Item 1. Business.
General
Peebles operates 65 specialty department stores offering merchandise for the entire family and selected decorative home accessories. Founded in 1891, the Company operates primarily in smaller communities in ten southeastern and mid-Atlantic states. Peebles positions itself as the leading fashion retailer in these communities, which typically do not have a traditional mall-based department store, and locates its stores in the primary shopping destinations in its markets. Peebles offers its customers consistent value by providing a broad assortment of moderately priced national brands supplemented with quality private label merchandise. Peebles' attractive stores and visual presentation, advertising and promotional programs further reinforce its image as the market's fashion leader.
References to 1991, 1992, 1993, 1994 and 1995 relate to the fiscal years of the Company ending February 1, 1992, January 30, 1993, January 29, 1994, January 28, 1995 and February 3, 1996, respectively. Fiscal years 1991, 1992, 1993 and 1994 each include 52 weeks. Results of operations for 1995 consisted of fifty-three weeks, with 17 weeks included in the four-month period ended May 27, 1995 and 36 weeks in the eight month period ended February 3, 1996. References herein to 1995 relate to the 53-week period ended February 3, 1996.
The entire equity interest of Peebles Inc. was acquired by PHC Retail Holding Company ("PHC Retail"), effective May 27, 1995. PHC Retail is an affiliate of Kelso & Company ("Kelso"), an investment firm located in New York, New York. PHC Retail has no significant assets other than the shares of Peebles common stock, and had no operations prior to the 1995 Acquisition. The acquisition was accounted for using the purchase method of accounting, and accordingly, a new accounting base year was established. The acquisition has not resulted in, and is not expected to result in any deviation from the Company's pre-acquisition strategic plans involving store operations, except that greater flexibility is afforded through the New Credit Agreement, as defined, and the added financial support of Kelso as an equity owner within that agreement.
Operating Strategy
The following are key elements to Peebles operating strategy:
Focus on Small Markets. Peebles locates its stores in smaller communities that typically do not have a traditional mall-based department store, thereby limiting competition and allowing Peebles to be the leading fashion retailer in these communities. The Company believes its ability to successfully operate in markets with as few as 5,000 households is an important competitive advantage over large department stores, which generally cannot profitably operate in such
markets. Peebles has operated in small communities for over 100 years and understands its markets and customers.
Operate Small Stores with Lower Cost Structure. Peebles, with its focus on small communities, operates stores that are significantly smaller than the traditional full-line department store. Peebles' stores average 32,000 square feet and vary in size from 10,000 to 65,000 square feet. The Company operates profitably despite its smaller stores and lower sales per square foot compared with other department store companies due to its high gross margins, emphasis on cost control and centralized operations.
Deliver Fashion to Small Communities. Peebles strives to provide its customers with a shopping experience similar to that found in a traditional mall-based department store, although with fewer merchandise categories. The Company emphasizes a broad selection of moderately-priced national brands and private label merchandise, which generally is not available through other retailers in the market. Peebles' attractive stores and visual presentation, advertising and promotional programs further reinforce its image as the market's fashion leader.
Offer Value to Customers. Peebles emphasizes value pricing and is less promotional than traditional department stores. It is the Company's strategy to use lower initial mark-ons and promote less, thereby maintaining a high level of credibility with its customers. Peebles' commitment to providing value to its customers is integral to creating repeat customers, a critical ingredient for success in smaller markets.
Centralize Operations, but Tailor Merchandise Locally. Peebles believes that centralized decision-making, controls and support functions are critical to its cost-efficient operations and enable the Company's store personnel to maximize the time devoted to selling. In contrast, Peebles employs a decentralized approach in merchandising its individual stores. The merchandise mix is tailored to individual stores to cater to local tastes and preferences based on customer and sales associate feedback and sales trends. Buyers and store associates work together to optimize the use of Peebles' smaller selling spaces to meet customer demand and maximize sales.
Adapt to Local Real Estate Opportunities. Smaller stores and a flexible store format give the Company the ability to locate in a variety of new or existing sites. As a result, Peebles' growth is not dependent upon the development of new malls. Peebles attempts to position its stores in the primary shopping destination in its markets, which are typically strip shopping centers co-anchored by leading discount, grocery and drug retailers. The Company also operates successfully in enclosed malls and downtown locations.
Expansion Strategy
The Company has expanded by opening new stores, acquiring and converting stores and groups of stores, and remodeling or relocating existing stores. The Company anticipates expanding its operations through the following:
Opening New Stores. The Company intends to open five new stores in 1996 and ten new stores in 1997. As of April 1, 1996 the Company has signed three leases for stores scheduled to open in 1996, representing approximately 67,000 in total square footage. The Company's new stores will be located in existing and contiguous markets where it can realize distribution efficiencies and where the Peebles concept and merchandise mix will correspond to local demographics. The Company explores a wider range of real estate options than retailers which rely only on new shopping center development, and actively considers space vacated by other retailers.
Remodeling and Relocating Stores. In addition to new store growth, the Company has an ongoing remodeling program, both upgrading existing stores and reallocating selling space to provide its customers a pleasant, fashion-oriented shopping environment for the merchandise mix for that market. Since January 30, 1993, the Company has remodeled eleven stores and relocated four stores. The Company expects to relocate selected stores in the future to the desired shopping destination in that market.
Acquisitions. The Company believes that from time to time opportunities may arise for the acquisition of individual stores or groups of stores. In 1993, the Company acquired one store and in 1988, the Company acquired ten stores in Kentucky and Tennessee, adding to its then existing base of 38 stores. The Company is continually evaluating acquisitions of both individual stores and groups of stores.
Peebles Stores
Peebles stores are designed and managed to create an appealing shopping experience, foster customer convenience and maximize operating efficiency. The Company's stores range in size from 10,000 to 65,000 square feet and average 32,000 square feet, which is significantly smaller than the traditional full-line department store. The Company does not have a standard store format and instead adapts its stores to existing real estate opportunities. The Company's stores feature a bright, modern and accessible layout with an emphasis on the visual presentation of merchandise. The store layout is designed to draw the customer through the store, creating opportunities for cross-selling.
The Company targets communities with between 10,000 and 25,000 households. According to Company estimates, as of February 3, 1996, approximately 60% of the Company's stores are located in markets with fewer than 20,000 households. Peebles can operate profitably in markets with as few as 5,000 households. The Company enters larger markets and suburban areas with 25,000 to 40,000 households where the customer base and competitive factors exhibit characteristics similar to markets where the Company's operating strategy has proven successful. The Company prefers to locate its stores in strip shopping centers and enclosed malls where other anchors such as a leading grocery, discount and
drug retailers will create a destination shopping location. Of the 65 stores currently in operation, 42 are located in strip shopping centers, 19 in enclosed malls and 4 in downtown locations.
Merchandising
The Company's merchandise, approximately 80% of which is apparel, is targeted to middle income customers shopping for their families and homes. The Company has fewer departments than a traditional full-line department store, but strives to carry a wide assortment of merchandise within its targeted categories in order to appeal to a broad range of customers. To position itself as the primary fashion retailer in the community with merchandise not found elsewhere in the market, the Company emphasizes moderately-priced national brands, supplemented by a limited selection of prestige brand names and a selection of quality private label merchandise. Peebles merchandise is fashion responsive rather than fashion forward, limiting the Company's inventory exposure. The Company's stores carry apparel for the entire family, accessories and cosmetics, and decorative home accessories.
Management believes that brand name merchandise is a significant attraction to its customers and intends to continue emphasizing such merchandise in its stores. For example, the Company carries nationally branded cosmetics in as many of its stores as possible because Peebles is typically the only retailer in the community where consumers can purchase that merchandise. While the gross margins on cosmetics are typically lower than the Company's average gross margin, the availability of this merchandise generates store traffic which facilitates the sale of higher margin merchandise.
In 1995, a majority of the merchandise sold by the Company was nationally branded merchandise. Key brands featured by the Company include:
Ladies........ Liz Claiborne, Etienne Aigner, Alfred Dunner, Oak Hill, Koret, Monet, Hanes, Goodman Knitting, Playtex, Forecaster, Byer of California, Shadowline, Pendleton, Michael Stevens, Halmode Apparel, Stuart Alan, Fritzi of California
Men's......... Levi, Haggar, Bugle Boy, Arrow, Van Heusen, Champion, Swank
Young Men's and Juniors.. Levi, Bugle Boy, Byer of California, B.U.M. Equipment, Union Bay, Lee, Rampage, Bongo, Zeppelin, Gotchaco, Fritzi of California
Children's.... Buster Brown, HealthTex, Oshkosh B'Gosh, Baby Togs, William Carter
Shoes......... Reebok, Nike, Brown Shoe, Keds, Fila, Nunn Bush, What's What
Home.......... Springs, Pacific Home, Arch, Whiting, World Bazaars, Mikasa,
Cosmetics..... Estee Lauder, Elizabeth Arden, Fashion Fair, Calvin Klein, Liz Claiborne,
As a complement to its national brand merchandise, the Company offers private label merchandise in selected departments to give its customers a wider range of products. Management believes that its private label merchandise provides value to the Peebles customer by offering a quality merchandise alternative at prices lower than national brands. In addition, private label merchandise often has higher gross margins than brand name merchandise and allows the Company to avoid direct price competition.
In order to efficiently utilize its smaller selling space, Peebles tailors the merchandise selection at individual stores. The Company utilizes its knowledge of its markets and customers developed over 104 years along with input from the store managers and sales associates to allocate merchandise to the stores. The Company also maintains an inventory tracking system which provides daily information as to sales and inventory levels by store, department, vendor, class, style, size and color. Based on this information, the Company analyzes market trends, identifies fast or slow moving merchandise and makes reordering and pricing decisions on a daily basis.
