a low investment in fixtures and equipment (approximately $275,000), working capital (approximately $500,000, of which one-third is typically financed by vendors) and real estate (leased "built-to-suit" locations).
The CIT Credit Facility and the Senior Notes indenture contain various covenants which impose certain restrictions on the Company, including the incurrence of additional indebtedness, the payment of dividends, and the ability to make acquisitions. In addition, the CIT Credit Facility requires compliance with the maintenance of certain financial ratios and other financial covenants. The Company is in compliance with all the covenants under the CIT Credit Agreement and the Senior Notes indenture.
The Company is not aware of any material environmental liabilities relating to either past or current properties owned, operated or leased by it. There can be no assurance that such liabilities do not currently exist or will not exist in the future.
SEASONALITY
The Company's business is seasonal in nature. As a result, the Company's results of operations are likely to vary during its fiscal year. Historically, the Company's revenues and income are highest during its fourth quarter, due to industry wide retail sales trends. The fourth quarter contributed 27.8% in 1998 and 26.9% in 1997 of fiscal year net sales and 32.9% in 1998 and 33.7% in 1997 of fiscal year EBITDA. Any decrease in sales for such period could have a material adverse effect on the Company's business, financial condition and operating results for the entire fiscal year.
YEAR 2000
Background
The Year 2000 issue is primarily the result of computer programs using a two-digit format, as opposed to four digits, to indicate the year. Computer programs that are date dependent are found in the software that operates many information technology ("IT") systems as well as in the computer based devices which control many types of electronic equipment. Computer programs that are not Year 2000 compliant will be unable to interpret dates beyond the year 1999, which could cause a system failure or other computer errors, leading to a disruption in the operation of the related IT systems or electronic equipment.
General
In 1997, the Company began to develop a program to coordinate changes to computer and non-computer systems in order to achieve a Year 2000 date conversion without disruption to the Company's operations. The Year 2000 effort, which includes the implementation of previously planned business critical systems and specific Year 2000 projects, is on track to be completed before the end of 1999, although no assurances can be given. The majority of the Company's applications that are not Year 2000 compliant have been, or will be replaced by upgrades to existing systems. Making the remaining non-compliant applications Year 2000 compliant will not result in incremental costs to the Company, but rather will be accomplished by the redeployment of existing IT resources. Accordingly, the Company does not expect its internal Year 2000 effort to have a material impact on its results of operations, liquidity or financial condition, although the Company cannot predict whether its outside vendors, suppliers and support systems will be compliant and whether that might have an effect. In addition, the Company has not deferred any other projects that will have a material impact on its results of operations, liquidity or financial condition.
IT Systems
During 1997, the Company began a study to determine the scope of its Year 2000 exposure. Since the Company relies on outside software vendors for all of its merchandise distribution and financial systems, the Company's first efforts were to gain assurance that all systems were either compliant or upgradable to a Year 2000 compliant version. After completion of its study in March 1998, the Company found that all of its systems either were compliant, or could be compliant with an upgrade to existing
software. Certain of these outside software systems have customized add-on features created by the Company's IT department. Therefore, the Company has redeployed one full-time programmer to the Year 2000 project to update software code that was customized by the Company and added on to its outside software systems to make these custom changes compliant. These changes are expected to be completed before the end of the second quarter of 1999.
The Year 2000 plan also focuses on the Company's IT hardware where date sensitive embedded technology could create the need for upgrades. In August and September of 1997 the Company's main computer platform, two IBM AS 400's, were upgraded from CISC technology to Year 2000 compliant RISC technology. In addition, all personal computers have been checked for compliance. Approximately 40% of all personal computers currently comply, with the remainder to be upgraded before the end of 1999. The Company's network server was upgraded in late 1997 and is fully compliant. Other hardware, including Telxon hand held radio frequency devices, cash registers, modems, routers and other IT communications devices are either Year 2000 compliant, or are in the process of being upgraded. There are no other internal software or hardware issues to the best of the Company's knowledge and the Company fully expects to have all systems compliant prior to the end of 1999.
Non-IT Systems
Non-IT systems may contain date sensitive embedded technology requiring Year 2000 upgrades. Examples of this technology include security equipment such as access and alarm systems, as well as telephone equipment. The Company is not a product manufacturer; therefore, the embedded chip issue relates to equipment used by the Company in its internal facilities. The Company expects to complete assessment of its non-IT systems by the end of the first quarter of 1999.
The Company has contacted each of its major suppliers and vendors prior to the end of 1998 to request written certification regarding their Year 2000 compliance. Approximately 20% of suppliers and vendors have responded to the Company's requests to date. The Company will continue follow-up mailings throughout 1999 but cannot guarantee full supplier and vendor compliance by year-end.
Costs
The total cost associated with required modifications for Year 2000 compliance is not expected to be material to the Company's results of operations, liquidity and financial condition. The estimated total cost of the Year 2000 effort is approximately $0.5 million, plus as additional $6.5 million in replacement costs for projects that are not Year 2000 related but have some Year 2000 remediation benefits. The total amount expended through December 1998, was approximately $0.2 million directly related to Year 2000 remediation and $2.0 million for projects which are not Year 2000 related but have some Year 2000 remediation benefits. The estimated future cost of completing the Year 2000 effort is estimated to be approximately $0.3 million. The Year 2000 effort is funded primarily from the existing IT budget and has not forced the deferral or cancellation of any budgeted IT projects.
Risks and Contingency Planning
The Company has initiated contingency planning for possible Year 2000 issues including such outside factors as credit card processing, supply chain and banking operations. Where needed, the Company will establish contingency plans based on the Company's actual testing experience and assessment of outside risks. The Company anticipates final contingency plans to be in place by June 1999. However, to the extent outside support systems (such as credit card processors and suppliers) may not be Year 2000 compliant by the end of 1999, such noncompliance could result in circumstances which could have a material adverse effect on the Company's business, financial condition, and operating results.
Readers are cautioned that forward looking statements contained in the Year 2000 Update should be read in conjunction with the Company's disclosures under the heading "Forward-Looking Statements."
IMPACT OF NEW ACCOUNTING PRONOUNCEMENTS
The Financial Accounting Standards Board issued Statement No. 133, (Accounting for Derivative Instruments and Hedging Activities) effective for all fiscal quarters of fiscal years beginning after June 15, 1999. Management has determined that the disclosure requirements from this statement will not impact the financial statements of the Company.
