UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended October 31, 2001
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from ______ to _______
Commission file number 001-04129
ZALE CORPORATION
(Exact name of registrant as specified in its charter)
Delaware (State or other jurisdiction of incorporation or organization) |
75-0675400 (I.R.S.Employer Identification No.) |
|
901 W. Walnut Hill Lane, Irving, Texas (Address of principal executive offices) |
75038-1003 (Zip Code) |
(972) 580-4000
(Registrants telephone number, including area code)
None
(Former name, former address and former
fiscal year, if changed since last report.)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X]. No [ ] .
APPLICABLE ONLY TO CORPORATE ISSUERS:
As of December 3, 2001, 34,862,519 shares of the registrants common stock were outstanding.
ZALE CORPORATION AND SUBSIDIARIES
Index
Page | ||||
Part I | Financial Information: | |||
Item 1. | Financial Statements | |||
Consolidated Statements of Operations | 3 | |||
Consolidated Balance Sheets | 4 | |||
Consolidated Statements of Cash Flows | 5 | |||
Notes to Consolidated Financial Statements | 6 | |||
Item 2. | Managements Discussion and Analysis of Financial | |||
Condition and Results of Operations | 19 | |||
Item 3. | Quantitative and Qualitative Disclosures About Market Risk | 24 | ||
Part II | Other Information: | |||
Item 1. | Legal Proceedings | 24 | ||
Item 4. | Submission of Matters to a Vote of Security Holders | 25 | ||
Item 6. | Exhibits and Reports on Form 8-K | 25 | ||
Signature | 26 |
2
Part I. Financial Information
Item 1. Financial Statements
ZALE CORPORATION AND SUBSIDIARIES
Three Months Ended | ||||||||||
October 31, | ||||||||||
2001 | 2000 | |||||||||
Net Sales |
$ | 405,395 | $ | 371,802 | ||||||
Cost of Sales |
199,391 | 188,945 | ||||||||
Gross Margin |
206,004 | 182,857 | ||||||||
Selling, General and Administrative Expenses |
195,160 | 160,396 | ||||||||
Depreciation and Amortization Expense |
14,612 | 12,999 | ||||||||
Unusual Item Executive Transactions |
| 2,507 | ||||||||
Operating (Loss) Earnings |
(3,768 | ) | 6,955 | |||||||
Interest Expense, Net |
2,035 | 254 | ||||||||
(Loss) Earnings Before Income Taxes |
(5,803 | ) | 6,701 | |||||||
Income Taxes |
(2,153 | ) | 2,614 | |||||||
(Loss) Earnings Before Effect of Accounting Change |
(3,650 | ) | 4,087 | |||||||
Effect of a Change in Accounting for the Write
Off of the Excess of Revalued Net Assets Over
Stockholders Investment |
(41,287 | ) | | |||||||
Net Earnings |
$ | 37,637 | $ | 4,087 | ||||||
Earnings Per Common Share Basic: |
||||||||||
Before effect of change in accounting principle |
$ | (0.10 | ) | $ | 0.12 | |||||
Net Earnings Per Share |
$ | 1.08 | $ | 0.12 | ||||||
Earnings Per Common Share Diluted: |
||||||||||
Before effect of change in accounting principle |
$ | (0.10 | ) | $ | 0.12 | |||||
Net Earnings Per Share |
$ | 1.08 | $ | 0.12 | ||||||
Weighted Average Number of Common
Shares Outstanding: |
||||||||||
Basic |
34,791 | 35,059 | ||||||||
Diluted |
34,906 | 35,339 |
See Notes to Consolidated Financial Statements.
3
ZALE CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(amounts in thousands)
October 31, | July 31, | October 31, | |||||||||||
2001 | 2001 | 2000 | |||||||||||
(unaudited) | (unaudited) | ||||||||||||
ASSETS |
|||||||||||||
Current Assets: |
|||||||||||||
Cash and Cash Equivalents |
$ | 29,762 | $ | 29,390 | $ | 29,819 | |||||||
Restricted Cash |
| | 1,003 | ||||||||||
Merchandise Inventories |
902,978 | 724,157 | 865,337 | ||||||||||
Other Current Assets |
63,589 | 57,153 | 44,912 | ||||||||||
Total Current Assets |
996,329 | 810,700 | 941,071 | ||||||||||
Property and Equipment, Net |
302,252 | 296,413 | 277,540 | ||||||||||
Goodwill, Net |
215,474 | 206,402 | 235,699 | ||||||||||
Other Assets |
34,330 | 33,768 | 38,034 | ||||||||||
Deferred Tax Asset, Net |
47,734 | 47,704 | 64,689 | ||||||||||
Total Assets |
$ | 1,596,119 | $ | 1,394,987 | $ | 1,557,033 | |||||||
LIABILITIES AND STOCKHOLDERS INVESTMENT |
|||||||||||||
Current Liabilities: |
|||||||||||||
Accounts Payable and Accrued Liabilities |
$ | 432,881 | $ | 269,111 | $ | 421,358 | |||||||
Deferred Tax Liability, Net |
16,184 | 16,129 | 26,860 | ||||||||||
Total Current Liabilities |
449,065 | 285,240 | 448,218 | ||||||||||
Non-current Liabilities |
115,459 | 118,434 | 122,552 | ||||||||||
Long-term Debt |
157,705 | 109,463 | 176,801 | ||||||||||
Excess of Revalued Net Assets Over
Stockholders Investment, Net |
| 41,287 | 45,711 | ||||||||||
Commitments and Contingencies
Stockholders Investment: |
|||||||||||||
Preferred Stock |
| | | ||||||||||
Common Stock |
404 | 404 | 396 | ||||||||||
Additional Paid-In Capital |
539,839 | 539,904 | 519,013 | ||||||||||
Accumulated Other Comprehensive Income (Loss) |
(6,295 | ) | (2,355 | ) | (2,068 | ) | |||||||
Accumulated Earnings |
523,472 | 485,835 | 407,874 | ||||||||||
Deferred Compensation |
(7,671 | ) | (8,253 | ) | (1,418 | ) | |||||||
1,049,749 | 1,015,535 | 923,797 | |||||||||||
Treasury Stock |
(175,859 | ) | (174,972 | ) | (160,046 | ) | |||||||
Total Stockholders Investment |
873,890 | 840,563 | 763,751 | ||||||||||
Total Liabilities and Stockholders Investment |
$ | 1,596,119 | $ | 1,394,987 | $ | 1,557,033 | |||||||
See Notes to Consolidated Financial Statements.