Peebles emphasizes value pricing and is less promotional than the traditional department store. It is the Company's pricing strategy to use lower initial mark-ons and promote less, thereby maintaining a high level of credibility with its customers. Peebles' commitment to providing value to its customers is integral to creating repeat customers, a critical ingredient for success in smaller markets. Peebles utilizes its "Our Price" program with approximately 30% of the Company's merchandise. With this program, the Company has even lower initial mark-ons on certain national brand name products which are considered to be less fashion sensitive such as jeans, socks and underwear. Products in this program are marketed through special point of sale displays and are featured in the Company's advertising.
Advertising and Promotion
The Company's advertising and promotion strategy is designed to support its marketing goals of providing quality merchandise at value-oriented prices and reinforces the Company's image as the leading fashion retailer in its markets. Peebles utilizes a direct mail program, which in part employs information obtained from its charge card program to target mailings to its charge card holders. The Company emphasizes newspaper advertising and mailers rather than television and radio, due to the size and nature of the markets served. Peebles uses both black and white advertisements and full color mailers to highlight promotional items and events as well as products in its "Our Price" program.
In addition, the Company's advertising and promotional staff organizes special events at the stores and arranges for all Grand Opening and Grand Reopening events. In 1995, the Company continued as an associate sponsor of a racing team in the NASCAR Busch Grand National stock car racing series, which the Company believes will increase its exposure in both existing and potential markets.
The Company's net advertising expenses in 1993, 1994 and 1995 were 2.7%, 2.5% and 2.6% of net sales, respectively, which the Company believes is lower than traditional department stores due to emphasis on an everyday fair price policy and a less promotional strategy.
Purchasing and Distribution
The Company employs 24 buyers and seven merchandise managers who are responsible for most merchandising decisions including purchasing, pricing, sales promotions, inventory allocations and markdowns. While these decisions are made centrally, the Company endeavors to refine its merchandise assortment to appeal to the customers in each market. Peebles' buying staff has developed specific knowledge with regard to purchasing, inventory and promotions for the Company's smaller sized stores. The merchandising group participates in an incentive plan based on sales, gross margin dollars generated and inventory turnover.
The Company places special emphasis on maintaining all merchandise in stock, particularly advertised and basic merchandise, to build and maintain credibility with its customers. By monitoring unit sale information by store, buyers are able to quickly determine the styles, colors and sizes of merchandise to be reordered and distributed to individual stores.
The Company purchases its merchandise from approximately 1,275 suppliers and is not dependent on any single source of supply. The Company is a member of Frederick Atkins, Inc., an international cooperative buying service. This cooperative offers members merchandise purchasing opportunities, which the Company has taken advantage of particularly in connection with its imported private label merchandise. During 1993, 1994 and 1995, Frederick Atkins, Inc. was the Company's largest supplier, accounting for retail purchases totaling approximately 17.0%, 17.7% and 17.3%, respectively. The Company believes it has a good relationship with Frederick Atkins, Inc. and is not aware of a situation in which Frederick Atkins, Inc. would not continue to supply the Company. In the event such a situation arose, the Company believes that it could avoid significant disruptions in its purchasing process or significant changes to its merchandise mix through the use of other resources.
Virtually all merchandise is shipped directly from vendors to the Company's distribution center where it is inspected, sorted, marked, ticketed, packed and held in bins for each individual store. The Company does not warehouse merchandise and has a goal of processing goods through the distribution center in three days. Merchandise is shipped to each store an average of twice a week on Company-owned trucks.
The Company's distribution center is located on 31 acres in South Hill, Virginia, adjacent to the Company's headquarters and close to major interstates. In 1992, the Company renovated and expanded the distribution center from 85,000 square feet to its current 117,000 square feet and further automated its distribution process, including an extensive network of conveyors and recycling equipment. The distribution center currently operates one eight hour shift daily. In 1996, the Company plans to add an additional 30,000 square feet to the distribution center. Management believes the cost of this expansion will be approximately $2.5 million and that, with such expansion, the distribution center can service 110 stores.
Store Operations
The Company has structured its store operations to maintain what management believes are key operating advantages including a thorough knowledge of its customer base, the ability to share information between the stores, and cost efficient operations through centralized decision making.
Peebles performs as many functions as possible at the corporate level so that store level management and sales associates can spend most of their time with customers. Non-sales store personnel are kept to a minimum due to control functions performed at the corporate offices, including sales associate scheduling, customer credit and marking merchandise. All stores utilize a minimum 85% of their total payroll hours in a selling capacity.
Peebles encourages the participation of all store level management and sales associates in decision making, and management regularly solicits input and suggestions from its employees who are closest to the customer. In addition to its management information systems, Peebles stays in close contact with store operations through its seven regional managers. Each store manager reports to a regional manager, who also manages a store. Regional managers visit their stores at least once a month to review merchandise presentation, personnel training and performance, enforcement of the Company's security procedures and adherence to Company operating procedures. The regional managers meet quarterly to share information.
The Company conducts a management training program, which coordinates instruction at the Company's corporate headquarters facility with on-the-job experience. The Company stresses promotion from within, and substantially all of the current store managers have been selected in this manner. Approximately 45% of the store managers have been with the Company ten or more years.
Most stores typically employ several assistant managers and approximately 30 sales associates, a number of whom are part-time. All Peebles' store personnel, including assistant store managers and sales associates, participate in incentive plans. The Company uses periodic productivity reports and personal reviews to apprise each employee of his or her performance.
Peebles Charge Card
In 1993, 1994 and 1995, 42.0%, 40.4% and 38.8%, respectively, of net sales were made using the Company's proprietary credit card. As of February 3, 1996, the Company had approximately 592,500 credit card accounts, of which 153,100 were billed accounts.
Peebles' charge card sales represent an important element in its marketing strategy because the Company believes that Peebles charge card holders generally constitute its most loyal and active customers. Information regarding purchases by the Company's credit card customers is recorded at the stores' point-of-sale terminals and transmitted directly to the Company's data processing center. This information is used to bill accounts as well as to provide marketing information regarding purchasing habits and merchandise preferences. The Company uses this data to develop segmented advertising and promotional programs to reach specific groups of customers who have established purchasing patterns for certain brands, departments and store locations.
Peebles administers all aspects of its credit card program, and decisions with respect to the opening of new accounts, extensions of "instant credit," adjustments to bills and responses to customer inquiries are made by Company-trained associates located at Peebles' headquarters. Management believes this in-house credit program provides the Company with an important customer relations advantage over competing retailers which administer their credit programs from remote processing locations or contract for such services from unrelated third parties.
The Company's credit plans provide for the option of paying in full within 28 days of the billed date with no finance charge or with revolving credit terms. Terms of the short-term revolving charge accounts require customers to make minimum monthly payments in accordance with prescribed schedules. Peebles bears the risk of the collecting its credit card receivables. Peebles' credit card program has had a positive impact on net income.
The following table presents a summary of information relating to the Company's charge card sales and receivables (in thousands):
Period-End Allowance Net Bad Debt Expenses For Doubtful Accounts ----------------------- ------------------------------------------ % of Period-End Total % of Total Years Sales Amount Sales Customer Receivables Amount Receivables ------- ------- ------ ----- -------------------- ------ ----------- 1993..... 63,696 696 1.1 29,336 950 3.2 1994..... 67,651 640 1.0 29,742 930 3.1 1995..... 68,216 766 1.1 29,494 960 3.3
Management Information Systems
The Company's management information systems provide the daily financial and merchandising information to make timely and effective pricing decisions and for inventory control. The Company is able to allocate its inventory effectively as a result of its management information systems and can tailor the merchandise mix to meet the individual customer demands at each store.
The Company maintains central management information and data processing systems at its corporate headquarters. Each of its stores is equipped with compatible point-of-sale registers, which are polled every evening by the central system to gather sales, accounts receivable and inventory information.
The Company's management information and data processing systems primarily use internally developed software. The Company believes this allows management to more closely control the quality,
suitability and expense of management information systems and data processing. The Company continues to make selected improvements in computer hardware technology as well as enhancements to software applications as needed.
Employees
At February 3, 1996, the Company had 961 full-time employees and 1,311 part-time employees. None of the Company's employees is covered by a collective bargaining agreement. The Company considers its employee relations to be good.
Competition
The retail industry is highly competitive, with selection, price, quality, service, location and store environment being the principal competitive factors. The Company competes with national and local retail stores, specialty apparel chains, department stores, discount stores and mail order merchandisers, many of which have substantially greater financial and marketing resources than the Company. Demographic changes may alter the character of the Company's markets, which can result in increased competition from other retailers.
Trademarks
The Peebles name is registered as a trademark and a servicemark of the Company. Additionally, the Company has registered several merchandise labels as trademarks under which it sells quality merchandise such as Cape Classic(TM), Private Expressions(TM), Meherrin River Outfitters(TM), Harmony Grove(TM) and Sonoma Bay(TM).
Regulation
The Company is subject to federal, state and local laws and regulations affecting retail department stores generally. The Company believes that it is in substantial compliance with these laws and regulations.
Item 2.
Item 2. Properties.
All but one of the Company's stores are leased, and most of the leases contain renewal options. The stores range in size from 10,000 square feet to 65,000 square feet, and average 32,000 square feet. The following table indicates the location of the Company's stores in operation as of April 1, 1996:
Delaware Tennessee Rehoboth Beach Columbia Seaford Cookeville Dyersburg Kentucky Hermitage Hopkinsville Humbolt Madisonville Murfreesboro
Maryland Virginia Bowie Ashland Chestertown Appomattox Easton Blackstone Eldersburg Christiansburg Elkton Colonial Heights Lexington Park Covington Prince Frederick Danville Salisbury Emporia Waldorf Front Royal Hayes New Jersey Hampton Rio Grande Hopewell Lawrenceville New York Leesburg Geneva Auburn Virginia Lexington North Carolina Luray Aberdeen Manassas Charlotte Norfolk Eden Onley Jacksonville Richmond Monroe Rocky Mount Marion Smithfield Roxboro South Hill Statesville Stafford Warrenton Pennsylvania Waynesboro Gettysburg Williamsburg Woodbridge South Carolina Woodstock Conway Wytheville Florence Georgetown Myrtle Beach
The Company owns the real estate upon which its Lawrenceville, Virginia store is located.