In March 1998, the AICPA Accounting Standard Executive Committee issued Statement of Position 98-1 ("SOP 98-1"), Accounting for the Costs of Computer Software Developed or Obtained for Internal Use. The SOP requires capitalization of certain costs related to computer software developed or obtained for internal use. The Company will adopt SOP 98-1 effective in fiscal 1999. Based on the information currently available, the Company does not expect the adoption of SOP 98-1 to have a significant impact on its financial position or results of operations.
In April 1998, the AICPA Accounting Standards Executive Committee issued Statement of Position 98-5 ("SOP 98-5"), Reporting on the Costs of Start-up Activities. SOP 98-5 requires that costs of start-up activities, including organization costs and store openings, be expensed as incurred. SOP 98-5 is effective for financial statements for fiscal years beginning after December 15, 1998. Restatement of previously issued financial statements is not permitted. In the fiscal year SOP 98-5 is first adopted, the application should be reported as a cumulative effect of a change in accounting principle. The Company has adopted the application of SOP 98-5 in Fiscal 1998 without a material impact on the Company's financial position or results of operations.
IMPACT OF INFLATION
The Company does not believe that inflation has a material impact on the Company's earnings from operations. The Company believes that it is generally able to pass any inflationary increases in costs to its customers.
FORWARD-LOOKING STATEMENTS
Certain information contained herein includes "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995 and is subject to the safe harbor created by that Act. Forward-looking statements can be identified by the use of forward-looking terminology, such as "may," "will," "should," "expect," "anticipate," "estimate," "continue," "plan," "intend" or other similar terminology. Such forward-looking statements, which relate to, among other things, the financial condition, results of operations and business of the Company, are subject to significant risks and uncertainties that could cause actual results to differ materially and adversely from those set forth in such statements. These include, without limitation, the Company's ability to open new stores on a timely and profitable basis, the impact of competition on revenues and margins, the effect of weather conditions and general economic conditions in the Western United States (which is the Company's area of operation), the seasonal nature of the Company's business, and other risks and uncertainties including the risk factors listed in the Company's Registration Statement on Form S-4 as filed with the Securities and Exchange Commission on January 16, 1998 and as may be detailed from time to time in the Company's public announcements and filings with the Securities and Exchange Commission. The Company assumes no obligation to publicly release the results of any revisions to the forward-looking statements contained herein which may be made to reflect events or circumstances occurring subsequent to the filing of this Form 10-K with the Securities and Exchange Commission or otherwise to revise or update any oral or written forward-looking statements that may be made from time to time by or on behalf of the Company.
ITEM 7A:
ITEM 7A: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS
In the ordinary course of its business, the Company is exposed to certain market risks, primarily changes in interest rates. After an assessment of these risks to the Company's operations, the Company believes that its primary market risk exposures (within the meaning of Regulation S-K Item 305) are not material and are not expected to have any material adverse effect on the Company's financial condition, results of operations or cash flows for the next fiscal year. (See Note 3 of the accompanying financial statements.)
ITEM 8:
ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Information called for by this item is set forth in the Company's financial statements contained in this report. Specific financial statements can be found at the pages listed in the following index.
ITEM 9:
ITEM 9: CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
None.
PART III
ITEM 10:
ITEM 10: DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
EXECUTIVE OFFICERS AND DIRECTORS
The following table sets forth certain information regarding the current executive officers and directors of the Company. The Company's directors are elected at each annual meeting of shareholders to serve for a period of one year or until their successors are duly elected and qualified. The Company's executive officers serve at the discretion of the Company's Board of Directors.
ROBERT W. MILLER became Chairman of the Board of the Company in September 1992. Mr. Miller has been the Company's Chief Executive Officer and was President from 1973 to September, 1992.
STEVEN G. MILLER became President, Chief Operating Officer and a Director of the Company in September 1992. Mr. Miller is Robert W. Miller's son and Dr. Michael D. Miller's brother. He had been the Company's Executive Vice President, Administration, since 1988.
CHARLES P. KIRK became Senior Vice President and Chief Financial Officer of the Company in September 1992. Mr. Kirk had been Thrifty's Director of Planning and Vice President of Planning and Treasury since October 1990. Prior to joining Thrifty, Mr. Kirk had held various financial positions with Thrifty's former parent, Pacific Enterprises ("PE"), since 1981.
GARY S. MEADE became Secretary, Vice President and General Counsel of the Company in August 1997. Mr. Meade had been Thrifty Payless, Inc.'s Vice President, Secretary and General Counsel since September 1992 and Thrifty's Vice President - Legal Affairs since 1979.
RICHARD A. JOHNSON became Senior Vice President, Store Operations, for the Company in July 1992. Mr. Johnson had been the Company's Vice President, Store Operations, since 1986.
THOMAS J. SCHLAUCH became Senior Vice President, Buying, for the Company in July 1992. Mr. Schlauch had been the Company's Head of Buying since 1990 and Vice President, Buying, since 1982.
MICHAEL D. MILLER, PH.D became a director of the Company in October 1997. Dr. Miller is a senior mathematician at RAND. Dr. Miller is Robert W. Miller's son and Steven G. Miller's brother.
JOHN G. DANHAKL became a director of the Company in October 1997. Mr. Danhakl has been an executive officer and equity owner of LGP, a merchant banking firm which manages GEI, since 1995. Mr. Danhakl had previously been a Managing Director at Donaldson, Lufkin & Jenrette Securities Corporation ("DLJ") and had been with DLJ since 1990. Prior to joining DLJ, Mr. Danhakl was a Vice President at Drexel Burnham Lambert Incorporated. Mr. Danhakl is also a director of the Arden Group, Inc. and Twinlab Corporation.
ITEM 11:
ITEM 11: EXECUTIVE COMPENSATION
SUMMARY COMPENSATION TABLE
The following table sets forth the annual and long-term compensation of the Company's Chief Executive Officer and four additional most highly compensated executive officers whose annual salaries and bonus exceeded $100,000 in total during the fiscal year ended January 3, 1999.
(1) Represents stock options issued under the Parent 1992 Management Equity Plan (the "Plan"). Options granted under the Plan had an exercise price equal to the fair market value of the Common Stock at the date of the grant as determined by Parent's Board of Directors. The options vested and became exercisable in cumulative 20% installments commencing one year from the date of grant, with full vesting on the fifth anniversary. Shares of Common Stock acquired pursuant to the exercise of options are generally subject to terms and conditions comparable to those contained in various Management Subscription and Stockholders Agreements pursuant to which members of management have previously acquired Common Stock. See "Principal Stockholders." Pursuant to the Recapitalization substantially all of such options became fully vested and were exercised (see "Management Stock Purchases") and the restrictions under such agreements (other than those relating to federal and state securities acts) became inapplicable.