4
ZALE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(amounts in thousands)
Three Months Ended | Three Months Ended | ||||||||
October 31, | October 31, | ||||||||
2001 | 2000 | ||||||||
Net Cash Flows from Operating Activities: |
|||||||||
Net earnings |
$ | 37,637 | $ | 4,087 | |||||
Adjustments to reconcile net earnings to
net cash provided by operating activities: |
|||||||||
Depreciation and amortization expense |
14,691 | 12,074 | |||||||
Amortization of deferred compensation |
578 | 368 | |||||||
Effect of change in accounting principle |
(41,287 | ) | | ||||||
Restricted cash |
| 2,910 | |||||||
Merchandise inventories |
(181,815 | ) | (170,697 | ) | |||||
Other current assets |
(6,551 | ) | 1,615 | ||||||
Other assets |
(497 | ) | (915 | ) | |||||
Accounts payable and accrued liabilities |
155,050 | 106,885 | |||||||
Non-current liabilities |
(2,975 | ) | (138 | ) | |||||
Net Cash Used In Operating Activities |
(25,169 | ) | (43,811 | ) | |||||
Net Cash Flows from Investing Activities: |
|||||||||
Additions to property and equipment |
(21,904 | ) | (24,234 | ) | |||||
Dispositions of property and equipment |
902 | 524 | |||||||
Acquisition of Piercing Pagoda, Inc., net of cash acquired |
| (239,530 | ) | ||||||
Net Cash Used In Investing Activities |
(21,002 | ) | (263,240 | ) | |||||
Net Cash Flows from Financing Activities: |
|||||||||
Payments on long-term debt |
| (6,924 | ) | ||||||
Payments on revolving credit agreement |
(80,732 | ) | (80,799 | ) | |||||
Borrowings under revolving credit agreement |
129,331 | 147,464 | |||||||
Proceeds from exercise of stock options |
30 | 556 | |||||||
Purchase of common stock |
(1,924 | ) | (21,554 | ) | |||||
Net Cash Provided by Financing Activities |
46,705 | 38,743 | |||||||
Effect of Exchange Rate Changes on Cash |
(162 | ) | (107 | ) | |||||
Net Increase (Decrease) in Cash and Cash Equivalents |
372 | (268,415 | ) | ||||||
Cash and Cash Equivalents at Beginning of Period |
$ | 29,390 | $ | 298,234 | |||||
Cash and Cash Equivalents at End of Period |
$ | 29,762 | $ | 29,819 | |||||
Supplemental cash flow information: |
|||||||||
Interest paid |
$ | 4,184 | $ | 4,433 | |||||
Interest received |
$ | 197 | $ | 2,711 | |||||
Income taxes paid (net of refunds received) |
$ | 400 | $ | (8,375 | ) |
See Notes to Consolidated Financial Statements.
5
ZALE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
BASIS OF PRESENTATION
Zale Corporation and its wholly-owned subsidiaries (the Company) is the largest specialty retailer of fine jewelry in North America. At October 31, 2001, the Company operated 2,360 specialty retail jewelry stores and kiosks located primarily in shopping malls throughout the United States, Canada and Puerto Rico. The Company principally operates under several distinct brand names: Zales Jewelers®, Zales the Diamond Store Outlet®, Gordons Jewelers®, Bailey Banks & Biddle Fine Jewelers®, Peoples Jewellers®, and Piercing Pagoda®. Zales Jewelers provides traditional, moderately priced jewelry to a broad range of customers. Zales the Diamond Store Outlet focuses on the brand conscious, value oriented shopper, offering discounts off retail prices everyday in outlet malls. Gordons Jewelers offers contemporary merchandise designed to attract slightly higher purchases. Bailey Banks & Biddle Fine Jewelers operates upscale jewelry stores which are considered among the finest jewelry stores in their markets. Peoples Jewellers offers traditional, moderately priced jewelry to customers across Canada. With the acquisition of Piercing Pagoda, Inc. in September 2000, the Company broadened its market base to include the opening price point customer, principally through kiosks throughout the United States and Puerto Rico.
The accompanying Consolidated Financial Statements are those of the Company as of and for the three month period ended October 31, 2001. The Company consolidates substantially all of its U.S. operations into Zale Delaware, Inc. (ZDel), a wholly-owned subsidiary of Zale Corporation. ZDel is the parent company for several subsidiaries, including three that are engaged primarily in providing credit insurance to credit customers of the Company. The Company consolidates its Canadian retail operations into Zale International, Inc., which is a wholly-owned subsidiary of Zale Corporation. All significant intercompany transactions have been eliminated. The Consolidated Financial Statements are unaudited and have been prepared by the Company in accordance with accounting principles generally accepted in the United States for interim financial information. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In managements opinion, all material adjustments and disclosures necessary for a fair presentation have been made. The accompanying Consolidated Financial Statements should be read in conjunction with the audited Consolidated Financial Statements and related notes thereto included in the Companys Form 10-K for the fiscal year ended July 31, 2001. The classifications in use at October 31, 2001, have been applied to the financial statements for July 31, 2001 and October 31, 2000.
The results of operations for the three month periods ended October 31, 2001 and 2000, are not indicative of the operating results for the full fiscal year due to the seasonal nature of the Companys business. Seasonal fluctuations in retail sales historically have resulted in higher earnings in the quarter of the fiscal year which includes the holiday selling season.
EARNINGS PER COMMON SHARE
Basic earnings per share is computed by dividing income available to common shareholders by the weighted average number of common shares outstanding for the reporting period. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock. Outstanding stock options issued by the Company represent the only dilutive effect reflected in diluted weighted average shares. There were antidilutive common stock equivalents (options whose exercise price exceeds the average market price of the common stock in the period) of 2,802,875 and 1,347,505 for the three months ended October 31, 2001 and October 31, 2000, respectively.
6
ZALE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
(continued)
EARNINGS PER COMMON SHARE (continued)
Three Months Ended | ||||||||
October 31, | ||||||||
2001 | 2000 | |||||||
(amounts in thousands, | ||||||||
except per share amounts) | ||||||||
Net earnings available to shareholders |
$ | 37,637 | $ | 4,087 | ||||
Basic: |
||||||||
Weighted average number of common
shares outstanding |
34,791 | 35,059 | ||||||
Earnings per share before effect of
accounting change |
(0.10 | ) | 0.12 | |||||
Net earnings per common share basic |
$ | 1.08 | $ | 0.12 | ||||
Diluted: |
||||||||
Weighted average number of common
shares outstanding |
34,791 | 35,059 | ||||||
Effect of dilutive stock options |
115 | 280 | ||||||
Weighted average number of common
shares outstanding as adjusted |
34,906 | 35,339 | ||||||
Earnings per share before effect of
accounting change |
(0.10 | ) | 0.12 | |||||
Net earnings per common share diluted |
$ | 1.08 | $ | 0.12 |
STOCK REPURCHASE PLAN
In August 2001, the Company announced a stock repurchase program pursuant to which the Company, from time to time at the discretion of management and the Board of Directors and in accordance with the Companys usual policies and applicable securities laws, may purchase up to an aggregate of $50 million of Zale Corporation common stock on the open market through July 31, 2002. As of October 31, 2001, the Company had repurchased 70,000 shares at an aggregate cost of $1.9 million under this program.
7
ZALE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
COMPREHENSIVE INCOME
Comprehensive income is defined as the change in equity during a period from transactions and other events, except those resulting from investments by and distributions to stockholders. The components of comprehensive income for the three month periods ended October 31, 2001 and 2000 are as follows:
Three Months Ended October 31, | |||||||||
2001 | 2000 | ||||||||
(amounts in thousands) | |||||||||
Net Earnings |
$ | 37,637 | $ | 4,087 | |||||
Other Comprehensive Income: |
|||||||||
Unrealized gain on investment securities, net |
114 | 143 | |||||||
Unrealized gain on derivative instruments |
48 | | |||||||
Cumulative translation adjustments |
(4,102 | ) | (2,622 | ) | |||||
Total Comprehensive Income |
$ | 33,697 | $ | 1,608 | |||||
EFFECT OF A CHANGE IN ACCOUNTING PRINCIPLE
On July 21, 2001, the Financial Accounting Standards Board (FASB) issued Statements of Financial Accounting Standards (SFAS) No. 141 Business Combinations, and SFAS No. 142 Goodwill and Other Intangible Assets. SFAS No. 141 establishes specific criteria for the recognition of intangible assets subsequent to their acquisition, including negative goodwill. SFAS No. 142 addresses financial accounting and reporting for goodwill and other intangible assets subsequent to their acquisition. SFAS No. 142 provides that goodwill and intangible assets which have indefinite useful lives will not be amortized but rather will be tested for impairment upon adoption and reviewed for impairment at least annually thereafter. Negative goodwill related to future acquisitions will be recorded as an extraordinary item.