Store leases provide for a base rent of between $1.00 and $6.00 per square foot per year. Most leases also have formulas requiring the payment of additional rent based on a percentage of net sales above specified levels. In 1993, 1994 and 1995, the Company's aggregate rental payments on operating leases were approximately $6.0 million, $6.4 million and $7.2 million, respectively.
The Company's corporate headquarters and distribution center facilities are located in South Hill, Virginia. The Company owns the property subject to deeds of trust and security interests granted in connection with the Company's credit agreement. The Company believes the location provides the Company with adequate undeveloped space to expand the corporate headquarters, distribution center or both to meet future growth requirements.
Item 3.
Item 3. Legal Proceedings.
The Company is from time to time involved in routine litigation. Based on consultations with legal counsel, the Company believes that none of the litigation in which it is currently involved is material to its financial condition or results of operations.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders.
NONE
PART II
Item 5.
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.
Market Information
All of the Company's common stock is owned by PHC Retail Holding Company. See Item 12. "Security Ownership of Certain Beneficial Owners and Management." There is no existing market for the Common Stock, nor is the Common Stock listed on any exchange. All currently outstanding shares of common stock were issued pursuant to exemptions from registration under the Securities Act of 1933, as amended (the "Act"), and any resales of such shares of Common Stock can only be made pursuant to an effective registration statement or an exemption from the registration requirements of the Act.
Dividends
The Company does not currently pay any dividends on its Common Stock. The Company's credit agreement prohibits the payment of dividends absent the consent of the lender. Accordingly, the Company does not currently intend to declare any dividends to the holders of the Common Stock in the foreseeable future.
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Item 6.
Item 6. Selected Financial Data.
The following selected historical financial data for Peebles for the five fiscal years ended February 3, 1996 are derived from the Company's audited financial statements. Effective May 27, 1995, PHC Retail Holding Company ("PHC Retail") acquired the entire equity interest of Peebles Inc. (the "1995 Acquisition"). The 1995 Acquisition was accounted for as a purchase; and accordingly, a new basis of accounting was begun. As a result, the financial data for the eight-month period subsequent to the 1995 Acquisition is not comparable to the financial data for the prior periods. The Company was recapitalized effective January 31, 1992. The data should be read in conjunction with the financial statements, related notes and other financial information included herein.
(Dollars in thousands except per share and selected other data)
Selected Financial Data Footnote Legend N/M*- Not meaningful. 1) On January 31, 1992, the Company was recapitalized. 2) Revaluation of goodwill is a result of the recapitalization of the Company. 3) Reflects a gain on the exchange of debt related to the recapitalization of the Company. 4) Only reflects data for comparable stores. Comparable stores for the current year are those stores which were open for the entire period in the immediately preceding year. 5) Net sales per selling square feet per store is based on stores open one full year. 6) Includes the long-term portion of the capital lease obligations and the current portion of long-term debt. 7) Retained earnings, included in stockholders' equity has been adjusted to zero on February 1, 1992 and May 27, 1995. On February 1, 1992, an accumulated deficit of $10,477 was eliminated in a quasi-reorganization resulting from the recapitalization of the Company. On May 27, 1995, accumulated earnings of $16,022 were eliminated in purchase accounting. 8) Comparable store net sales decreased 1% comparing the 53-week period ended February 3, 1996 versus the 52-week period ended January 28, 1995. Comparing the 53-week period ended February 3, 1996 to the corresponding 53-week period ended February 4, 1995, comparable store net sales decreased 2%.
Item 7.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.
The discussion and analysis included under the caption "Management's Discussion and Analysis of Financial Condition and Results of Operations", appears on page of this annual report on Form 10-K.
Recent Developments
None
Item 8.
Item 8. Financial Statements and Supplementary Data.
Information with respect to this Item is contained in the financial statements indicated on the Indices on page of this annual report on Form 10-K.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
None.
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PART III
Item 10.
Item 10. Directors and Executive Officers of the Registrant.
The Company's executive officers and directors, their ages, positions and years with the Company are as follows:
Years with Name Age Position the Company
Michael F. Moorman 53 Chairman of the Board, President and Chief Executive Officer 32 Ronnie W. Palmore 47 Senior Vice President, Merchandising and Assistant Secretary 23 Russell A. Lundy, Sr. 60 Senior Vice President, Stores 42 E. Randolph Lail 40 Senior Vice President, Finance, Chief Financial Officer, Secretary and Treasurer 8 Marvin H. Thomas, Jr. 40 Senior Vice President, Operations 17 William C. DeRusha 46 Director 4 Malcolm S. McDonald 57 Director 4 Wellford L. Sanders, Jr. 50 Director 3 Thomas R. Wall, IV 37 Director 1 Frank T. Nickell 48 Director 1
Michael F. Moorman has been Chairman of the Board, Chief Executive Officer, President and a Director of PHC Retail since June 9, 1995 . Mr. Moorman has also been Chairman of the Board and a Director of the Company since September 1989, Chief Executive Officer of the Company since May 1989 and President of the Company since June 1988. Prior thereto, Mr. Moorman served as Chief Financial Officer and Treasurer of the Company from August 1989 to June 1992 and Secretary of the Company from August 1989 to June 1990. Mr. Moorman has been employed by the Company in various positions since 1964. Mr. Moorman has been a Director of the Company since 1977.
Ronnie W. Palmore has been Senior Vice President, Merchandising of PHC Retail since June 9, 1995 and of the Company since September 1989 and Assistant Secretary of the Company since 1988. Mr. Palmore served as Senior Vice President, Stores of the Company from June 1988 to August 1989 and has been employed by the Company in various positions since 1973.
Russell A. Lundy, Sr. has been Senior Vice President, Stores of PHC Retail since June 9, 1995 and of the Company since September 1989. Mr. Lundy served as Vice
President, Stores of the Company from 1984 to August 1989 and has been employed by the Company in various positions since 1954.
E. Randolph Lail has been Senior Vice President, Finance, Chief Financial Officer, Secretary and Treasurer of PHC Retail since June 9, 1995. Mr. Lail has also been Senior Vice President, Finance of the Company since June 1993, Chief Financial Officer and Treasurer of the Company since June 1992 and Secretary of the Company since June 1990. Mr. Lail served as Vice President, Finance of the Company from June 1990 to June 1993 and as Controller of the Company from January 1988 to June 1990. Mr. Lail is a Certified Public Accountant and has been employed by the Company since January 1988.
Marvin H. Thomas, Jr. has been Senior Vice President, Operations of PHC Retail since June 9, 1995 and of the Company since June 1993. Mr. Thomas served as Vice President, Operations of the Company from June 1990 to June 1993 and Vice President, Merchandise Manager of the Company from May 1988 to June 1990. Mr. Thomas has been employed by the Company in various positions since 1979.
William C. DeRusha has been a Director of PHC Retail since June 9, 1995 and of the Company since March 1992. Mr. DeRusha is Chairman of the Board and Chief Executive Officer of Heilig-Meyers Company. Mr. DeRusha is a director of Heilig- Meyers Company, Best Products Co., Inc. and Signet Banking Corporation.
Malcolm S. McDonald has been a Director of PHC Retail since June 9, 1995 and of the Company since April 1992. Mr. McDonald is President and Chief Operating Officer of Signet Banking Corporation and President and Chief Executive Officer of Signet Bank/Virginia. From July 1988 to April 1990, Mr. McDonald was Vice Chairman of Signet Bank/Maryland and Signet Bank/Virginia. Prior to July 1988, Mr. McDonald was Vice Chairman of Signet Banking Corporation and Chairman of Signet Bank, N.A. Mr. McDonald is a director of Signet Banking Corporation and American Trading and Production Company.
Wellford L. Sanders, Jr. has been a Director of PHC Retail since June 9, 1995 and of the Company since February 1992. Mr. Sanders is a partner in the law firm of McGuire, Woods, Battle & Boothe, L.L.P. Mr. Sanders is a director of Catherines Stores Corporation and General Medical Corporation.
Thomas R. Wall, IV has been a Director of PHC Retail and the Company since June 9, 1995. Mr. Wall has been Managing Director of Kelso since 1990 and prior thereto General Partner of Kelso since 1989. From 1986 to 1989, Mr. Wall was a Vice President of Kelso. Mr. Wall is also a director of CCA Holdings Corp., CCT Holdings Corp., Ellis
Communications, Inc., General Medical Corporation, Mitchell Supreme Fuel Company, Mosler Inc., TransDigm, Inc. and Tyler Refrigeration Corporation.
Frank T. Nickell has been a Director of PHC Retail and the Company since June 9, 1995. Mr. Nickell has been President and a director of Kelso since March 1989. From 1984 to 1989, Mr. Nickell was a general partner of Kelso. He is also a director of American Standard Companies, Inc., CCA Holdings Corp., CCT Holdings Corp., The Bear and Stearns Companies Inc., Earle M. Jorgensen Company and Tyler Refrigeration Corporation.
On December 23, 1992, Kelso and its chief executive officer, without admitting or denying the findings contained therein, consented to an administrative order in respect of a Commission inquiry relating to the 1990 acquisition of a portfolio company by a Kelso affiliate. The order found that Kelso's tender offer filing in connection with the acquisition did not comply fully with the Commission's tender offer reporting requirements, and required Kelso and its chief executive officer to comply with these requirements in the future.