(2) Such compensation was to facilitate the named executives' Management Stock Purchases.
AGGREGATED OPTION/SAR EXERCISES IN FISCAL 1998 AND 1998 FISCAL YEAR-END OPTION VALUE
None.
EMPLOYMENT CONTRACTS AND CHANGE IN CONTROL ARRANGEMENTS
The Company and each of Steven G. Miller and Robert W. Miller (collectively, the "Millers") have entered into employment agreements, dated as of January 1, 1993, whereby Steven G. Miller is to continue to serve as President and Chief Operating Officer and Robert W. Miller as Chairman of the Board of Directors (the "Board") and Chief Executive Officer of the Company until December 31, 1994 and for additional successive one-year periods thereafter, unless any party gives timely notice to the other that the employment term shall not be so extended. The agreements require the Company to provide the Millers with a base salary and those benefits generally available to the Company's senior executive officers, including health insurance, sick leave, and profit sharing plan participation, and require the Board to make an annual determination as to whether each is entitled to receive a bonus for such year and an increase in base salary for the next year. Robert W. Miller's agreement also provides for supplemental annual retirement benefits and health insurance benefits for himself and his surviving spouse upon his retirement.
Employment under both agreements is terminable by the Company at any time, with or without cause, and, under Robert W. Miller's agreement, by him, if for good reason (as defined in his employment agreement). If Steven G. Miller or Robert W. Miller is terminated without cause or, in the case of Robert W. Miller, by him for good reason, each is entitled to receive as severance pay his base salary through the remainder of the employment term as then in effect. The agreement of either of the Millers may be terminated if such person becomes unable to render full services during certain prescribed periods of time. The agreements contain covenants precluding the Millers from engaging in certain competition with the Company and from soliciting certain employees of the Company and its affiliates for a specified period following the termination of employment, the basis of which depends upon the reason for the termination.
MANAGEMENT STOCK PURCHASES
Pursuant to the Recapitalization, Parent accelerated the vesting periods under substantially all outstanding employee option and restricted stock agreements. Parent facilitated the exercise of such stock options by existing employees by offering to such employees the option to pay the aggregate exercise price of such outstanding options (in excess of the par value of the shares being acquired upon exercise) by way of a personal recourse obligation secured by such employee's existing Common Stock and the Common Stock issued pursuant to the exercise of the options, and the proceeds thereof. Option holders who exercised their stock options at the effective date of the Recapitalization received the distributions on Common Stock described under the description of the Recapitalization included under the heading "Liquidity and Capital Resources". As a result thereof, there were outstanding 4,215,301 shares (or 4,612,945 shares on a fully diluted basis) of Common Stock immediately prior to the Recapitalization.
As part of the Recapitalization, and pursuant to Parent's newly adopted 1997 Management Equity Plan applicable to employees of Parent and its subsidiaries, Parent sold to existing middle and senior level management employees of the Company, 462,009 shares of Common Stock for $5 per share (the "Management Stock Purchases"). Such shares were not entitled to the distribution on Common Stock described above under the heading "Liquidity and Capital Resources," although any current employees who owned shares otherwise entitled to such distribution could pay all or a portion of the purchase price of the shares being purchased by having Parent offset or withhold such amount from the distribution. The agreements under the 1997 Management Equity Plan prohibit the transfer of such Common Stock until the fifth anniversary of the issuance thereof or the occurrence of any earlier specified event that terminates such prohibition, with an exception for transfers of vested shares to "related transferees" (as defined therein). Thereafter, such shares of Common Stock are transferrable subject to a right of first refusal in favor of Parent. The agreements also contain certain "call" options as to unvested shares of Common Stock,
exercisable, generally, upon termination of a management employee's employment with the Company. As a result of the Management Stock Purchases, immediately after the Recapitalization the continuing management and employees of the Company (and members of their families) beneficially owned approximately 55.3% of Parent on a fully diluted basis. Senior management (and members of their families) beneficially own approximately 34.3% of the outstanding Common Stock on a fully diluted basis.
COMPENSATION OF DIRECTORS
Directors of the Company, as such, do not receive any compensation. However, during the fiscal year ended January 3, 1999, the Company, on behalf of Parent, paid Leonard Green & Associates, L.P. ("LGP"), a California limited partnership, compensation for management services fees of $340,091 including out-of-pocket expenses. In 1994 and 1996 the Company paid LGA an additional $500,000 in fees for work performed in securing the Company's bank facility. In addition, as a result of the consummation of the Recapitalization, LGA was paid a fee of $4.3 million by the Parent in 1997. After the Recapitalization, Parent and the Company entered into a new Management Services Agreement with a term of seven and one-half years and pursuant to which Parent and the Company will pay LGA a reduced annual fee for management services ($333,333) plus reasonable and customary fees for financial advisory and investment banking services in connection with major financial transactions (plus expenses and indemnities, if any). LGA is an affiliate of LGP. Mr Danhakl and two former directors of the Company are executive officers and equity owners of LGP. LGA is the sole general partner and manager of GEI, a stockholder of Parent. The Company believes that the terms of its agreement and arrangements with LGA are comparable to what could be obtained from unrelated, but equally qualified, third parties.
ITEM 12:
ITEM 12: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
PRINCIPAL STOCKHOLDERS
The Company's outstanding capital stock is wholly owned by Parent. Parent's outstanding equity securities consist of Common Stock and the Parent New Preferred. The following table sets forth the ownership of Common Stock as of March 31, 1999 by any person known to the Company to be the beneficial owner of more than 5% of either class of Parent's securities, the Company's directors, executive officers named in the Summary Compensation Table above, and all executive officers and directors of the Company as a group.
(1) The address for each stockholder is 2525 East El Segundo Boulevard, El Segundo, California 90245, except GEI and Mr. Danhakl for which the address is 11111 Santa Monica Boulevard, Suite 2000, Los Angeles, California 90025.
(2) Pursuant to the Stockholders Agreement (as defined), each of GEI and the Millers has agreed to vote for the directors designated by the other. See "Parent Equity and Debt".
(3) Includes shares of Common Stock owned by Dr. Miller over which Robert W. Miller has voting control.