The Company adopted SFAS Nos. 141 and 142 in the first quarter of fiscal 2002. As a result, upon adoption of SFAS No. 141 the Company recognized a cumulative effect of a change in accounting principle of approximately $41.3 million in the first quarter of fiscal 2002 related to the write off of the Excess of Revalued Net Assets Over Stockholders Investment (negative goodwill). Additionally, in accordance with SFAS No. 142, the Company is in the process of having its reporting units that include goodwill valued. The Company expects to have these valuations completed by the second quarter of fiscal year 2001.
Also according to SFAS No. 142 guidance, goodwill related to the Companys acquisitions is no longer amortized. As a result of the adoption of both SFAS No. 141 and 142, net amortization expense for the three month period ended October 31, 2001 decreased $0.7 million from the comparable year.
8
ZALE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
ACQUISITION OF PIERCING PAGODA, INC.
On September 20, 2000, the Company completed the acquisition of Piercing Pagoda, Inc. (Piercing Pagoda), the largest retailer of gold jewelry through kiosk stores in the United States, for approximately $203 million, plus approximately $45 million to pay down existing debt, and the assumption of certain bank debt and liabilities.
The excess of the purchase price over the fair value of the net assets acquired, approximately $166.2 million, is classified as goodwill. In accordance with SFAS No. 142, adopted August 1, 2001, goodwill is no longer being amortized. Assets acquired and liabilities assumed have been recorded at their estimated fair values.
The acquisition described above was accounted for by the purchase method of accounting for business combinations. Accordingly, the accompanying Consolidated Statements of Operations do not include any revenues or expenses related to the acquisition prior to September 20, 2000. The entire cost of the acquisition was funded through the Companys available cash and working capital.
The following unaudited pro forma information presents a summary of our consolidated results of operations including Piercing Pagoda, as if the acquisition was effective on August 1, 2000.
Three Months Ended October 31, | |||||||||
2001 | 2000 | ||||||||
(unaudited) | |||||||||
(amounts in thousands, except per | |||||||||
share amounts) | |||||||||
Sales |
$ | 405,395 | $ | 402,250 | |||||
Net Earnings |
37,637 | 3,530 | |||||||
Earnings Per Common Share Diluted: |
|||||||||
Before Effect of Change in Accounting Principle |
(0.10 | ) | 0.10 | ||||||
Net Earnings Per Share |
$ | 1.08 | $ | 0.10 |
The unaudited pro forma information does not purport to represent what the results of operations of the Company would actually have been if the aforementioned transaction had occurred on August 1, 2000, nor does it project the results of operations or financial position for any future periods or at any future date.
LONG-TERM DEBT
In order to support the Companys growth plans and seasonal borrowing needs, the Company amended and restated its unsecured Revolving Credit Agreement on March 30, 2000. The Revolving Credit Agreement provides for (i) a U.S. Revolving Credit facility to the Company and to its operating subsidiary, Zale Delaware, Inc., in the aggregate principal amount of up to $215 million in commitments by certain U.S. lenders, including a $10 million sublimit for letters of credit, and (ii) a separate Canadian Revolving Credit facility, which provides for Canadian Dollar denominated loans in the aggregate principal amount of up to a U.S. Dollar equivalent of $10 million in commitments by a Canadian lender. The total amount of commitments under the Revolving Credit Agreement to the Company and its subsidiaries is approximately $225 million, and the term is five years. Under the Revolving Credit Agreement the Company may, subject to approval of the U.S. Agent or the Canadian Agent, as the case may be, increase the total U.S. commitment to $285 million and the Canadian commitment to a U.S. dollar equivalent of $25 million provided that the commitments together do not exceed a U.S. Dollar equivalent of $300 million. The increase can come from within or outside the bank group.
9
ZALE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
The revolving credit loans bear interest at floating rates as follows: (A) loans outstanding under the U.S. Revolving Credit facility bear interest, at the Companys option, at either (i) the applicable Eurodollar Rate plus a margin equal to 0.50 percent (subject to adjustment), or (ii) the Base Rate (which is the higher of the annual rate of interest announced from time to time by the agent bank under the Revolving Credit Agreement as its base rate or the Federal Funds Effective Rate plus 0.50 percent); and (B) loans outstanding under the Canadian Revolving Credit facility bear interest, at the Companys option, at either (i) a Bankers Acceptance Discount Rate (which varies depending upon whether the Canadian Lender is a bank named under Schedule I or II to the Bank Act (Canada) or neither) plus a margin equal to 0.50 percent (subject to adjustment), or (ii) the annual rate of interest announced from time to time by the Canadian agent bank under the Revolving Credit Agreement as its prime rate for commercial loans in Canadian Dollars to borrowers in Canada. At October 31, 2001, there were approximately $48.6 million in revolving credit loans outstanding under the U.S. Revolving Credit facility and there was a U.S. Dollar equivalent of approximately $9.4 million in revolving credit loans outstanding under the Canadian Revolving Credit facility to fund seasonal inventory growth.
DERIVATIVE FINANCIAL INSTRUMENTS
The Company accounts for derivative financial instruments in accordance with SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended by SFAS No. 138, Accounting for Certain Derivative Instruments and Certain Hedging Activities, which establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. SFAS No. 133, as amended, requires the recognition of all derivative instruments as either assets or liabilities in the statement of financial position measured at fair value.
The Company enters into foreign currency forward exchange contracts solely to reduce the effects of fluctuating foreign currency exchange rates. The Company enters into forward exchange contracts to hedge forecasted inventory, advertising, and purchases relating to real estate activities incurred for each fiscal year, denominated in foreign currencies for periods and amounts consistent with the Companys identified exposures. The purpose of the hedging activities is to minimize the effect of foreign exchange rate movements on cash flows. All foreign currency contracts are denominated in Canadian dollars and are with one large financial institution rated as investment grade by a major rating agency. The Company does not utilize derivative financial instruments for trading or speculative purposes.
The Company documents all relationships between hedging instruments and hedged items, as well as its risk-management objective and strategy for undertaking various hedge transactions. The Company also assesses, both at the hedges inception and on an ongoing basis, whether the derivatives that are used in hedging transactions are highly effective in offsetting changes in cash flows of hedged items. When it is determined that a derivative is not highly effective as a hedge or that it has ceased to be a highly effective hedge, the Company discontinues hedge accounting prospectively.
Changes in the fair value of derivatives that are highly effective and that are designated and qualify as foreign-currency cash flow hedges are recorded in Accumulated Other Comprehensive Income (Loss). Any hedge ineffectiveness and changes in the fair value of instruments that do not qualify as hedges are reported in current period earnings. As of October 31, 2001, the Company had $16.0 million of foreign currency contracts outstanding.