Executive officers of Peebles are elected annually and serve at the discretion of the Board of Directors.
Directors Compensation
Mr. DeRusha, Mr. McDonald and Mr. Sanders are paid an annual retainer of $20,000, payable quarterly in arrears, and are reimbursed for expenses incurred in attending meetings of the Board of Directors.
Agreements to Indemnify.
Peebles has entered into agreements with each of the directors and officers of Peebles pursuant to which Peebles agrees to indemnify such director or officer from claims, liabilities, damages, expenses, losses, costs, penalties or amounts paid in settlement incurred by such director or officer and arising out of his capacity as a director, officer, employee and/or agent of the corporation of which he is a director or officer to the maximum extent provided by applicable law. In addition, such director or officer shall be entitled to an advance of expenses to the maximum extent authorized or permitted by law to meet the obligations indemnified against. Such agreements also obligate the Company to purchase and maintain insurance for the benefit and on behalf of its directors and officers insuring against all liabilities that may be incurred by such director or officer, in or arising out of his capacity as a director, officer, employee and/or agent of the Company.
ITEM 11.
ITEM 11. Executive Compensation
The following tables set forth a summary of compensation paid by the Company to its five highest paid executive officers (the "Named Executives") during 1993, 1994 and 1995.
Summary Compensation Table
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(1) Salary amounts for 1993, 1994 and 1995 include tax-deferred contributions of compensation to the Company's 401(K) Profit Sharing Plan (the "401-K Plan"), adopted in October 1993. Salary compensation contributed to the 401-K Plan during 1993, 1994 and 1995 for each of the Named Executives is Mr. Moorman $2,207, $2,185 and $2,333; Mr. Palmore $0, $2,129 and $1,366; Mr. Lundy $980, $1,958 and $458; Mr. Lail $608, $1,621 and $2,168, and Mr. Thomas $666, $1,425 and $1,798.
(2) Bonus amounts for each of the Named Executives include the accrued bonus paid under the Company's annual incentive plans in 1993, 1994 and 1995. The 1994 and 1995 bonus amounts include tax-deferred contributions of compensation to the 401-K Plan for each of the Named Executives as Mr. Moorman, $6,809 and $3,897, Mr. Palmore, $2,639 and $1,364, Mr. Lundy, $1,806 and $1,075, Mr. Lail $1,033 and $879, and Mr. Thomas $971 and $519 Additionally, bonus amounts include the fair market value of shares granted under the Peebles Inc. 1991 Stock/Warrant plan (the "1991 Plan") in 1993.
(3) The benefits to be received by each of the Named Executives as a result of grants of discounted warrants under the 1991 Plan were excluded in 1993 because the warrants were exchanged for stock options on June 9, 1993 under the 1993 Stock Option Plan (the "1993 Plan"). The amounts shown for 1993 represent tax gross-up payments to cover the executive's tax withholding obligations resulting from the corresponding stock grants under the 1991 Plan.
(4) Option/warrant grants in 1993 to the Named Executives do not include any grants of warrants under the 1991 Plan. The warrants granted in 1992 were exchanged for stock options under the 1993 Plan. In 1993 and 1994, the stock options were granted to certain members of senior management under the 1993 Plan.
(5) The cash incentive payouts under the Company's long-term incentive plan were based upon performance versus established goals for the three year period from 1991 to 1993.
(6) The amounts shown in 1994 reflect the current value of the benefit to Mr. Lail and Mr. Thomas, respectively of the portion of the premium paid by the Company with respect to a split dollar insurance arrangements (see "Employment Agreements"). In 1995, amounts of $1,618 and $1,520 are included for Mr. Lail and Mr. Thomas respectively. The benefit was determined for each year by calculating the time value of money (including the applicable long term federal funds rate) of the premium paid by the Company in 1994 and 1995 ($11,210 for Mr. Lail and $9,650 for Mr. Thomas per year) for the appropriate period.
(7) In connection with the 1995 Acquisition, the stock options outstanding under the 1995 Stock Option Plan vested. The 1995 Acquisition mandated that all options be settled for cash only, either for i) the difference between the $30 per share price paid by PHC Retail for the common stock of Peebles Inc. and the $23.75 exercise price, or ii) as specified by certain change of control agreements. The amounts included in 1995 are $1,133,400, $329,062, $224,062, $179,063 and $157,850 for Mr. Moorman, Mr. Palmore, Mr. Lundy, Mr. Lail and Mr. Thomas, respectively. These amounts include tax-deferred contributions of compensation to the 401-K Plan of $3,136, $6,581, $3,581 and $3,157 for Mr. Moorman, Mr. Palmore, Mr. Lail and Mr. Thomas, respectively.
Option Grant Table. There were no options granted by the Company to the Named Executives during 1995.
Option Exercise Table. The following table sets forth information concerning the exercise of stock options during 1995 by each of the Named Executives and the year end value of unexercised options.
Options Exercised in 1995
- ---------------------------------------
(1) There were no stock options exercised by the Named Executives in 1995. (2) There were no unexercised options at year end.
As of the fiscal year ended February 3, 1996 there were no projected long-term incentive payouts.
Pension Plan
Peebles maintains a non-contributory qualified defined benefit pension plan that covers all employees of Peebles who (i) complete 1,000 hours of service during a one-year period with Peebles and (ii) attain age 21 (a "Participant"). Contributions to the plan are determined on an actuarial basis without allocation to individuals or groups.
Retirement benefits are based on a Participant's years of benefit service and the earnings during the five consecutive calendar years which produce the highest average. Earnings are limited to $150,000 in any one year and years of benefit service are limited to 30. A Participant is fully vested after completing five years of benefit service.
Benefits are payable to vested Participants at normal retirement (age 65), early retirement (age 55), upon a vested Participant's permanent and total disability, or upon a vested Participant's termination of employment.
The following table shows estimated annual retirement benefits payable to Participants under the pension plan upon normal retirement at age 65 under various assumptions as to final average annual earnings, date of retirement and years of continuous service without regard to the current earning limit of $150,000.
Final Years of Service Average Salary 15 20 25 30 35 -------- -- -- -- -- --
$ 75,000........ $11,993 $15,990 $19,988 $23,985 $ 23,985 100,000........ 16,868 22,490 28,113 33,735 33,735 125,000........ 21,743 28,990 36,238 43,485 43,485 150,000........ 26,618 35,490 44,363 53,235 53,235 175,000........ 31,493 41,990 52,488 62,985 62,985 200,000........ 36,368 48,490 60,613 72,735 72,735 225,000........ 41,243 54,990 68,738 82,485 82,485 250,000........ 46,118 61,490 76,863 92,235 92,235 300,000........ 55,868 74,490 93,113 111,735 111,735 350,000........ 65,618 87,490 109,363 131,235 131,235 400,000........ 75,368 100,490 125,613 150,735 150,735 450,000........ 85,118 113,490 141,863 170,235 170,235
As of February 3, 1996, the credited years of service for Mr. Moorman, Mr. Palmore, Mr. Lundy, Sr., Mr. Thomas, Jr. and Mr. Lail were 32, 23, 42, 17 and 8, respectively.
Peebles reserves the right at any time by action of its Board of Directors to terminate the plan, although it currently has no intention to do so. If the plan is terminated and appropriately funded at such time, Peebles will not be required to make any further contributions to the plan and each participant shall become 100% vested in his benefit under the plan. Each Participant's benefit will be paid to him after termination of the plan according to the terms of the plan.
In addition, Peebles also maintains a supplemental executive retirement plan (the "SERP") for certain designated executives. As of February 3, 1996, Mr. Moorman, and Mr. Palmore, were participants in this plan. Retirement benefits payable under the SERP are based
on 60% of the participant's earnings (without regard to the current earnings limit of $150,000) during the five consecutive calendar years which produce the highest average, reduced by the sum of the participant's qualified defined benefit pension benefit (computed with regard to the applicable earnings limit) and the participant's social security benefits.
Benefits under the SERP are fully vested upon the earlier of (1) the completion of five years of service with the Company beginning with the date of participation in the SERP, (2) the participant's permanent disability, or (3) the date on which a change of control occurs.
Retirement benefits are payable to vested participant's at normal retirement (age 65), early retirement (age 55 with 20 years of service), upon permanent and total disability, or upon a vested participant's termination of employment.
Compensation Committee Interlocks and Insider Participation
During the year ended February 3, 1996 the Company established a Compensation Committee of the Board of Directors. For 1995, the Board of Directors established compensation for the Company's officers for such year. Michael F. Moorman, the sole officer or employee of the Company who is also a member of the Board of Directors, made recommendations to the Board of Directors concerning executive compensation but did not otherwise participate in or vote upon the executive compensation decisions made by the Board of Directors for such year. Mr. Moorman is not a member of the Compensation Committee.
Certain Relationships
Wellford L. Sanders, Jr., a member of the Board of Directors of the Company, is a partner in the law firm of McGuire, Woods, Battle & Boothe, L.L.P., which rendered legal services to the Company during 1995.
Frank T. Nickell and Thomas R. Wall, IV, members of the Board of Directors of the Company, are affiliated with Kelso, which rendered management services to the Company during 1995.
Employment Agreements
During 1995, Peebles entered into employment agreements (the "Employment Agreements") with twenty three officers of Peebles including Mr. Lundy and Mr. Thomas. The Employment Agreements, which expire during 1997 provide that if the officer is terminated for any reason, other than for good cause, he will be entitled to receive his salary at the rate in effect immediately before such termination for the balance of the term of the Employment Agreement. For purposes of the Employment Agreements, good cause is
defined as (a) the commission of a serious crime, or (b) the officer, in carrying out his duties under the Employment Agreements, is guilty of (i) willful gross neglect, or (ii) willful gross misconduct resulting in either case in material harm to the Company or any of its subsidiaries.