(4) Effective as of the Recapitalization, Dr. Miller granted voting control over his shares to Robert W. Miller, and such shares are included with Robert W. Miller's shares.
(5) Mr. Danhakl is a general partner of LGP and may be deemed to be a beneficial owner of the shares of Common Stock and Parent New Preferred owned by GEI because of his interest in LGP, which is an affiliate of the sole general partner of GEI. GEI owns 273,423 shares of Parent New Preferred and an affiliate of GEI owns 35,070 shares of Parent New Preferred.
(6) Includes the shares identified in note (5) above.
REPURCHASE OF COMMON STOCK AND PE WARRANT
Pursuant to the Recapitalization Agreement, Parent redeemed all of the issued and outstanding Parent Old Preferred, including shares owned by GEI, at an aggregate redemption price of $15.0 million plus accrued and unpaid dividends of approximately $6.9 million.
Thereafter Parent made a distribution of $15 per share of Common Stock, or approximately $63.2 million in the aggregate, to all holders of record of Common Stock. Such holders included option holders whose vesting periods were accelerated as described under "Executive Compensation - Management Stock Purchases" and who exercised their outstanding stock options, but did not include shares of Common Stock sold to existing middle and senior level management as part of the Recapitalization.
Following such distribution to the holders of Common Stock, Parent repurchased (i) 2,737,310 shares of Common Stock, which were originally sold together with shares of Parent Old Preferred, from the holders of such Common Stock (including GEI) (the "Selling Stockholders"), and (ii) the PE Warrant. The aggregate purchase price for the PE Warrant and the Common Stock repurchased from the Selling Stockholders was approximately $17.6 million in cash and $35.0 million of liquidation value of Parent New Preferred.
As a result of the Recapitalization, the Selling Stockholders' ownership of Common Stock was reduced significantly. Their percentage ownership was reduced from 77.4% (based on the number of fully diluted shares of Common Stock immediately prior to the Recapitalization) to 41.7% (based on the number of fully diluted shares of Common Stock immediately after the Recapitalization). In addition, on a fully diluted basis, the 8.6% Common Stock interest of PE in respect of the PE Warrant was eliminated in its entirety.
PARENT EQUITY AND DEBT
Parent's certificate of incorporation contains restrictions on transfer of its outstanding stock and grants to Parent, or Parent's assignee, a right of first refusal in the event of a proposed sale by any stockholder of Parent. In addition to the Common Stock, Parent has outstanding the Parent New Preferred and the Warrant issued with the Parent Discount Notes. In connection with the Recapitalization, Parent, the Millers and GEI entered into a stockholders agreement (the "Stockholders Agreement") which, among other things, generally provides that GEI will vote its Common Stock (and will cause its affiliates to vote) in favor of the election of the Millers and an additional person designated by them to be directors of Parent. Likewise, the Millers agreed to vote their Common Stock (and will cause their affiliates to vote) in favor of the election of two persons designated by GEI to be directors of Parent. The Stockholders Agreement further provides that all such persons will cause Parent to vote the common stock of the Company in favor of the election of the same five persons as directors of the Company. The Stockholders Agreement and the respective certificates of incorporation of Parent and the Company contain a requirement for a supermajority director vote generally applicable to transactions not in the ordinary course of business. The Stockholders Agreement is generally for a term of ten years, subject to earlier termination upon the occurrence of certain events, including if the Common Stock is listed or admitted to trading on a national securities exchange or quoted on The Nasdaq Stock Market's National Market.
ITEM 13:
ITEM 13: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
RELATIONSHIP WITH THRIFTY PAYLESS AND RITE AID CORPORATION
Prior to September 1992, the Company was a wholly-owned subsidiary of Thrifty, which was in turn a wholly-owned subsidiary of PE. In December 1996, Thrifty was acquired by Rite Aid Corporation. References herein to "Rite Aid" include Rite Aid Corporation and its subsidiaries, including Thrifty PayLess, Inc. and Thrifty.
As a result of the Company's prior relationship with Thrifty and its affiliates, the Company continues to maintain certain relationships with Rite Aid and PE. These relationships include continuing indemnification obligations of PE to the Company for certain environmental matters; arrangements between the Company and PE with respect to various tax matters and obligations under ERISA (as defined), including the allocation of various tax obligations relating to the inclusion of the Company and each member of the affiliated group of which the Company is the common parent in certain consolidated and/or unitary tax returns of PE; and the subleases described below.
The Company previously subleased the building and improvements of its Fontana, California distribution center from Thrifty Realty Company, a California corporation and a wholly-owned subsidiary of Thrifty. See "Business - Distribution." On March 5, 1996, as permitted by the terms of such sublease, the Company purchased the facility from MLTC for a purchase price of $8.9 million, thereby terminating such sublease. Concurrently with such purchase, the Company entered into a sale/leaseback transaction with respect to the distribution center.
The Company subleases certain business equipment and other personal property from Thrifty, including the Company's point of sale system (the "Equipment"), pursuant to a Sublease (the "Sublease") dated as of September 25, 1992 between the Company and Thrifty, as subsequently amended. Thrifty currently holds a leasehold interest in the Equipment pursuant to an Amended and Restated Master Lease Agreement dated as of April 20, 1994 between MLTC, as lessor, and Thrifty, as lessee (the "Master Lease"). The Master Lease contains a non-disturbance and attornment agreement pursuant to which the Company's use and enjoyment of the Equipment will not be disturbed as a result of any default under the Master Lease provided that the Company is not in default under the Sublease.
The Master Lease provides Thrifty with an option to purchase the Equipment, and the Sublease provides the Company with the same option. The Company's option to purchase is exercisable notwithstanding any default under the Master Lease provided the Company is not otherwise in default under the Sublease; however, in the event a default exists under the Master Lease, the Company's exercise of its purchase option requires the payment by the Company of all amounts due and payable under the Master Lease at the time of the consummation of the purchase pursuant to the exercise of such option. Such amounts may include rent, fees and other expenses that are not allocable to the Equipment (the "Excess Fees") if the same are due and payable but have not otherwise been paid by Thrifty. To the extent the Company is required to pay such Excess Fees, Thrifty is obligated under the Sublease to reimburse the Company for the full amount of such Excess Fees.
The Company believes that all other material terms of the Sublease, including rent payments, are comparable to what could be obtained from an unrelated third party.