10
ZALE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
FINANCIAL ACCOUNTING PRONOUNCEMENTS
In October 2001, the FASB issued SFAS No. 143, Accounting for Asset Retirement Obligations, which addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. The Company will adopt SFAS No. 143 as required for fiscal year 2003. The Company does not expect that SFAS No. 143 will have a material impact on its results of operations or financial position.
In October 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or Disposal of Long Lived Assets, which addresses financial accounting and reporting for the impairment or disposal of long-lived assets. The Company will adopt SFAS No. 144 as required in the first quarter of fiscal 2003. The Company is currently assessing the impact of SFAS No. 144 and does not expect that it will have a material impact on its results of operations or financial position.
COMMITMENTS AND CONTINGENCIES
The Company is involved in certain legal actions and claims arising in the ordinary course of business. Management believes that such litigation and claims will be resolved without material effect on the Companys financial position or results of operations.
On November 3, 1999, a plaintiff amended a complaint filed in the Circuit Court for Colbert County, State of Alabama to commence a purported class action against the Company, Jewelers National Bank, Zale Indemnity Company, Zale Life Insurance Company, Jewelers Financial Services, Jewel Re-Insurance, Ltd., and certain employees of the Company. On July 21, 2000, the same plaintiff commenced a purported class action in the United States District Court for the Eastern District of Texas, Texarkana Division against the Company, Jewelers National Bank, Zale Indemnity Company, Zale Life Insurance Company, Jewel Re-Insurance, Ltd., and certain employees of the Company. Both purported class actions concern allegations that the defendants marketed credit insurance to customers in violation of state statutory and common laws and bring claims based on, inter alia, fraud, breach of contract, and consumer protection laws. The federal complaint alleges that the Companys credit insurance practices violated federal anti-racketeering laws. In both complaints, plaintiff seeks, among other things, compensatory and punitive damages as well as injunctive relief. Both actions are in the discovery stage, and neither has been certified as a class action. The Company intends to vigorously defend the alleged claims.
On October 23, 2001, a plaintiff filed a complaint against Zale Corporation and Zale Delaware, Inc. in the Superior Court of California, County of Los Angeles, Central District. The complaint is a purported class action on behalf of current and former salaried store managers and assistant store managers of the Company in California. The complaint alleges that these individuals were entitled to overtime pay and should not have been classified as exempt employees under California law. Plaintiff seeks recovery of overtime pay, declaratory relief and attorneys fees. The Company intends to vigorously defend the action.
11
ZALE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
SUPPLEMENTAL CONDENSED CONSOLIDATING FINANCIAL INFORMATION
On September 23, 1997, the Company sold $100 million in aggregate principal amount of 8 1/2 percent Senior Notes (the Senior Notes) due 2007 by means of an offering memorandum to qualified institutional buyers under Rule 144A promulgated under the Securities Act of 1933, as amended.
The Companys payment obligations under the Senior Notes are guaranteed by ZDel (the Guarantor Subsidiary). Such guarantee is full and unconditional with respect to ZDel. Separate financial statements of the Guarantor Subsidiary are not presented because the Companys management has determined that they would not be material to investors. The following supplemental financial information sets forth, on an unconsolidated basis, statements of operations, balance sheets, and statements of cash flow information for the Company (Parent Company Only), for the Guarantor Subsidiary and for the Companys other subsidiaries (the Non-Guarantor Subsidiaries). The supplemental financial information reflects the investments of the Company and the Guarantor Subsidiary in the Guarantor and Non-Guarantor Subsidiaries using the equity method of accounting. Certain reclassifications have been made to provide for uniform disclosure of all periods presented. These reclassifications are not material.
12
ZALE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited) (continued)
SUPPLEMENTAL CONDENSED CONSOLIDATING FINANCIAL
INFORMATION (continued)
SUPPLEMENTAL CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
Three Months Ended October 31, 2001
(unaudited)
(amounts in thousands)
Parent | ||||||||||||||||||||
Company | Guarantor | Non-Guarantor | ||||||||||||||||||
Only | Subsidiary | Subsidiaries | Eliminations | Consolidated | ||||||||||||||||
Net Sales |
$ | | $ | 370,090 | $ | 35,305 | $ | | $ | 405,395 | ||||||||||
Cost of Sales |
| 180,207 | 19,184 | | 199,391 | |||||||||||||||
Gross Margin |
| 189,883 | 16,121 | | 206,004 | |||||||||||||||
Selling, General and Administrative
Expenses |
38 | 181,966 | 13,156 | | 195,160 | |||||||||||||||
Depreciation and Amortization Expense |
| 13,538 | 1,074 | | 14,612 | |||||||||||||||
Operating Earnings (Loss) |
(38 | ) | (5,621 | ) | 1,891 | | (3,768 | ) | ||||||||||||
Interest Expense, Net |
(13,348 | ) | 15,352 | 31 | | 2,035 | ||||||||||||||
Earnings (Loss) Before Income Taxes |
13,310 | (20,973 | ) | 1,860 | | (5,803 | ) | |||||||||||||
Income Taxes |
4,938 | (7,781 | ) | 690 | | (2,153 | ) | |||||||||||||
Earnings Before Effect of Accounting
Change |
8,372 | (13,192 | ) | 1,170 | | (3,650 | ) | |||||||||||||
Effect of a Change in Accounting for the Write off of the Excess of Revalued Net Assets Over Stockholders Investment |
| (41,287 | ) | | | (41,287 | ) | |||||||||||||
Earnings Before Equity in
Earnings of Subsidiaries |
8,372 | 28,095 | 1,170 | | 37,637 | |||||||||||||||
Equity in Earnings of Subsidiaries |
29,265 | 1,836 | | (31,101 | ) | | ||||||||||||||
Net Earnings (Loss) |
$ | 37,637 | $ | 29,931 | $ | 1,170 | $ | (31,101 | ) | $ | 37,637 | |||||||||
13
ZALE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited) (continued)
SUPPLEMENTAL CONDENSED CONSOLIDATING FINANCIAL
INFORMATION (continued)
SUPPLEMENTAL CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
Three Months Ended October 31, 2000
(unaudited)
(amounts in thousands)