In addition, Mr. Lail and Mr. Thomas participate in split dollar insurance arrangements with the Company. The executive owns, and therefore has a vested interest in the cash surrender value of the policy in excess of the Company's premium investment. At retirement, the executive can either use the cash value for retirement income or keep the death benefit or a combination of the two. The Company would recover its cost at retirement. In the event of a change in control, the executive would have a nonforfeitable right to the Company's share of the cash surrender value of the policy.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management.
All of the outstanding common stock of the Company is owned by PHC Retail. The following table sets forth certain information regarding the beneficial ownership of Common Stock of PHC Retail, as of April 1, 1996, by (a) each person known by the Company to be the beneficial owner of more than 5% of the outstanding shares of Common Stock, (b) each of the Company's directors and Named Executives who owns shares of Common Stock and (c) all directors and Named Executives of the Company as a group. Unless otherwise noted in the footnotes to the table, the persons named in the table have sole voting and investing power with respect to all shares of Common Stock indicated as being beneficially owned by them.
Capital Stock of PHC Retail
* Less than 1 Percent
--------------------
(1) The information as to beneficial ownership is based on statements furnished to the Company by the beneficial owners. As used in this table, "beneficial ownership" means the sole or shared power to vote, or direct the voting of a security, or the sole or shared investment power with respect to a security (i.e., the power to dispose of , or direct the disposition of). A person is deemed as of any date to have "beneficial ownership" of any security that such person has the right to acquire within 60 days after such date. For purposes of computing the percentage of outstanding shares held by each person named above, any security that such person has the right
to acquire within 60 days of the date of calculation is deemed to be outstanding but is not deemed to be outstanding for purposes of computing the percentage of any other person.
(2) The business address for such person(s) is C/O Kelso & Company, 320 Park Avenue, 24th Floor, New York, New York 10022.
(3) Messrs. Schuchert, Nickell, Matelich and Wall may be deemed to share beneficial ownership of shares of PHC Common Stock owned of record by Kelso Investment Associates V, L.P. ("KIA V") and Kelso Equity Partners V, L.P. ("KEP V"), by virtue of their status as general partners of such partnerships. Messrs. Schuchert, Nickell, Matelich and Wall share investment and voting power with respect to securities owned by other Kelso affiliates. Messrs. Schuchert, Nickell, Matelich and Wall disclaim beneficial ownership of the shares of PHC Common Stock owned of record by KIA V and KEP V and the securities owned by other Kelso affiliates.
Item 13.
Item 13. Certain Relationships and Related Transactions.
See "Item 10. Directors and Executive Officers of the Registrant" and "Item 11. Executive Compensation" for a description of certain arrangements with respect to present and former executive officers and directors of Peebles.
(This space intentionally left blank.)
PART IV
Item 14.
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.
(a) 1. Financial statements.
Information with respect to this Item is contained in the financial statements indicated on the Indices on page of this annual report on Form 10-K.
2. Financial statement schedules.
Information with respect to Valuation and Qualifying Accounts appears in Note K on page of this annual report on Form 10-K.
All other schedules for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission are not required under the related instructions or are inapplicable and therefore have been omitted.
3. Exhibits.
The exhibits listed on the accompanying index to exhibits are filed as part of this Annual Report on Form 10-K.
(b) Reports on Form 8-K.
NONE
(c) Exhibits.
2.1*** Form of Agreement and Plan of Merger dated April 3, 1995 among PHC Retail Holding Company, Peebles Acquisition Corp. and Peebles Inc., exclusive of exhibits and schedules. The Registrant hereby undertakes to furnish to the Commission supplementally upon request a copy of any omitted exhibit or schedule.
3.1+ Form of Amended and Restated Articles of Incorporation of Peebles Inc.
3.2+ Form of Amended and Restated Bylaws of Peebles Inc.
3.3*** Amendment to Amended and Restated Articles of Incorporation dated May 3, 1993
3.4 Amendment to Amended and Restated Bylaws of Peebles Inc.dated June 9, 1995.
3.5 Amendment to Amended and Restated Articles of Incorporation dated June 9, 1995
4.2* Form of Warrant Agreement between PBL Acquisition Corp. and the Warrant Agent
4.3* Form of Warrant Certificate (included in the Warrant Agreement filed as Exhibit 4.2 hereto).
10.1 Credit Agreement dated June 9, 1995, by and amoung Peebles Inc. And NatWest Bank, N.A. as Agent (the "Agent"), and the financial institutions named therein. (the "Credit Agreement")
10.20 Form of A Term Note.
10.21 Form of B Term Note.
10.22 Form of Bridge Note.
10.23 Form of Revolving Note.
10.24 Form of Swingline Note.
10.3 Security Agreement made June 9, 1995 by and between Peebles Inc. and the Agent.
10.4 Trademark Security Agreement made June 9, 1995 by and between Peebles Inc. and the Agent.
10.5 Guaranty Agreement made June 9, 1995 by and between PHC Retail Holding Company and the Agent.
10.6 Pledge Agreement made June 9, 1995 by and between PHC Retail Holding Company and the Agent.
10.61 Equity Contribution Agreement made June 9, 1995 by and between Kelso & Company and the Agent.
10.62 Deed of Trust made June 9, 1995 by and between Peebles Inc., the Trustee party thereto and the Agent.
10.63 First Amendment of the Credit Agreement dated September 15, 1995.
10.64 Second Amendment and Limited Consent to the Credit Agreement dated March 8, 1996.
10.8*** Standard Service Agreement, as amended, dated January 17, 1995 between Frederick Atkins, Incorporated and Peebles Inc.
10.11 Form of Indemnification, Guarantee and Contribution Agreement dated as of August 23, 1995 PHC Retail Holding Company, Peebles Inc. and each of the directors and officers of Peebles Inc.
10.16*** Form of Employment Agreement, dated March 30, 1995 entered into by Peebles Inc.and fourteen executives of Peebles Inc.
21 Subsidiaries of the Registrant.
27 Financial Data Schedule
----------------------------
* Incorporated by reference from the Registration Statement of PBL and Peebles on Form S-1 (Registration No. 33-27126), which was declared effective by the Commission on July 14, 1989.
** Incorporated by reference from the Form 10-K of PBL and the Company for the fiscal year ended February 2, 1991.
+ Incorporated by reference from the Form 10-K of the Company for the fiscal year ended February 1, 1992.
++ Incorporated by reference from the Form 10-K of the Company for the fiscal year ended January 30, 1993.
+++ Incorporated by reference from the Form 10-K of the Company for the fiscal year ended January 29, 1994.
*** Incorporated by reference from the Form 10-K of the Company for the fiscal year ended January 28, 1995.
(d) Financial Statement Schedules
Information with respect to Valuation and Qualifying Accounts appears in Note K on page of this annual report on Form 10-K.
All other schedules for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission are not required under the related instructions or are inapplicable and therefore have been omitted.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
PEEBLES INC. --------------------- (Registrant)
By /s/ Michael F. Moorman Date: May 3, 1996 ---------------------------------- Michael F. Moorman, President and Chief Executive Officer (Principal Executive Officer)
By /s/ E. Randolph Lail Date: May 3, 1996 -------------------------------------- E. Randolph Lail, Senior Vice President Finance, CFO, (Principal Financial and Accounting Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
By /s/ Wellford L. Sanders Date: May 3 , 1996 ------------------------------------ Wellford L. Sanders, Jr., Director
By /s/ William C. DeRusha Date: May 3, 1996 ----------------------------------- William C. DeRusha, Director
By /s/ Malcolm S. McDonald Date: May 3, 1996 -------------------------------- Malcolm S. McDonald, Director
By /s/ Frank T. Nickell Date: May 3, 1996 --------------------------------------- Frank T. Nickell, Director
By /s/ Thomas R. Wall Date: May 3, 1996 -------------------------------------- Thomas R. Wall, IV, Director
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.
EXHIBIT INDEX
----------------------------
* Incorporated by reference from the Registration Statement of PBL and Peebles on Form S-1 (Registration No. 33-27126), which was declared effective by the Commission on July 14, 1989.
** Incorporated by reference from the Form 10-K of PBL and the Company for the fiscal year ended February 2, 1991.
+ Incorporated by reference from the Form 10-K of the Company for the fiscal year ended February 1, 1992.
++ Incorporated by reference from the Form 10-K of the Company for the fiscal year ended January 30, 1993.
+++ Incorporated by reference from the Form 10-K of the Company for the fiscal year ended January 29, 1994.
*** Incorporated by reference from the Form 10-K of the Company for the fiscal year ended January 28, 1995.
Audited Financial Statements
PEEBLES INC.
February 3, 1996
Report of Independent Auditors.............................................F-1
Balance Sheet..............................................................F-2
Statement of Operations....................................................F-3
Statement of Changes in Stockholders' Equity...............................F-4
Statement of Cash Flows....................................................F-5
Notes to Financial Statements..............................................F-6
Management's Discussion and Analysis of Financial Condition and Results of Operations..................................................F-15
Report of Ernst & Young LLP, Independent Auditors
Board of Directors Peebles Inc.
We have audited the accompanying balance sheet of Peebles Inc. as of February 3, 1996 and January 28, 1995, and the related statements of operations, changes in stockholders' equity, and cash flows for the eight-month period ended February 3, 1996 and the four-month period ended May 27, 1995, and for each of the two fiscal years in the period ended January 28, 1995. These financial statements reflect the new basis of accounting established by the acquisition of Peebles Inc. as described in Note A. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements 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.
As described in Note A to the financial statements, the Company reflected a new basis of accounting on May 27, 1995 as a result of the 1995 Acquisition.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Peebles Inc. at February 3, 1996 and January 28, 1995, and the results of its operations and its cash flows for the eight-month period ended February 3, 1996 and the four-month period ended May 27, 1995, and for each of the two fiscal years in the period ended January 28, 1995, in conformity with generally accepted accounting principles.