POTENTIAL CONFLICTS OF INTEREST; PAST TRANSACTIONS WITH AFFILIATES
Mr. Danhakl of LGP holds a seat on the Board of Directors of the Company. Jonathan Sokoloff and Jonathan Seiffer, who previously served as directors of the Company, hold two seats on the Board of Directors of Gart Sports Company ("Gart"). Also, affiliates of LGA have a controlling interest in Gart, and LGA and LGP are affiliates. Mr. Danhakl may have conflicts of interest with respect to certain matters affecting the Company, such as potential business opportunities and business dealings between the Company and LGP and its affiliated companies.
Gart completed a merger with Sportmart in January, 1998. Gart and Sportmart compete with the Company. Although Gart and Sportmart currently pursue different business strategies than the Company, they compete in some of the Company's markets and offer some of the same or similar merchandise, and there can be no assurance that the Company will not encounter increased competition from Gart or Sportmart in the future or that actions by either will not inhibit the Company's growth strategy. In addition, there can be no assurance that all potential conflicts will be resolved in a manner that is favorable to the Company, or that the Company will be offered business opportunities made available to Gart or Sportmart. The Company believes it is impossible to predict the precise circumstances under which future potential conflicts may arise and therefore intends to address potential conflicts on a case-by-case basis. Under Delaware law, directors have a fiduciary duty to act in good faith and in what they believe to be in the best interest of the corporation and its stockholders. Such duties include the duty to refrain from impermissible self-dealing and to deal fairly with respect to transactions in which the directors, or other companies with which such directors are affiliated, have an interest.
OWNERSHIP OF OLD SUBORDINATED NOTES BY AFFILIATES
Certain of the Old Subordinated Notes that were defeased and repaid as a result of the Recapitalization were owned by certain of the Selling Stockholders and by affiliates of GEI.
CONSULTING FEES
As consideration for the provision of ongoing management and financial advisory services, the Company, on behalf of the Parent, pays LGA certain fees. See "Executive Compensation - Compensation of Directors."
PART IV
ITEM 14
ITEM 14 EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(A) Documents filed as part of this report:
(1) Financial Statements. See Financial Statements Index included in Item 8 of Part II of this Form 10-K.
(2) Financial Statement Schedule. See Financial Statements Index included in Item 8 of Part II of this Form 10-K.
(3) Exhibits and Reports on Form 8-K.
(a) Exhibits
3.1(i)(1) Restated Certificate of Incorporation of the Company
3.1(ii)(1) By-Laws of the Company, as amended October 27, 1997
4.1(5) Indenture dated as of November 13, 1997 between the Company and First Trust National Association, as trustee
4.2(5) Form of the Company's Series B 10 7/8% Senior Notes due 2007 (included in Exhibit 4.1)
10.1(a)(2) Employment Agreement between the Company and Robert W. Miller dated as of January 1, 1993
10.1(b)(2) Employment Agreement between the Company and Steven G. Miller dated as of January 1, 1993
10.1(c)(2) Sublease between the Company and Thrifty dated as of September 25, 1992
10.2(a)(3) Amended and Restated Indemnification Implementation Agreement between the Company (formerly known as United Merchandising Corp.) and Thrifty PayLess Holdings, Inc. dated as of April 20, 1994
10.2(b)(3) Agreement and Release among Pacific Enterprises, Thrifty PayLess Holdings, Inc., Thrifty PayLess, Inc., Thrifty and the Company (formerly known as United Merchandising Corp.) dated as of March 11, 1994
10.3(a)(4) Financing Agreement dated March 8, 1996 between The CIT Group/Business Credit, Inc. and the Company
10.3(b)(4) Grant of Security Interest in and Collateral Assignment of Trademarks and Licenses dated as of March 8, 1996 by the Company in favor of The CIT Group/Business Credit, Inc.
10.3(c)(4) Guarantee dated March 8, 1996 by Big 5 Corporation (now known as Big 5 Holdings Corp.) in favor of The CIT Group/Business Credit, Inc.
10.4(a)(4) Agreement on Purchase and Sale among the Company and the State of Wisconsin dated as of February 13, 1996
10.4(b)(4) Lease among the Company (Lessee) and the State of Wisconsin Investment Board (Lessor) dated as of March 5,
10.5(5) Purchase Agreement, dated as of November 13, 1997, by and among the Company and the Initial Purchasers named therein
10.6(5) Registration Rights Agreement, dated as of November 13, 1997, by and among the Company and the Initial Purchasers named therein
10.7(5) Management Services Agreement, dated as of November 13, 1997, by and between the Company, Big 5 Holdings Corp. and Leonard Green & Associates, L.P.
10.8(5) Letter from The CIT Group/Business Credit, Inc. to the Company dated November 13, 1997, amending the Financing Agreement, dated March 8, 1996 between the Company (formerly known as United Merchandising Corp.) and The CIT Group/Business Credit, Inc.
12.1 Ratio of Earnings to Fixed Charges
27 Financial Data Schedule
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(1) Incorporated by reference to the Company's Current Report on Form 8-K filed November 26, 1997.
(2) Incorporated by reference to the Company's Registration Statement on Form S-4 (file no. 33-61096) effective as of June 29, 1993.
(3) Incorporated by reference to the Company's Annual Report on Form 10-K for the year ended January 1, 1995
(4) Incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1995.
(5) Incorporated by reference to the Company's Registration Statement on Form S-4 (file no. 333-43129) filed with the Securities and Exchange Commission on December 23, 1997.
SUPPLEMENTAL INFORMATION TO BE FURNISHED WITH REPORTS FILED PURSUANT TO SECTION 15 (d) OF THE ACT BY REGISTRANTS WHICH HAVE NOT REGISTERED SECURITIES PURSUANT TO SECTION 12 OF THE ACT.
The Company has not provided any annual report covering its last fiscal year nor any proxy statement to security holders.
SIGNATURES
Pursuant to the requirements of Section 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.
BIG 5 CORP. a Delaware Corporation
Date: March 31, 1999 By: /S/Robert W. Miller -------------------- ------------------------------ Robert W. Miller Chairman of the Board of Directors and Chief Executive Officer of the Company
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:
BIG 5 CORP.
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholder Big 5 Corp.:
We have audited the accompanying balance sheets of Big 5 Corp. (formerly United Merchandising Corp.) as listed in the accompanying index. In connection with our audits of the financial statements, we also have audited the financial statement schedule as listed in the accompanying index. These financial statements and financial statement schedule II are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. 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 Big 5 Corp. as of January 3, 1999 and December 28, 1997 and the results of its operations and its cash flows for each of the years ended January 3, 1999, December 28, 1997 and December 29, 1996 in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedule II, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
KPMG LLP
Los Angeles, California February 24, 1999
BIG 5 CORP.