Parent | ||||||||||||||||||||
Company | Guarantor | Non-Guarantor | ||||||||||||||||||
Only | Subsidiary | Subsidiaries | Eliminations | Consolidated | ||||||||||||||||
Net Sales |
$ | | $ | 309,917 | $ | 61,885 | $ | | $ | 371,802 | ||||||||||
Cost of Sales |
| 160,108 | 28,837 | | 188,945 | |||||||||||||||
Gross Margin |
| 149,809 | 33,048 | | 182,857 | |||||||||||||||
Selling, General and Administrative
Expenses |
38 | 133,975 | 26,383 | | 160,396 | |||||||||||||||
Depreciation and Amortization Expense |
| 8,888 | 4,111 | | 12,999 | |||||||||||||||
Unusual Item Executive Transaction |
| 2,507 | | 2,507 | ||||||||||||||||
Operating Earnings (Loss) |
(38 | ) | 4,439 | 2,554 | | 6,955 | ||||||||||||||
Interest Expense, Net |
(17,078 | ) | 14,879 | 2,453 | | 254 | ||||||||||||||
Earnings (Loss) Before Income Taxes |
17,040 | (10,440 | ) | 101 | | 6,701 | ||||||||||||||
Income Taxes |
7,656 | (4,691 | ) | (351 | ) | | 2,614 | |||||||||||||
Earnings Before Equity in
Earnings of Subsidiaries |
9,384 | (5,749 | ) | 452 | | 4,087 | ||||||||||||||
Equity in Earnings of Subsidiaries |
(5,297 | ) | 650 | | 4,647 | | ||||||||||||||
Net Earnings (Loss) |
$ | 4,087 | $ | (5,099 | ) | $ | 452 | $ | 4,647 | $ | 4,087 | |||||||||
14
ZALE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
SUPPLEMENTAL CONDENSED CONSOLIDATING FINANCIAL INFORMATION (continued)
SUPPLEMENTAL CONDENSED CONSOLIDATING BALANCE SHEET
October 31, 2001
(unaudited)
(amounts in thousands)
ASSETS
Parent | |||||||||||||||||||||
Company | Guarantor | Non-Guarantor | |||||||||||||||||||
Only | Subsidiary | Subsidiaries | Eliminations | Consolidated | |||||||||||||||||
Current Assets: |
|||||||||||||||||||||
Cash and Cash Equivalents |
$ | | $ | 15,336 | $ | 14,426 | $ | | $ | 29,762 | |||||||||||
Merchandise Inventories |
| 823,861 | 79,117 | | 902,978 | ||||||||||||||||
Other Current Assets |
| 58,321 | 5,268 | | 63,589 | ||||||||||||||||
Total Current Assets |
897,518 | 98,811 | | 996,329 | |||||||||||||||||
Investment in Subsidiaries |
101,483 | 349,072 | | (450,555 | ) | | |||||||||||||||
Property and Equipment, Net |
| 282,487 | 19,765 | | 302,252 | ||||||||||||||||
Intercompany Receivable |
871,563 | | 1,900 | (873,463 | ) | | |||||||||||||||
Goodwill, Net |
| 164,325 | 51,149 | | 215,474 | ||||||||||||||||
Other Assets |
| 2,595 | 31,735 | | 34,330 | ||||||||||||||||
Deferred Tax Assets, Net |
785 | 47,402 | (453 | ) | | 47,734 | |||||||||||||||
Total Assets |
$ | 973,831 | $ | 1,743,399 | $ | 202,907 | $ | (1,324,018 | ) | $ | 1,596,119 | ||||||||||
LIABILITIES AND STOCKHOLDERS INVESTMENT |
|||||||||||||||||||||
Current Liabilities: |
|||||||||||||||||||||
Accounts Payable and Accrued Liabilities |
$ | 6,766 | $ | 403,077 | $ | 23,038 | $ | | $ | 432,881 | |||||||||||
Deferred Tax Liability, Net |
646 | 16,918 | (1,380 | ) | | 16,184 | |||||||||||||||
Total Current Liabilities |
7,412 | 419,995 | 21,658 | | 449,065 | ||||||||||||||||
Non-current Liabilities |
| 108,051 | 7,408 | | 115,459 | ||||||||||||||||
Intercompany Payable |
1,276 | 871,773 | | (873,049 | ) | | |||||||||||||||
Long-term Debt |
99,676 | 48,599 | 9,430 | | 157,705 | ||||||||||||||||
Total Stockholders Investment |
865,467 | 294,981 | 164,411 | (450,969 | ) | 873,890 | |||||||||||||||
Total Liabilities and Stockholders
Investment |
$ | 973,831 | $ | 1,743,399 | $ | 202,907 | $ | (1,324,018 | ) | $ | 1,596,119 | ||||||||||
15
ZALE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
SUPPLEMENTAL CONDENSED CONSOLIDATING FINANCIAL INFORMATION (continued)
SUPPLEMENTAL CONDENSED CONSOLIDATING BALANCE SHEET
July 31, 2001
(unaudited)
(amounts in thousands)
ASSETS
Parent | |||||||||||||||||||||
Company | Guarantor | Non-Guarantor | |||||||||||||||||||
Only | Subsidiary | Subsidiaries | Eliminations | Consolidated | |||||||||||||||||
Current Assets: |
|||||||||||||||||||||
Cash and Cash Equivalents |
$ | | $ | 11,440 | $ | 17,950 | $ | | $ | 29,390 | |||||||||||
Merchandise Inventories |
| 593,887 | 130,270 | | 724,157 | ||||||||||||||||
Other Current Assets |
| 57,028 | 125 | | 57,153 | ||||||||||||||||
Total Current Assets |
| 662,355 | 148,345 | | 810,700 | ||||||||||||||||
Investment in Subsidiaries |
76,127 | 125,918 | | (202,045 | ) | | |||||||||||||||
Property and Equipment, Net |
| 254,384 | 42,029 | | 296,413 | ||||||||||||||||
Intercompany Receivable |
859,771 | | | (859,771 | ) | | |||||||||||||||
Goodwill, Net |
| 5,020 | 201,382 | | 206,402 | ||||||||||||||||
Other Assets |
| 3,762 | 30,006 | | 33,768 | ||||||||||||||||
Deferred Tax Assets, Net |
785 | 51,534 | (4,615 | ) | | 47,704 | |||||||||||||||
Total Assets |
$ | 936,683 | $ | 1,102,973 | $ | 417,147 | $ | (1,061,816 | ) | $ | 1,394,987 | ||||||||||
LIABILITIES AND STOCKHOLDERS INVESTMENT |
|||||||||||||||||||||
Current Liabilities: |
|||||||||||||||||||||
Accounts Payable and Accrued Liabilities |
$ | 4,633 | $ | 236,180 | $ | 28,298 | $ | | $ | 269,111 | |||||||||||
Deferred Tax Liability, Net |
646 | 31,934 | (16,451 | ) | | 16,129 | |||||||||||||||
Total Current Liabilities |
5,279 | 268,114 | 11,847 | | 285,240 | ||||||||||||||||
Non-current Liabilities |
| 109,077 | 9,357 | | 118,434 | ||||||||||||||||
Intercompany Payable |
| 706,609 | 153,148 | (859,757 | ) | | |||||||||||||||
Long-term Debt |
99,665 | | 9,798 | | 109,463 | ||||||||||||||||
Excess of Revalued Net Assets
Over Stockholders Investment, Net |
| 41,287 | | | 41,287 | ||||||||||||||||
Total Stockholders Investment |
831,739 | (22,114 | ) | 232,997 | (202,059 | ) | 840,563 | ||||||||||||||
Total Liabilities and Stockholders
Investment |
$ | 936,683 | $ | 1,102,973 | $ | 417,147 | $ | (1,061,816 | ) | $ | 1,394,987 | ||||||||||
16
ZALE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
SUPPLEMENTAL CONDENSED CONSOLIDATING FINANCIAL INFORMATION (continued)
SUPPLEMENTAL CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
Three Months Ended October 31, 2001
(unaudited)
(amounts in thousands)
Parent | ||||||||||||||||||||
Company | Guarantor | Non-Guarantor | ||||||||||||||||||
Only | Subsidiary | Subsidiaries | Eliminations | Consolidated | ||||||||||||||||
Net Cash Provided by (Used in) Operating
Activities |
$ | 1,894 | $ | (27,038 | ) | $ | 1,150 | $ | (1,175 | ) | $ | (25,169 | ) | |||||||
Net Cash Flows from Investing Activities: |
||||||||||||||||||||
Additions to property and equipment |
| (18,484 | ) | (3,420 | ) | | (21,904 | ) | ||||||||||||
Dispositions of property and equipment |
| 818 | 84 | | 902 | |||||||||||||||
Net Cash Used in Investing Activities |