/s/ Ernst & Young LLP
Richmond, Virginia March 11, 1996
BALANCE SHEET
PEEBLES INC. (dollars in thousands, except per share amounts) February January 3, 1996 28, 1995
(Prior ASSETS to 1995 Acquisition) CURRENT ASSETS Cash $ 193 $ 408 Accounts receivable, net 28,534 28,812 Merchandise inventories 42,684 44,703 Prepaid expenses 386 306 Refundable income taxes -- 778 Other 62 62 TOTAL CURRENT ASSETS 71,859 75,069
PROPERTY AND EQUIPMENT Fixtures and equipment 43,089 43,991 Land and building 6,725 5,751 Leasehold improvements 1,595 368 51,409 50,110 Accumulated depreciation and amortization 19,161 21,159 32,248 28,951
Buildings under capital leases, net 1,060 1,230
OTHER ASSETS Excess of cost over net assets acquired, net 51,129 37,111 Deferred financing costs, net 3,659 277 Beneficial leaseholds, net 2,960 3,345 Sundry 2,638 2,971 60,386 43,704 $165,553 $148,954
LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES Accounts payable $ 9,957 $ 8,722 Accrued compensation and other expenses 3,955 5,587 Income taxes payable 855 -- Deferred income taxes 2,788 4,472 Current maturities of long-term debt 5,377 5,850 Other 532 568 TOTAL CURRENT LIABILITIES 23,464 25,199 LONG-TERM DEBT 69,774 34,240 LONG-TERM CAPITAL LEASE OBLIGATIONS 1,627 1,865 DEFERRED INCOME TAXES 6,350 5,416 STOCKHOLDERS' EQUITY Preferred stock--no par value, authorized 1,000,000 shares, none issued or outstanding -- --
Common stock--par value $.10 per share, authorized 5,000,000 shares, issued and outstanding 1,000 and 2,942,690 respectively 1 294
Additional capital 59,307 64,390
Retained earnings: accumulated from May 27, 1995 and February 1, 1992, respectively; $10,477 deficit eliminated February 1, 1992. 5,030 17,550 64,338 82,234
$165,553 $148,954
See notes to financial statements.
STATEMENT OF OPERATIONS PEEBLES INC. (dollars in thousands, except per share amounts)
See notes to financial statements.
STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY PEEBLES INC. (dollars in thousands, except per share amounts)
Common Stock Par Additional Retained Shares Value Capital Earnings
Balance January 30, 1993 2,913,562 $ 291 $63,699 $ 4,547
Common stock issued in connection with the Equity Incentive Plan 20,000 2 475 --
Common stock warrants redemption price adjustment -- -- -- (11)
Net income -- -- -- 5,527
Balance January 29, 1994 2,933,562 293 64,174 10,063
Common stock issued in redemption of Common Stock Warrants 6,391 1 151 10
Common stock issued upon exercise of common stock options 2,737 -- 65 --
Net income -- -- -- 7,477
Balance January 28, 1995 2,942,690 294 64,390 17,550
Net (loss) -- -- -- (1,528)
Balance May 27, 1995, prior to 1995 Acquisition 2,942,690 294 64,390 16,022
1995 Acquisition adjustments (2,941,690) (293) (5,083) (16,022)
Balance May 27, 1995, following 1995 Acquisition 1,000 1 59,307 --
Net income -- -- -- 5,030
Balance February 3, 1996 1,000 $ 1 $59,307 $ 5,030
See notes to financial statements.
STATEMENT OF CASH FLOWS
PEEBLES INC. (dollars in thousands)
Eight-Month Four-Month Period Ended Period Ended FISCAL YEARS ENDED February May 27, January January 3, 1996 1995 28, 1995 29, 1994 (Prior to 1995 Acquisition) OPERATING ACTIVITIES Net income (loss) $ 5,030 $ (1,528) $ 7,477 $ 5,527 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Depreciation 2,491 1,453 3,677 3,088 Amortization 2,502 896 3,508 3,376 Deferred income taxes 970 (400) 450 553 Provision for doubtful accounts 531 265 620 546 Extraordinary loss,net -- 216 -- -- LIFO reserve adjustment (970) 1,035 (182) 1,144 Changes in operating assets and liabilities net of effects from acquisition adjustments Accounts receivable (2,199) 1,681 (1,046) (2,066) Merchandise inventories (113) (2,217) (2,869) (5,802) Accounts payable (658) 1,893 1,416 (2,420) Other assets and liabilities 692 (561) 19 1,819 NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES 8,276 2,733 13,070 5,765
INVESTING ACTIVITIES Acquisition of Peebles Inc. -- (90,923) -- -- Purchase of property and (5,683) (2,411) (8,454) (7,372) equipment Other -- 281 (257) (105)
NET CASH USED IN INVESTING ACTIVITIES (5,683) (93,053) (8,711) (7,477)
FINANCING ACTIVITIES Proceeds from revolving line of credit and long-term debt 227,686 58,145 173,754 163,554 Reduction in revolving line of credit and long-term debt (230,164) (56,129) (177,804) (161,836) Proceeds from acquisition debt -- 76,390 -- -- Retirement of pre-acquisition debt -- (40,917) -- -- Proceeds from equity -- 59,308 -- -- Acquisition and financing fees -- (6,807) -- --
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES (2,478) 89,990 (4,050) 1,718
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 115 (330) 309 6
Cash and cash equivalents beginning of period 78 408 99 93
CASH AND CASH EQUIVALENTS END OF PERIOD $ 193 $ 78 $ 408 $ 99
See notes to financial statements.
NOTES TO FINANCIAL STATEMENTS PEEBLES INC. FEBRUARY 3, 1996
(dollars in thousands, except per share amounts)
NOTE A--ACQUISITION OF PEEBLES INC.
1995 Acquisition (the "1995 Acquisition"): PHC Retail Holding Company ("PHC Retail") acquired the entire equity interest of Peebles Inc. ("Peebles" or the "Company") for approximately $136 million, which included acquisition related expenses of approximately $5.6 million and the refinancing of existing debt. PHC Retail is owned by an affiliate of Kelso & Company ("Kelso"), an investment firm located in New York, New York and management. PHC Retail has no significant assets other than the shares of Peebles common stock, $.10 par value (the "Common Stock") and had no operations prior to the 1995 Acquisition.
The 1995 Acquisition has been accounted for using the purchase method of accounting with an effective date of May 27, 1995, and accordingly, a new accounting basis was begun. The 1995 Acquisition cost has been allocated to the assets and liabilities of Peebles as follows:
Cash purchase price $135,558 Pre-acquisition debt refinanced (40,917) Adjusted purchase price 94,641 Tangible net assets at historical cost (63,840) Incremental acquisition debt 35,474 Purchase price to be allocated 66,275 Purchase price allocations: Merchandise inventories $7,436 Buildings 1,133 Land 1,411 Beneficial leaseholds 3,232 Pension asset 533 13,745 Excess of cost over net assets acquired $ 52,530
The excess of cost over net assets acquired is being amortized on a straight-line basis over 25 years beginning May 27, 1995. Beneficial leaseholds are amortized on a straight-line basis over the composite useful lives of the related leases. Buildings are amortized on a straight-line basis over their estimated useful lives.
As a result of the debt refinancing related to the 1995 Acquisition, the Company recorded an extraordinary loss of $216, net of $144 income tax benefit, as financing costs capitalized in periods prior to the 1995 Acquisition were written-off.
Pro Forma Financial Information (UNAUDITED): The following unaudited pro forma financial information reflects the results of operations of the Company as if the 1995 Acquisition occurred at the beginning of the respective 1994 fiscal years. These pro forma results have been prepared for comparative purposes only and do not purport to be indicative of what would have occurred had the acquisition been made at the beginning of fiscal 1994 or the results of which may occur in the future.
1995 1994
Net sales $175,664 $167,662 Operating income 18,019 17,285 Net income 3,829 4,902 Net income per share 3,829 4,902
NOTES TO CONDENSED FINANCIAL STATEMENTS-Continued PEEBLES INC. FEBRUARY 3, 1996
NOTE B--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
FISCAL YEAR: The Company's fiscal year ends on the Saturday nearest January 31. Fiscal years 1995, 1994, and 1993 ended on February 3, 1996, January 28, 1995, and January 29, 1994, respectively. Results of operations for 1995 consisted of fifty-three weeks, with 17 weeks included in the four-month period ended May 27, 1995 and 36 weeks in the eight-month period ended February 3, 1996. Results of operations for 1994 and 1993 each consisted of fifty-two weeks. References to years relate to fiscal years rather than calendar years.
NATURE OF OPERATIONS: Peebles currently operates 65 department stores offering predominately soft-apparel, fashion merchandise for the entire family, and other selected home accessories. The Company operates primarily in small and medium sized communities, which typically do not have a mall-based department store, in ten Southeastern and Mid-Atlantic States.
USE OF ESTIMATES: The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.
QUASI-REORGANIZATION: As a result of a recapitalization of the Company completed January 31, 1992, a quasi-reoganization was implemented as of February 1, 1992. An accumulated deficit was transferred to additional capital on that date.
STATEMENT OF CASH FLOWS: Peebles considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents. There were no cash equivalents at February 3,1996 or January 28, 1995. The issuance of certain common stock and common stock warrants increased shareholders' equity by $162 and $477 in 1994 and 1993, respectively, and accordingly, has been excluded from the Statement of Cash Flows as a non-cash transaction.
MERCHANDISE INVENTORIES: Merchandise inventories are accounted for by the retail inventory method applied on a last in, first out ("LIFO") basis.