Balance Sheets
(Dollar amounts in thousands)
(Continued)
BIG 5 CORP.
Balance Sheets, Continued
(Dollar amounts in thousands)
See accompanying notes to financial statements.
BIG 5 CORP.
Statements of Operations
(Dollar amounts in thousands)
See accompanying notes to financial statements.
BIG 5 CORP.
Statements of Stockholder's Equity (Deficit)
Years ended December 29, 1996, December 28, 1997 and January 3, 1999
(Dollar amounts in thousands)
See accompanying notes to financial statements.
BIG 5 CORP.
Statements of Cash Flows
(Dollar amounts in thousands)
(Continued)
BIG 5 CORP.
Statements of Cash Flows, Continued
(Dollar amounts in thousands)
See accompanying notes to financial statements.
BIG 5 CORP.
Notes to Financial Statements
January 3, 1999 and December 28, 1997
(Dollar amounts in thousands)
(1) BASIS OF PRESENTATION AND DESCRIPTION OF BUSINESS
The accompanying financial statements for the fiscal years ended January 3, 1999 and December 28, 1997 represent the financial position and results of operations of Big 5 Corp. In connection with the November 13, 1997 Recapitalization (as discussed below), the Company was reincorporated in Delaware and changed its name to Big 5 Corp. Prior to this reincorporation, the Company was incorporated in California as United Merchandising Corp. The accompanying financial statements for the fiscal year ended December 29, 1996 represent the financial position and results of operations of United Merchandising Corp. As used herein, the Company means Big 5 Corp. when discussing the financial position and results of operations subsequent to the Recapitalization and United Merchandising Corp. when discussing the financial position or results of operations prior to the Recapitalization. The Company is a wholly owned subsidiary of Big 5 Holdings Corp.
The Company operates in one business segment, as a sporting goods retailer under the Big 5 Sporting Goods name carrying a broad range of hardlines, softlines and footwear, operating 221 stores at January 3, 1999 in California, Washington, Arizona, Oregon, Texas, New Mexico, Nevada, Utah and Idaho.
In October 1997, Big 5 Holdings Corp. (the Parent), Robert W. Miller and Green Equity Investors, L.P. (GEI) agreed to a Plan of Recapitalization and Stock Repurchase Agreement (the Recapitalization Agreement). On November 13, 1997, the following transactions (collectively referred to as the Recapitalization) were effected pursuant to the Recapitalization Agreement: (i) the Company issued 10 7/8% Senior Notes due 2007 (the Senior Notes) ($130,409 gross proceeds); (ii) the Company defeased and repaid all of its outstanding 13 5/8% Senior Subordinated Notes due 2002; (iii) Parent issued its Senior Discount Notes in an aggregate principal amount at maturity of $48.2 million maturing on November 30, 2008 (the Parent Discount Notes) with a warrant to purchase approximately 3% of the Common Stock of Parent, par value $.01 per share at a nominal exercise price (the Warrant) ($24,500 proceeds); (iv) Parent accelerated vesting of substantially all outstanding options and restricted stock held by management and employees of the Company; (v) Parent redeemed for cash its existing Series A 9% Cumulative Redeemable Preferred Stock (the Parent Old Preferred) for approximately $21.9 million in the aggregate, including accrued dividends; (vi) Parent paid a cash distribution of $15 per share on its outstanding shares of Common Stock (approximately $63.2 million in the aggregate); (vii) Parent repurchased from Pacific Enterprises (PE) its warrant respecting 397,644 shares of Common Stock and 16,667 shares of Parent Old Preferred the (PE Warrant) and approximately 2,737,310 shares of Common Stock from the Selling Stockholders (of which GEI owned 86.8%) for an aggregate of $17.6 million in cash and $35.0 million of Parent Senior Exchangeable Preferred Stock (the Parent New Preferred); (viii) Parent sold additional Common Stock to middle and senior level management of the Company (approximately $2.3 million gross proceeds), increasing the beneficial ownership of management and employees (and members of their families) from 14.0% to 55.3% (in each instance on a fully diluted basis); and (ix) other transactions occurred, including a distribution from the Company to Parent, aggregating $81.5 million, so that the above-referenced transactions could be effected.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
REPORTING PERIOD
The Company reports on a 52-53 week fiscal year ending on the Sunday nearest December 31. Information presented for the year ended January 3, 1999 represents a 53-week fiscal year, while information presented for the years ended December 28, 1997 and December 29, 1996 represent 52-week fiscal years.
REVENUE RECOGNITION
The Company's revenue is received from retail sales of merchandise through the Company's stores. Revenue is recognized when merchandise is received by the customer and is shown net of returns. The costs of distribution center operations are included in cost of sales, buying and occupancy.
EARNINGS PER SHARE
Earnings per share data are not presented as they are not meaningful to the financial statements.
CASH EQUIVALENTS
The Company considers all highly liquid investments with original maturities of three months or less to be cash equivalents.
OTHER RECEIVABLES
Other receivables consist principally of amounts due from vendors for certain co-op advertising and amounts due from credit card companies. An allowance for doubtful accounts is provided when accounts are determined to be uncollectible.
MERCHANDISE INVENTORIES
The Company values its merchandise inventories using the lower of average cost (which approximates the first-in, first-out cost) or market method. Average cost includes the direct purchase price of merchandise inventory and overhead costs associated with the Company's distribution center.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost and depreciated over the estimated useful lives or lease terms, using the straight-line method.
The estimated useful lives are 40 years for buildings, 7 to 10 years for fixtures and equipment and the shorter of the lease term or 10 years for leasehold improvements. Maintenance and repairs are charged to expense as incurred.
LEASEHOLD INTEREST
Upon acquisition of the Company by management in conjunction with Leonard Green & Partners L.P. in 1992, certain assets were recorded for the net fair value of favorable operating lease agreements. The leasehold interest asset is being amortized on a straight-line basis. During the year ended December 28, 1997, the Company revised its estimated average useful life from 10 years to 13.5 years. The
unamortized balance attributable to leases terminated since the acquisition has been reflected as a component of the gain or loss upon disposition of the underlying properties.
GOODWILL
Goodwill, which represents the excess of purchase price over fair value of net assets acquired, is amortized on a straight-line basis over periods ranging from 15 to 30 years.
OTHER ASSETS
Other assets consist principally of deferred financing costs and long-term investments. Deferred financing costs are amortized straight line over the terms of the respective debt.