| (17,666 | ) | (3,336 | ) | | (21,002 | ) | ||||||||||||
Net Cash Flows from Financing Activities: |
||||||||||||||||||||
Payments on revolving credit agreement |
| (71,300 | ) | (9,432 | ) | | (80,732 | ) | ||||||||||||
Borrowings under revolving credit agreement |
| 119,900 | 9,431 | | 129,331 | |||||||||||||||
Proceeds from exercise of stock options |
30 | | | | 30 | |||||||||||||||
Purchase of common stock |
(1,924 | ) | | | | (1,924 | ) | |||||||||||||
Dividends paid |
| | (1,175 | ) | 1,175 | | ||||||||||||||
Net Cash (Used in) Provided by Financing
Activities |
(1,894 | ) | 48,600 | (1,176 | ) | 1,175 | 46,705 | |||||||||||||
Effect of Exchange Rate Changes on Cash |
| | (162 | ) | | (162 | ) | |||||||||||||
Net Increase (Decrease) in Cash and Cash
Equivalents |
| 3,896 | (3,524 | ) | | 372 | ||||||||||||||
Cash and Cash Equivalents at Beginning of Period |
| 11,440 | 17,950 | | 29,390 | |||||||||||||||
Cash and Cash Equivalents at End of Period |
$ | | $ | 15,336 | $ | 14,426 | $ | | $ | 29,762 | ||||||||||
17
ZALE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
SUPPLEMENTAL CONDENSED CONSOLIDATING FINANCIAL INFORMATION (continued)
SUPPLEMENTAL CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
Three Months Ended October 31, 2000
(unaudited)
(amounts in thousands)
Parent | ||||||||||||||||||||
Company | Guarantor | Non-Guarantor | ||||||||||||||||||
Only | Subsidiary | Subsidiaries | Eliminations | Consolidated | ||||||||||||||||
Net Cash Provided by (Used in) Operating Activities |
$ | 20,998 | $ | (315,148 | ) | $ | 251,623 | $ | (1,284 | ) | $ | (43,811 | ) | |||||||
Net Cash Flows from Investing Activities: |
||||||||||||||||||||
Additions to property and equipment |
| (22,054 | ) | (2,180 | ) | | (24,234 | ) | ||||||||||||
Dispositions of property and equipment |
| 398 | 126 | | 524 | |||||||||||||||
Acquisition of Piercing Pagoda, net of cash acquired |
| | (239,530 | ) | | (239,530 | ) | |||||||||||||
Net Cash Used in Investing Activities |
| (21,656 | ) | (241,584 | ) | | (263,240 | ) | ||||||||||||
Net Cash Flows from Financing Activities: |
||||||||||||||||||||
Payments on other long term debt |
| | (6,924 | ) | | (6,924 | ) | |||||||||||||
Payments on revolving credit agreement |
| (78,000 | ) | (2,799 | ) | | (80,799 | ) | ||||||||||||
Borrowings under revolving credit agreement |
| 145,500 | 1,964 | | 147,464 | |||||||||||||||
Proceeds from exercise of stock options |
556 | | | | 556 | |||||||||||||||
Purchase of common stock |
(21,554 | ) | | | | (21,554 | ) | |||||||||||||
Dividends paid |
| | (1,284 | ) | 1,284 | | ||||||||||||||
Net Cash Provided by (Used in) Financing Activities |
(20,998 | ) | 67,500 | (9,043 | ) | 1,284 | 38,743 | |||||||||||||
Effect of Exchange Rate Changes on Cash |
| | (107 | ) | | (107 | ) | |||||||||||||
Net (Decrease) Increase in Cash and Cash Equivalents |
| (269,304 | ) | 889 | | (268,415 | ) | |||||||||||||
Cash and Cash Equivalents at Beginning of Period |
| 281,213 | 17,021 | | 298,234 | |||||||||||||||
Cash and Cash Equivalents at End of Period |
$ | | $ | 11,909 | $ | 17,910 | $ | | $ | 29,819 | ||||||||||
18
Item 2.
ZALE CORPORATION AND SUBSIDIARIES MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This discussion and analysis should be read in conjunction with the unaudited Consolidated Financial Statements of the Company (and the related notes thereto) included elsewhere in this report.
Results of Operations
The following table sets forth certain financial information from the Companys unaudited Consolidated Statements of Operations expressed as a percentage of net sales.
Three Months Ended | ||||||||
October 31, | ||||||||
2001 | 2000 | |||||||
Net Sales |
100.0 | % | 100.0 | % | ||||
Cost of Sales |
49.2 | 50.8 | ||||||
Gross Margin |
50.8 | 49.2 | ||||||
Selling, General and Administrative Expenses |
48.1 | 43.1 | ||||||
Depreciation and Amortization Expense |
3.6 | 3.5 | ||||||
Unusual Item Executive Transaction |
| 0.7 | ||||||
Operating Earnings |
(0.9 | ) | 1.9 | |||||
Interest Expense, Net |
0.5 | 0.1 | ||||||
Earnings Before Income Taxes |
(1.4 | ) | 1.8 | |||||
Income Taxes |
(0.5 | ) | 0.7 | |||||
Earnings Before Effect of Accounting Change |
(0.9 | ) | 1.1 | |||||
Effect of a Change in Accounting for the Write Off of the
Excess of Revalued Net Assets Over Stockholders
Investment |
(10.2 | ) | | |||||
Net Earnings |
9.3 | % | 1.1 | % | ||||
Three Months Ended October 31, 2001 Compared to Three Months Ended October 31, 2000
Net Sales. Net sales for the three months ended October 31, 2001 of $405.4 million, an increase of 9.0 percent over net sales of $371.8 million for the prior year. Sales related to the kiosk operations acquired in September 2000 accounted for 7.7 percent of the total sales increase. Excluding the kiosk operations, sales increased 1.4 percent.
Comparable store sales decreased 2.3 percent in the three months ended October 31, 2001 on a constant currency basis. Comparable store sales include sales for those stores that were in operation for a full 12-month period in both the current year and prior year.
Management believes that sales were negatively affected as a result of the uncertain economic environment and the tragic events of September 11, 2001. While comparable store sales increased 5 percent from August 1 through September 10, they declined 7 percent from September 12 through October 31. Individual brand performance has been consistent, with the exception of our high-end brand, which has been sharply affected by recent events. Management expects the challenges in the high-end of the business to continue.
Strong sales in the bridal category, despite the economic slowdown, contributed to this sales increase. The Company benefitted from strong sales in the diamond and solitaire categories, especially the certified diamonds and exclusive branded diamonds. The following items contributed to the sales increase: improved quality of product offerings; diminished reliance on clearance items; and improved inventory control which allowed stores to remain in stock on key items.
19
Gross Margin. Gross Margin as a percentage of sales was 50.8 for the three months ended October 31, 2001, an increase of 1.6 percentage points over the prior year. The addition of the kiosk operations, which have a higher gross margin rate than the rest of the Companys in-line stores, improved the gross margin by 1.0 percentage point. The remaining improvement in gross margin is primarily due to a reduced emphasis on clearance items and reduced promotional activity, resulting in lower markdowns.