PROPERTY AND EQUIPMENT: Property and equipment is stated on the basis of cost. Depreciation of property and equipment is provided primarily by the straight-line method over their estimated useful lives for financial reporting purposes and by accelerated methods for income tax purposes. The cost of leasehold improvements is amortized over the shorter of their economic lives or the terms of the leases by the straight-line method. Amortization of buildings under capital leases is computed by the straight-line method over the lease term and is included in depreciation and amortization expense.
LONG-LIVED ASSETS: In March 1995, the FASB issued Statement of Financial Accounting Standards No. 121, "Accounting for Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed Of", effective for fiscal years beginning after December 15, 1995. Adoption of this statement is not expected to have a material impact on the Company's financial position or results of operations.
STORE OPENING COSTS: Store opening costs are charged to selling, general and administrative expenses as incurred.
ADVERTISING COSTS: Advertising costs, charged to selling, general and administrative expenses as incurred, aggregated $3,075, $1,449, $4,255, and $4,089 for the eight-month period ended February 3, 1996, the four-month period ended May 27, 1995, and fiscal years 1994 and 1993, respectively.
EXCESS OF COST OVER NET ASSETS ACQUIRED: The excess of cost over net assets acquired ("Goodwill") is being amortized on a straight-line basis over a twenty-five year period. Accumulated amortization at February 3, 1996 and January 28, 1995 was $1,401 and $5,060, respectively.
DEFERRED FINANCING COSTS: Deferred financing costs are amortized by the interest method over a period consistent with the related financing. Amortization expense of $585 and $68 is included in interest expense for the eight-month period ended February 3, 1996 and the four-month period ended May 27, 1995, respectively. Amortization expense of $457 and $435 is included in interest expense for 1994 and 1993, respectively. Accumulated amortization at February 3, 1996 and January 28, 1995 was $585 and $2,803, respectively.
NOTES TO FINANCIAL STATEMENTS--Continued PEEBLES INC.
NOTE B--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--CONTINUED
BENEFICIAL LEASEHOLDS: Amortization is provided by the straight-line basis over the estimated composite useful lives of the related leases. Accumulated amortization at February 3, 1996 and January 28, 1995 was $2,438 and $2,117, respectively.
INCOME TAXES: Deferred income taxes are provided for temporary differences between income and expense for financial reporting purposes and for income tax purposes.
NET INCOME PER SHARE: Net Income per share is based on the weighted-average number of shares and common stock equivalents outstanding.
NOTE C--ACCOUNTS RECEIVABLE
Accounts receivable are shown net of $960 and $930 representing the allowance for uncollectible accounts at February 3, 1996 and January 28, 1995, respectively. The provision for doubtful accounts was $531, $265, $620 and $546 for the eight-month period ended February 3, 1996, the four-month period ended May 27, 1995, and fiscal years 1994 and 1993, respectively. Finance charges on credit sales, included as a reduction of selling, general and administrative expenses, aggregated $3,175, $1,643, $4,818 and $4,576, for the eight-month period ended February 3, 1996, the four-month period ended May 27, 1995, and fiscal years 1994 and 1993, respectively.
As a service to its customers, the Company offers credit through the use of its own charge card, certain major credit cards and a layaway plan. The Peebles' customer usually resides in the local community immediately surrounding the store location. Peebles stores serve these local customers in Virginia, Maryland, North Carolina, South Carolina, Tennessee, Kentucky, Delaware, New Jersey, Pennsylvania and New York. The Company does not require collateral from its customers.
NOTE D--MERCHANDISE INVENTORIES
The 1995 Acquisition was accounted for using the purchase method of accounting with an effective date of May 27, 1995. The normal seasonal increase in merchandise inventory between January and May resulted in a significant LIFO increment in the four-month period ended May 27, 1995. Consistent with the purchase method of accounting, the LIFO reserve was eliminated, the recorded value of merchandise inventories was increased to fair value (the "Fair Value Adjustment") and a new LIFO base year was established at May 27, 1995. Seasonal decreases in inventory levels and costs from May to January resulted in LIFO cost greater than FIFO cost, and a market reserve was established.
Merchandise inventories consisted of the following:
NOTES TO FINANCIAL STATEMENTS--Continued PEEBLES INC.
NOTE E--SUNDRY ASSETS
Sundry consisted of:
February 3, 1996 January 28, 1995 (Prior to 1995 Acquisition)
Advances to buying office $1,820 $1,694 Pension asset, net 284 1,032 Other 534 245 $2,638 $2,971
NOTE F--LONG-TERM DEBT
Long-term debt consisted of the following:
February 3, 1996 January 28, 1995 (prior to 1995 Acquisition) 1995 Senior Revolving Facility $25,000 $ -- Senior Term Note A 19,250 -- Senior Term Note B 27,775 -- Swingline Facility 3,126 -- Pre-Acquisition Senior Revolving Facility -- 28,550 Pre-Acquisition Senior Term Facility -- 11,340 Other -- 200 75,151 40,090 Less current maturities 5,377 5,850 $69,774 $34,240
On June 9, 1995, the Company entered into a $120 million credit facility (the "1995 Credit Agreement") to i) refinance the existing debt under the pre-acquisition Credit Agreement, ii) provide the additional funding necessary to complete the 1995 Acquisition, and iii) provide working capital and funds for capital expenditures. The 1995 Credit Agreement is secured by a first priority security interest in substantially all the personal property and certain real property of Peebles. The 1995 Credit Agreement provides a Senior Term Facility, a Senior Revolving Facility (the "1995 Revolving Facility"), and a "Swingline Facility". Restrictive covenants prohibit the payment of cash dividends in any fiscal year.
The Senior Term Facility includes two notes, Senior Term Note A and Senior Term Note B, with original principal balances of $20 million and $30 million, respectively. Senior Term Note A and Senior Term Note B each require quarterly payments, coinciding with the Company's fiscal quarters, of principal (increasing annually from $250 and $75 per quarter, respectively) and interest in arrears through maturity. Senior Term Note A and Senior Term Note B mature on June 9, 2000 and 2002, respectively. On September 8, 1995 the Company reduced the Senior Term Note B principal balance by $2 million, satisfying certain pre-defined conditions of the 1995 Credit Agreement. Senior Term Note A and Senior Term Note B bore interest through November, 1995 at prime plus 1-1/2% and prime plus 2%, respectively.
The amount available under the 1995 Senior Revolving Facility is determined by a defined asset based formula with maximum borrowings limited to $65 million less outstanding amounts under letters of credit. The Company pays a fee of 1/2 of 1% per annum on any unused portion of the 1995 Senior Revolving Facility. The 1995 Senior Revolving Facility matures on June 9, 2000 and has no specific paydown provisions. Based on the anticipated operations of the Company in the succeeding twelve-month period, $24,600 and $24,800 were considered long-term obligations at February 3, 1996 and January 28, 1995, respectively. The 1995 Senior Revolving Facility bore interest at prime plus 1-1/2%.
NOTES TO FINANCIAL STATEMENTS--Continued PEEBLES INC.
NOTE F--LONG-TERM DEBT--Continued
The 1995 Credit Agreement provided for optional conversion to LIBOR-based interest rates upon the occurrence of certain pre- defined events. These rates are as follows: i) Senior Term Note A: LIBOR plus 2.75%; ii) Senior Term Note B: LIBOR plus 3.25%; iii) 1995 Senior Revolving Facility: LIBOR plus 2.75%. In November, 1995, the pre-defined conditions were satisfied. At February 3, 1996, the entire outstanding balance of the Senior Term Facility, $47,025, and $24,000 of the 1995 Senior Revolving Facility were converted to the LIBOR-based interest rates. In compliance with the 1995 Credit Agreement, the Company has entered into a three-year interest rate protection agreement covering a principal amount of $40,000 against increases in the prime rate above 7.5% per annum.
Loans under the Swingline facility are drawn and repaid daily based on the operating activity of the Company. Aggregate amounts outstanding under the Swingline Facility cannot exceed $5 million. Excess borrowings or funding outside these amounts revert to the 1995 Senior Revolving Facility. The Swingline Facility currently bears interest at prime plus 1-1/2% and has no LIBOR conversion option.
Peebles has commitments for letters of credit with a bank which totaled $307 and $462 at February 3, 1996 and January 28, 1995, respectively. Approximately $50 expire during 1996, and the remainder expires August 1, 1998.
Peebles made cash interest payments of $6,353, $973, $4,091, and $3,548 for the eight-month period ended February 3, 1996, the four-month period ended May 27, 1995, and fiscal years 1994 and 1993, respectively.
Aggregate principal payments on long-term debt for the next five fiscal years are: 1996--$5,377, 1997--$2,750, 1998-- $6,375, 1999--$10,125 ,and 2000--$36,324.
NOTE G--LEASES
The Company leases substantially all of its store locations under capital and operating leases with initial terms ranging from 1 to 25 years and renewal options of 1 to 5 years expiring at various dates through 2033. The following is a summary of assets under capitalized leases:
February 3, 1996 January 28, 1995 (Prior to 1995 Acquisition) Buildings under capital leases $ 3,018 $ 3,018 Less--accumulated amortization (1,958) (1,788) $ 1,060 1,230
Total rental expense under operating leases was as follows:
Contingent rentals are based upon a percentage of annual sales in excess of specified amounts. Future minimum lease payments under capital leases and noncancellable operating leases at February 3, 1996 were as follows:
Capital Operating Fiscal Year Leases Leases 1996 $ 487 $ 6,363 1997 487 6,089 1998 377 5,768 1999 377 5,700 2000 377 5,266 Thereafter 782 34,503 Total minimum lease payments 2,887 $63,689 Less: amounts representing interest (1,022) Present value of net minimum lease payments, including current maturities of $238, with interest rates ranging from 11.3% to $18.1% $1,865
NOTE H--EMPLOYEE BENEFIT PLANS
The Employees Retirement Plan of Peebles Inc.: The Company provides a defined benefit pension plan (the "Pension Plan") which covers substantially all employees. Participation is dependent on meeting certain age and service requirements. Benefits are based on total years of benefit service and the employee's compensation during the five consecutive calendar years which produce the highest average. Peebles makes annual contributions to the Pension Plan equal to the contribution required to satisfy minimum funding standards under ERISA.