SELF-INSURANCE RESERVES
The Company maintains self-insurance programs for workers' compensation and general liability risks. The Company is self-insured up to specified per-occurrence limits and maintains insurance coverage for losses in excess of specified amounts. Estimated costs under these programs, including incurred but not reported claims, are recorded as expenses based upon actuarially determined historical experience and trends of paid and incurred claims.
PREOPENING EXPENSES
New store preopening expenses are charged against operations as incurred.
ADVERTISING EXPENSES
The Company recognizes advertising costs the first time the advertising takes place. Advertising expenses amounted to $22,990 for the year ended December 29, 1996, $24,937 for the year ended December 28, 1997, and $28,465 for the year ended January 3, 1999. Advertising expense is included in selling and administrative.
INCOME TAXES
The Company accounts for income taxes under the asset and liability method whereby deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. The realizability of deferred tax assets is assessed throughout the year and a valuation allowance is established accordingly.
The Company files a consolidated tax return with its Parent, however, tax expense is recorded based on the stand alone operations of the Company. In 1998, the Company was not required to make any tax payments to Parent in settlement of the Company's tax liabilities.
USE OF ESTIMATES
Management of the Company has made a number of estimates and assumptions relating to the reporting of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and reported amounts of revenues and expenses during the reporting period to prepare these financial statements in conformity with generally accepted accounting principles. Actual results could differ from these estimates.
CONCENTRATION OF CREDIT RISK
The Company's deposits are with various high-quality financial institutions. Customer purchases are generally transacted using cash or credit cards. In certain instances, the Company grants credit to schools and youth-oriented organizations, under normal trade terms. Trade accounts receivable were approximately $437 and $462 at December 28, 1997 and January 3, 1999, respectively. Credit losses have historically been within management's expectations.
RECLASSIFICATIONS
Certain prior year balances in the accompanying financial statements have been reclassified to conform to current year presentation.
IMPAIRMENT OF LONG-LIVED ASSETS AND LONG-LIVED ASSETS TO BE DISPOSED OF
The Company reviews its long-lived assets and certain identifiable intangibles for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future undiscounted net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value, less costs to sell.
(3) FAIR VALUES OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value:
Cash and cash equivalents, trade and other receivables, trade accounts payable and accrued expenses: The carrying amounts approximate the fair values of these instruments due to their short-term nature.
The fair value of the Company's Senior notes at January 3, 1999 approximated $131,748 based on recent market prices as quoted by Donaldson, Lufkin & Jenrette. The carrying amount of the revolving credit facility reflects the fair value based on current rates available to the Company for debt with the same remaining maturities.
(4) LONG-TERM DEBT
Long-term debt consists of the following:
In connection with the Recapitalization, the Company issued $131 million face amount, 10 7/8% Senior Notes due 2007 (Senior Notes), less unamortized discount of $591 based on an imputed interest rate of 10.95%. The notes require semiannual interest payments on each May 15 and November 15, commencing on May 15, 1998. The Company has no mandatory payments of principal on the Senior Notes prior to their maturity in 2007. The notes may be redeemed in whole or in part, at the option of the Company, at any time on or after November 15, 2002, at the redemption prices set forth below with respect to the indicated redemption date, together with any accrued and unpaid interest to such redemption date.
If redeemed during the 12-month period beginning November 15:
The Company used the proceeds from the issuance of the Senior Notes, to redeem, at a premium of 5.838%, all of the then outstanding unsecured Senior Subordinated Notes, including all accrued and unpaid interest. Accordingly, the Company incurred a charge of $2,707, consisting of $2,128 in prepayment penalties and $579 related to a write-off of deferred finance costs related to the unsecured Senior Subordinated Notes. The total charge is reflected as an extraordinary loss from early extinguishment of debt (net of income taxes of $1,110) of $1,597 in the statement of operations for the year ended December 28, 1997.
In connection with the Recapitalization, the Company amended its then-current credit agreement facility with the CIT Group. The amended agreement provides the Company with a five year, non-amortizing $125 million revolving credit (the CIT Credit Facility), expiring in November 2002. The original agreement became effective March 8, 1996, when the Company entered into a credit agreement (the CIT Credit Agreement) among the Company and the CIT Group. The CIT Credit Agreement provided the Company with a three-year nonamortizing $100 million revolving debt facility (the CIT Facility). Proceeds from the initial funding under the CIT Facility were used to repay in full all of the Company's outstanding obligations under its then existing revolving credit facility with General Electric Capital Corporation (the GECC Facility).
Pursuant to the refinancing of its revolving credit facility in 1996, the Company incurred a charge of $2,222, consisting of $1,160 in prepayment penalties and $1,062 related to a write-off of deferred finance costs related to the GECC Facility. The total charge is reflected as an extraordinary loss from early extinguishment of debt (net of income taxes of $937) of $1,285 in the statement of operations for the year ended December 29, 1996.
The CIT Credit Facility bears interest at various rates based on the Company's performance, with a floor of LIBOR plus 1.5% or the Chase Manhattan prime lending rate and a ceiling of LIBOR plus 2.5% or the Chase Manhattan prime lending rate plus 0.75% and are secured by trade accounts receivable, merchandise inventory and general intangible assets (including trademarks and tradenames) of the Company. At January 3, 1999, loans under the CIT Credit Facility currently bear interest at a rate of LIBOR (5.1% at January 3, 1999) plus 1.75% or the Chase Manhattan prime lending rate (7.75% at
January 3, 1999) plus 0.0%. A monthly fee of 0.325% per annum is assessed on the unused portion of the facility. On January 3, 1999, the Company had $20,908 in LIBOR and prime lending rate borrowings and letters of credit of $3,773 outstanding. The Company's maximum eligible borrowing available under the facility is limited to 70% of the aggregate value of eligible inventory during November through February and 65% of the aggregate value of eligible inventory during the remaining months of the year. Available borrowings over and above actual LIBOR and prime rate borrowings and letters of credit outstanding on the CIT Credit Facility amounted to $71,074 at January 3, 1999.
The various debt agreements contain covenants restricting the ability of the Company to, among other things, incur additional debt, pay dividends, merge or consolidate with or invest in other companies, sell, lease or transfer all or substantially all of its properties or assets, or make certain payments with respect to its outstanding capital stock, and engage in certain transactions with affiliates. In addition, the Company must comply with certain financial covenants. The Company was in compliance with such covenants at January 3, 1999.