Selling, General and Administrative Expenses. Selling, general and administrative (SG&A) expenses increased 5.0 percent to 48.1 percent of sales for the three months ended October 31, 2001, from 43.1 percent of sales for the three months ended October 31, 2000. Approximately 0.7 percentage points of this increase is due to the acquisition of the kiosk operations in September 2000. This business has higher store expense as a percentage of sales.
Excluding the kiosk operations, SG&A expenses were 46.0 percent of sales, an increase of 4.3 percentage points over the prior year. Occupancy costs increased 1.8 percent during the period due to an increase in total lease costs for both existing and new stores. This increase is primarily due to new leases with higher fixed rent and, consequently, less variable based rent during a period of slower sales.
Other store expenses increased 2.5 percent of sales, principally due to the cost of offering more interest free programs, in the three months ended October 31, 2001 as compared to the prior year. Payroll expenses increased by 0.8 percent of sales due to an investment in store personnel, while advertising costs decreased by 0.2 percent of sales due to the Companys effort to monitor its return on advertising investments.
Unusual Item Executive Transactions. The Company recorded a severance benefit charge for Robert J. DiNicolas retirement as Chairman of the Board in September 2000. Mr. DiNicola was re-appointed as Chairman of the Board and Chief Executive Officer in the third quarter of fiscal 2001.
Depreciation and Amortization Expense. Depreciation and Amortization Expense increased by $1.6 million, primarily from the purchase of new assets, principally for new store openings, renovations and refurbishments. The increase from new assets is offset by the elimination of goodwill amortization and the excess of revalued net assets (negative goodwill) amortization, due to the adoption of SFAS No. 141 and 142 on August 1, 2001. As a result of the adoption of both SFAS No. 141 and 142, net amortization expense for the three month period ended October 31, 2001 decreased $0.7 million from the comparable period of the prior year.
Interest Expense, Net. Interest Expense, Net was $2.0 million and $0.3 million for the three months ended October 31, 2001 and 2000, respectively. The increase in Interest Expense, Net is principally a result of reduced Interest Income (which offsets Interest Expense), as compared to the prior year. During the first two months of the first quarter of fiscal 2000, the Company invested cash proceeds from the sale of its customer receivables in interest earning assets. A significant portion of those cash proceeds were subsequently used to acquire Piercing Pagoda, Inc. in September 2000.
Income Taxes. The income tax (benefit) provision for the three month periods ended October 31, 2001 and 2000 was ($2.2) million and $2.6 million, respectively, reflecting an effective tax rate of 37.1 percent and 39.0 percent, respectively. The decrease in the effective rate is principally due to the elimination of the goodwill amortization in the current year due to the adoption of SFAS Nos. 141 and 142 on August 1, 2001. The Company will realize a cash benefit from utilization of tax net operating loss carryforward (NOL) (after limitations) against current and future tax liabilities. As of July 31, 2001, the Company had a remaining NOL (after limitations) of approximately $152.9 million.
20
Effect of a Change in Accounting for the Write Off of the Excess of Revalued Net Assets Over Stockholders Investment. On July 21, 2001, the Financial Accounting Standards Board issued SFAS No. 141 Business Combinations. SFAS No. 141 establishes specific criteria for the recognition of intangible assets subsequent to their acquisition, including negative goodwill. Negative goodwill related to future acquisitions should be recorded as an extraordinary item. In addition, upon adoption, existing negative goodwill (or excess of revalued net assets over stockholders investment) should be written off as a change in accounting principle. The Company adopted SFAS No. 141 in the first quarter of fiscal 2002. As a result, the Company wrote off the Excess of Revalued Net Assets Over Stockholders Investment (negative goodwill) of approximately $41.3 million in the first quarter of fiscal 2002.
Liquidity and Capital Resources
The Companys cash requirements consist principally of funding inventory, capital expenditures primarily for new store growth, renovations, and upgrades to its management information systems and debt service. As of October 31, 2001 and 2000, the Company had unrestricted cash and cash equivalents of $29.8 million and $29.8 million, respectively. At the same time, the Companys borrowings as shown in long-term debt have been reduced from $176.8 million at October 31, 2000 to $157.7 million at October 31, 2001. The retail jewelry business is highly seasonal, with a significant proportion of sales and operating income being generated in November and December of each year. Approximately 42 percent and 41 percent of the Companys annual sales were made during the three months ended January 31, 2001 and 2000, respectively, which includes the holiday selling season. The Companys working capital requirements fluctuate during the year, increasing substantially during the fall season as a result of higher planned seasonal inventory levels.
Finance Arrangements
In order to support the Companys growth plans, the Company amended and restated its unsecured Revolving Credit Agreement on March 30, 2000. The Revolving Credit Agreement provides for (i) a U.S. Revolving Credit facility to the Company in the aggregate principal amount of up to $215 million in commitments by certain U.S. lenders, including a $10 million sublimit for letters of credit, and (ii) a separate Canadian Revolving Credit facility, which provides for Canadian Dollar denominated loans in the aggregate principal amount of up to a U.S. Dollar equivalent of $10 million in commitments by a Canadian lender. The total amount of commitments under the Revolving Credit Agreement to the Company and its subsidiaries is approximately $225 million, and the term is five years. Under the Revolving Credit Agreement the Company may, subject to approval of the U.S. Agent or the Canadian Agent, as the case may be, increase the total U.S. commitment to $285 million and the Canadian commitment to a U.S. Dollar equivalent of $25 million provided that the commitments together do not exceed a U.S. Dollar equivalent of $300 million.
The revolving credit loans bear interest at floating rates as follows: (A) loans outstanding under the U.S. Revolving Credit facility bear interest, at the Companys option, at either (i) the applicable Eurodollar Rate plus a margin equal to 0.50 percent (subject to adjustment), or (ii) the Base Rate (which is the higher of the annual rate of interest announced from time to time by the agent bank under the Revolving Credit Agreement as its base rate or the Federal Funds Effective Rate plus 0.50 percent); and (B) loans outstanding under the Canadian Revolving Credit facility bear interest, at the Companys option, at either (i) a Bankers Acceptance Discount Rate (which varies depending upon whether the Canadian Lender is a bank named under Schedule I or II to the Bank Act (Canada) or neither) plus a margin equal to 0.50 percent (subject to adjustment), or (ii) the annual rate of interest announced from time to time by the Canadian agent bank under the Revolving Credit Agreement as its prime rate for commercial loans in Canadian Dollars to borrowers in Canada. At October 31, 2001, there were approximately $48.6 million in revolving credit loans outstanding under the U.S. Revolving Credit facility and there was a U.S. Dollar equivalent of approximately $9.4 million in revolving credit loans outstanding under the Canadian Revolving Credit facility to fund seasonal inventory growth.
In order to support the Companys longer term capital financing requirements, the Company issued $100 million of Senior Notes (the Senior Notes) on September 23, 1997. These notes bear interest at 81/2 percent and are due in 2007. The Senior Notes are unsecured and are fully and unconditionally guaranteed by ZDel. The proceeds were utilized to repay indebtedness under the Companys Revolving Credit Agreement and for general corporate purposes. The indenture relating to the Senior Notes contains certain restrictive covenants including
21
but not limited to limitations on indebtedness, limitations on dividends and other restricted payments (including repurchases of the Companys common stock), limitations on transactions with affiliates, limitations on liens and limitations on disposition of proceeds of asset sales, among others.