(5) LEASES
The Company currently leases certain stores, distribution facilities, vehicles and equipment under noncancelable operating leases that expire through the year 2019. These leases generally contain renewal options for periods ranging from 5 to 15 years and require the Company to pay all executory costs such as maintenance and insurance. Certain leases contain options to purchase the leased assets.
Certain leases contain escalation clauses and provide for contingent rentals based on percentages of sales. The Company recognizes rental expense on a straight-line basis over the terms of the underlying leases, without regard to when rentals are paid. The accrual of the current noncash portion of this rental expense has been included in depreciation and amortization in the accompanying statements of operations and cash flows and deferred rent in the accompanying balance sheets.
Rental expense for operating leases consisted of the following:
Future minimum lease payments (cash rentals) under noncancelable operating leases (with initial or remaining lease terms in excess of one year) as of January 3, 1999 are:
(6) ACCRUED EXPENSES
Accrued expenses consist of the following:
(7) INCOME TAXES
Total income tax expense consists of the following:
The provision for income taxes differs from the amounts computed by applying the Federal statutory tax rate of 35% to earnings before income taxes and extraordinary item, as follows:
Deferred tax assets and liabilities consist of the following tax-effected temporary differences:
In 1996, 1997 and 1998, the Company reduced the valuation allowance to reflect realizability of its deferred tax assets. In doing so, management considers whether it is more likely than not that some portion or all of the deferred tax assets will be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversals of deferred tax liabilities, projected future taxable income and tax planning strategies in making this assessment. Based upon the level of historical taxable income and projections of future taxable income over the periods during which the deferred tax assets are deductible, management believes it is more likely than not that the Company will realize the benefits of these deductible differences. The amount of the deferred tax
asset considered realizable, however, could be reduced in the near term if estimates of future taxable income during the carryforward period are reduced.
(8) EMPLOYEE BENEFIT PLANS
Effective January 4, 1993, the Company established a 401(k) plan to cover all eligible employees. All employees' contributions may be supplemented by Company contributions. The Company contributed $1,017 for the year ended December 29, 1996, $1,269 for the year ended December 28, 1997 and $1,411 for the year ended January 3, 1999 in employer matching and profit sharing contributions.
The Company has no other significant postretirement or postemployment benefits.
(9) RELATED PARTY TRANSACTIONS
Prior to September 1992, the Company was a wholly owned subsidiary of Thrifty, which was in turn a wholly owned subsidiary of Pacific Enterprises (PE). In December 1996, Thrifty was acquired by Rite Aid Corporation.
As a result of the Company's prior relationship with Thrifty and its affiliates, the Company continues to maintain certain relationships with Rite Aid and PE. These relationships include continuing indemnification obligations of PE to the Company for certain environmental matters; agreements between the Company and PE with respect to various tax matters and obligations under ERISA, including the allocation of various tax obligations relating to the inclusion of the Company and each member of the affiliated group of which the Company was a subsidiary in certain consolidated and/or unitary tax returns of PE; and subleases described as follows.
The Company leases certain property and equipment from Thrifty, which leases this property and equipment from an outside party. Charges related to these leases totaled $1,008 for the year ended December 29, 1996, totaled $655 for the year ended December 28, 1997, $435 for the year ended January 3, 1999.
During the year ended January 3, 1999, the Company, on behalf of the Parent, paid $340, plus expenses (included in other assets), to an advisor group of one of its investors. An individual of the investor advisor group that is a shareholder of the Parent is a member of the Company's Board of Directors. In 1996, the Company paid this advisor group an additional $500 for services related to securing of the CIT Facility. In 1997, the Company, and the Parent, entered into a new Management Services Agreement with a term of seven and one-half years for which $333, plus expenses, will be paid annually for financial advisory and investment banking services.
The 1997 Management Equity Plan (the "1997 Plan") provides for the granting of incentive stock options or nonqualified options to officers, directors and selected key employees of the Company to purchase shares of the Parent's common stock. The 1997 Plan is administered by the Board of Directors of the Parent and the granting of awards under the Plan is discretionary with respect to the individuals to whom and the times at which awards are made, the number of options awarded, and the vesting and exercise period of such awards. The options granted under the Plan must have an exercise price that is no less than 85% of the market value of the Parent common stock at the time the stock option is granted. The aggregate number of Parent common shares that may be allocated to awards under the Plan is 560,000 shares.
The Company has elected to follow Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB 25) and related interpretation in accounting for its employee stock options under the Plan. No awards have been granted under the Plan as of January 3, 1999.
(10) CONTINGENCIES
The Company is involved in various claims and legal actions arising in the ordinary course of business. In the opinion of management, the ultimate disposition of these matters will not have a material adverse effect on the Company's financial position, results of operations or liquidity.
(11) BUSINESS CONCENTRATIONS
The Company operates specialty sporting goods retail stores located principally in the Western states of the United States. The Company is subject to regional risks such as the local economies, weather conditions and natural disasters and government regulations. If the region were to suffer an economic downturn or if other adverse regional events were to occur, there could be a significant adverse effect on management's estimates and an adverse impact on the Company's performance. The retail industry is impacted by the general economy. Changes in the marketplace may significantly affect management's estimates and the Company's performance.
(12) SALE LEASEBACK
On March 5, 1996, the Company entered into a sale and leaseback agreement (the transaction) with regard to its warehouse facility located in Fontana, California. Prior to this transaction, the Company owned the land associated with the facility and leased the buildings and improvements. In contemplation of the transaction, the Company purchased the building and improvements at a purchase price of $8,910. The transaction was then completed with the sale of the land, building and improvements at a sale price of $13,900. The gain on the transaction was insignificant and will be amortized on a straight-line basis over the related lease term. The net cash proceeds after expenses totaled $4,728 which was used to repay a portion of the GECC Facility.
Under the leaseback agreement, the Company has committed to lease the facility for ten years under a noncancelable operating lease. The future minimum lease payments are reflected in the future minimum lease payments under noncancelable operating leases.
On October 31, 1996, the Company entered into a sale and leaseback agreement with regard to its store located in Culver City, California. The sale amount of the property was $817 resulting in a $214 loss for the Company which is included in the statements of operations. The Company has committed to lease the property for 15 years under a noncancelable operating lease. The future minimum lease payments are reflected in the future minimum lease payments under noncancelable leases.
BIG 5 CORP. Schedule II - Valuation and Qualifying Accounts (Dollar amounts in thousands)
II-1