Capital Growth
As a result of current business conditions and its conservative cash management strategy, the Company has scaled back its capital expenditure plan. Accordingly, the Company will reduce fiscal year 2002 capital expenditures to approximately $55 million. Approximately $43 million will be used to open 63 new stores and kiosks, and remodel, relocate or refurbish approximately 180 locations. The Company also estimates it will make capital expenditures of approximately $12 million during fiscal year 2002 for enhancements to its management information systems and infrastructure expansion. The Revolving Credit Agreement limits the Companys capital expenditures to $135 million for fiscal year 2002.
Other Activities Affecting Liquidity
In August 2001, the Company announced a stock repurchase program pursuant to which the Company, from time to time at the discretion of management and the Board of Directors and in accordance with the Companys usual policies and applicable securities laws, may purchase up to an aggregate of $50 million of Zale Corporation common stock on the open market through July 31, 2002. As of October 31, 2001, the Company had repurchased 70,000 shares at an aggregate cost of $1.9 million under this program.
Future liquidity will be enhanced to the extent that the Company is able to realize the cash benefit from utilization of its net operating loss (NOL) against current and future tax liabilities. The cash benefit realized in fiscal year 2001 was approximately $7 million. As of July 31, 2001, the Company had a NOL (after limitations) of approximately $152.9 million, which represents up to $59 million in future tax benefits. The utilization of this asset is subject to limitations. The most restrictive limitation is the Internal Revenue Code Section 382 annual limitation. The NOL can be utilized through 2008.
Management believes that operating cash flow and amounts available under the Revolving Credit Agreement should be sufficient to fund the Companys current operations, debt service and currently anticipated capital expenditure requirements for the foreseeable future.
Inflation
In managements opinion, changes in net sales and net earnings that have resulted from inflation and changing prices have not been material during the periods presented. However, there is no assurance, that inflation will not materially affect the Company in the future.
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Cautionary Notice Regarding Forward-Looking Statements
This Report contains forward-looking statements, including statements regarding the Companys objectives and expectations regarding its sales and earnings, merchandising and marketing strategies, store renovation, remodeling and expansion, inventory performance, capital expenditures, liquidity, productivity and profitability which are based upon managements beliefs as well as on assumptions made by and data currently available to management. These forward-looking statements are not guarantees of future performance and a variety of factors could cause the Companys actual results to differ materially from those anticipated or expected results expressed in these forward looking statements. The following list, which is not intended to be an all-encompassing list of risks and uncertainties affecting the Company, summarizes several factors that could cause the Companys actual results to differ from those anticipated or expected in these forward-looking statements: that low or negative growth in the economy or in the financial markets will occur and reduce discretionary spending on goods that are, or are perceived to be, luxuries; that the events of September 11, 2001 and related events will negatively impact the economy or the financial markets and reduce discretionary spending on such goods; that warehousing and distribution productivity and capacity can be further improved to support the Companys distribution requirements; that strong competitive responses may impact the Companys efforts to leverage its brand power with its marketing, merchandising and promotional efforts; that seasonality of the retail jewelry business or downturns in consumer spending during the fourth calendar quarter may adversely affect the Companys results; that the Company may not be able to continue to manage its inventory and product supply effectively to respond to consumer demand; that fluctuations in diamond prices may negatively effect the business; that the Company may not be able to integrate acquisitions into its existing operations or that new acquisitions and alliance opportunities that enhance shareholder value may not be available on terms acceptable to the Company; that the efforts to redefine the strategic role of each brand may not be successful; that litigation may have an adverse effect on the financial results or reputation of the Company; that key personnel who have been hired or retained by the Company may depart; that any disruption in the Companys private label credit card arrangement may adversely affect the Companys ability to provide consumer credit; or that changes in government or regulatory requirements may increase the cost of or adversely affect the Companys operations. The Company disclaims any obligation to update or revise publicly or otherwise any forward-looking statements to reflect subsequent events, new information or future circumstances.
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Item 3. Quantitative and Qualitative Disclosures About Market Risk
The Company believes that the market risk of the Companys financial instruments as of October 31, 2001 has not materially changed since July 31, 2001. The market risk profile on July 31, 2001 is disclosed in the Companys Annual Report on Form 10-K for the year ended July 31, 2001.
The Companys commodity risk exposure to diamond and gold market price fluctuation is not hedged by financial instruments. The Company addresses commodity price risk through retail price points.
Part II. Other Information
Item 1. Legal Proceedings
The Company is involved in certain legal actions and claims arising in the ordinary course of business. Management believes that such litigation and claims will be resolved without material effect on the Companys financial position or results of operations.
On October 23, 2001, a plaintiff filed a complaint against Zale Corporation and Zale Delaware, Inc. in the Superior Court of California, County of Los Angeles, Central District. The complaint is a purported class action on behalf of current and former salaried store managers and assistant store managers of the Company in California. The complaint alleges that these individuals were entitled to overtime pay and should not have been classified as exempt employees under California law. Plaintiff seeks recovery of overtime pay, declaratory relief and attorneys fees. The Company intends to vigorously defend the action.
Otherwise, legal proceedings of the Company as of October 31, 2001 have not materially changed since July 31, 2001. Legal proceedings as of July 31, 2001 are disclosed in the Companys Annual Report on Form 10-K for the year ended July 31, 2001.
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Item 4. Submission of Matters to a Vote of Security Holders
(a) | On November 2, 2001, the Annual Meeting of Stockholders of the Company was held at the Omni Park West Hotel Dallas, Texas. There were 34,825,378 shares of common stock outstanding on the record date and entitled to vote at the Annual Meeting. | |
(b) | The following directors were elected: |
Name of Nominee | Votes For | Votes Withheld | ||||||
Robert J. DiNicola |
29,615,566 | 140,118 | ||||||
Glen Adams |
29,616,237 | 139,447 | ||||||
A. David Brown |
29,474,737 | 280,947 | ||||||
Peter P. Copses |
29,616,187 | 139,497 | ||||||
Richard C. Marcus |
29,616,187 | 139,497 | ||||||
Charles H. Pistor |
29,616,015 | 139,669 | ||||||
Alan P. Shor |
26,392,631 | 3,363,053 | ||||||
Andrew Tisch |
29,612,587 | 143,097 |
(c) | The adoption of the amendment to the Restated Certificate of Incorporation of Zale Corporation was ratified with 28,761,198 votes for, 782,993 votes against, and 211,493 abstentions. | |
(d) | The appointment of Arthur Andersen LLP as Independent Public Accountants for the fiscal year ending July 31, 2002 was ratified with 29,331,063 votes for, 413,435 votes against and 11,186 abstentions. |
Item 6. Exhibits and Reports on Form 8-K
(a) | Exhibits |
3.1 | Restated Certificate of Incorporation of Zale Corporation, as amended. |
(b) | Reports on Form 8-K | |
On September 5, 2001, the Company filed a Current Report on Form 8-K under Item 9, Regulation D Disclosure, to furnish a slide presentation from a meeting with institutional investors. |
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SIGNATURE
Pursuant to the requirements 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.
Zale Corporation (Registrant) |
Date December 7, 2001 |
/s/ Mark R. Lenz Mark R. Lenz Senior Vice President, Controller (principal accounting officer of the registrant) |
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INDEX TO EXHIBITS
Exhibit Number | Description | |||||||
3.1 |
Restated Certificate of Incorporation of Zale Corporation, as amended. |
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