Net periodic pension cost included the following components:
The following table sets forth the Pension Plan's funded status and amounts recognized in Peebles balance sheet:
NOTE H--EMPLOYEE BENEFIT PLANS--Continued
In calculating the present value of projected benefit obligations for 1995 and 1994, a 5.0% weighted average rate of compensation was used, and a weighted-average discount rate of 7.25% and 8.75%, respectively. The expected long-term rate of return on plan assets was 9% for 1995, 1994 and 1993.
The Peebles Inc. 401 (k) Profit Sharing Plan: The Company maintains a qualified profit sharing and retirement savings plan, which under Section 401 (k) of the Internal Revenue Code, allows tax deferred contributions from eligible employees of up to 12% of their annual compensation. The Company does not currently contribute to the plan.
Supplemental Benefits Program: The Company maintains a benefits program designed to provide certain key executives supplemental retirement income, such that together with Social Security payments and amounts payable under the Pension Plan, the executives will receive replacement income in retirement equal to 60% of final average compensation, as defined in the Pension Plan. The program is funded through life insurance contracts covering the participating executives. At February 3, 1996, the Company had a net obligation of $65 recognized in the balance sheet calculated based upon a discount rate of 7.5%. The Company recognized net expense related to the program of $146 and $73 in the eight-month period ended February 3, 1996 and the four-month period ended May 27, 1995, respectively.
NOTE I--SETTLEMENT OF THE 1993 STOCK OPTION PLAN
The 1993 Stock Option Plan was established in April 1993 to replace the Equity Incentive Plan, both of which were intended to provide a long-term incentive to certain key management personnel. At May 27, 1995, 432,699 options to purchase one share of Common Stock at an exercise price of $23.75 were issued and outstanding. Under certain change in control provisions in the 1993 Stock Option Plan, all outstanding options vested as a result of the 1995 Acquisition. The 1995 Acquisition mandated that all options would be settled for cash only, either for i) the difference between the $30 per share price paid by PHC Retail for the Common Stock and the $23.75 exercise price, or ii) as specified by certain change of control agreements. As result of the cash settlement, $3,089 has been included as an operating expense in the four-month period ended May 27, 1995. Prior to the 1995 Acquisition, no compensation expense related to the 1993 Stock Option Plan had been incurred.
NOTE J--INCOME TAXES
The provisions for income taxes consisted of the following:
Eight-Month Four-Month Period Ended Period Ended February 3, 1996 May 27, 1995 1994 1993 (Prior to 1995 Acquisition) Current: Federal $ 2,703 $ (382) 4,354 3,273 State 573 (92) 943 687
Deferred: Federal 805 (323) 371 455 State 165 (77) 79 98 $ 4,246 $ (874) 5,747 4,513
Income taxes differ from the amounts computed by applying the applicable federal statutory rates due to the following:
Eight- Four- Month Month Period Period Ended Ended February May 27, 3, 1996 1995 1994 1993 (Prior to 1995 Acquisition) Taxes at the federal statutory rate $ 3,248 $(765) $4,628 $3,514 Increases (decreases): State income taxes, net of federal tax 469 (110) 676 518 Amortization of purchase accounting adjustments 484 190 574 574 Other 45 (189) (131) (93) $ 4,246 $(874) $5,747 $4,513
Significant components of deferred tax liabilities and assets are as follows:
Peebles made cash income tax payments of $2,782, $6,183 and $4,175 for 1995, 1994 and 1993, respectively.
NOTE K - VALUATION AND QUALIFYING ACCOUNTS
Activity related to valuation and qualifying accounts is as follows:
Allowance for Doubtful LIFO Accounts Reserve
Balance January 30, 1993 $ 1,100 $ 1,876 Charges to expense 546 1,144 Deductions - net write-off of uncollectible accounts (696) -- Balance January 29, 1994 950 3,020 Charges to expense 620 (182) Deductions - net write-off of uncollectible accounts (640) -- Balance January 28, 1995 930 2,838 Charges to expense 265 1,035 Deductions - net write-off of uncollectible accounts (265) -- Balance May 27, 1995 930 3,873 Purchase accounting elimination -- (3,873) Charges to expense 531 (449) Deductions - net write-off of uncollectible accounts (501) -- Balance February 3, 1996 $ 960 $ (449)
NOTES TO FINANCIAL STATEMENTS--Continued PEEBLES INC.
NOTE L - QUARTERLY FINANCIAL DATA (UNAUDITED) The 1995 Acquisition was effective May 27, 1995. As a result, the first quarter of 1995, the first fiscal month of the second quarter of 1995, and all quarters in 1994 reflect operating results prior to the 1995 Acquisition. Operating income in the second quarter of 1995 was reduced by $3,089 related to the settlement of the 1993 Stock Option Plan. Net income in the second, third and fourth quarter of 1995 was affected by greater interest expense resulting from the increased debt assumed in the 1995 Acquisition.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
Peebles operates specialty department stores primarily in small and medium sized communities which do not typically have a mall-based department store. The stores, located in ten Southeastern and Mid-Atlantic states, offer customers a broad selection of moderately-priced fashion merchandise and selected home accessories, which is generally not available through other retailers in the market.
The entire equity interest of Peebles was acquired by PHC Retail Holding Company, an affiliate of Kelso & Company, effective May 27, 1995. The acquisition was accounted for using the purchase method of accounting and a new accounting basis was established. Accordingly, the audited financial statements present the Peebles results of operations for the four-month period ended May 27, 1995 and the eight-month period ended February 3, 1996. Net sales and the results of operations expressed as a percentage of net sales are presented below for the twelve-month period ended February 3, 1996 in comparison to the 1994 and 1993 fiscal years.
(dollars in thousands) 1995 1994 1993
Net sales $175,664 $167,662 $151,772 % increase 4.8% 10.5% 7.7% % increase (decrease) in sales at comparable stores (1.0%) 4.6% 4.3% Total stores 65 58 54
Operations as a Percentage of Net Sales: Cost of sales 58.6% 58.5% 60.0% Selling, general & administrative expenses 27.3 27.0 26.6 Settlement of the 1993 Stock Option Plan 1.7 -- -- Depreciation and amortization 3.8 4.0 4.0 Operating Income 8.6 10.5 9.4
Interest Expense 4.5 2.7 2.8 Other income (expense) (.1) .1 -- Provision for income taxes 1.9 3.4 3.0 Net Income 2.1% 4.5% 3.6%
Net sales in 1995 increased over 1994 due to the opening of seven new stores in 1995 and the first full year of operation in five stores opened during 1994. Net sales at comparable stores, stores opened the entire twelve months in the previous fiscal year, declined $1,656, or 1%, comparing fiscal 1995, comprised of 53 weeks, to fiscal 1994, which included 52 weeks. Net sales at these comparable stores declined $3,383, or 2% when comparing the 53-week period ended February 3, 1996 to the 53-week period ended February 4, 1995 ("Adjusted 1994"), The decrease is attributable to a general weakening in consumer spending on soft apparel, especially in Metro Washington D.C., which includes Northern Virginia and Southern Maryland, and unseasonable or severe weather. Five weeks significantly impacted comparable store sales. Unseasonably warm weather in the first two weeks of October 1995, which included the Company's anniversary and Columbus day sales, resulted in a net sales decrease of $1,028 in comparable stores. With severe snowstorms in the first two weeks, and again in the fifth week of January 1996, net sales at comparable stores declined $1,855 in comparison to the same weeks in Adjusted 1994. Aggregated, these five weeks represented 85% of the comparable store decrease in comparing 1995 to Adjusted 1994.
The Company's gross margin percentage of 41.4% in 1995 is comparable to 41.5% in 1994 and up from 40.0% in 1993 as cost of sales was controlled through effective management of inventory levels and adherence to the everyday fair pricing strategy. Excluding the effects of LIFO inventory, cost of sales as percentage of net sales was 58.6%, 58.6% and 59.3% in 1995, 1994 and 1993, respectively. In 1993, the Company completed an expansion of its distribution center, which created greater flexibility in managing the flow of inventory. As such, inventory levels can be adjusted more timely in response to the changing economic and competitive environment affecting the Company's markets. During 1995, the Company continued to expand its pricing strategy of offering customers a fair, consistent merchandise price rather than increasing initial markon and offering highly-promotional, deep discounts.
Selling, general and administrative expenses increased to 27.3% of net sales, up from 27.0% and 26.6% in 1994 and 1993, respectively. This increase is primarily due to the opening of new stores, seven of which were opened in 1995, and five in 1994. New stores typically have higher occupancy, payroll and advertising expenses as a percentage of net sales as compared to mature stores. The increase noted in 1995 was partially offset by lower compensation expense associated with performance-based management incentive plans.
As discussed in detail in Note I to the audited financial statements, the Company recorded compensation expense of $3,089, 1.7% of net sales, in the settlement of the 1993 Stock Option Plan. No compensation expense related to this plan had been recorded in either 1994 or 1993. This non-recurring expense recognized in 1995 represents the entire liability of the Company under the 1993 Stock Option Plan.
Depreciation and amortization expense decreased to 3.8% of net sales, down from 4.0% in both 1994 and 1993. This decrease is the net result of the capital expenditures necessary to open the seven new stores in 1995 and a full year of depreciation on 1994 capital expenditures, offset by a reduction in the accounting basis of certain assets related to the 1995 Acquisition.
As a result of the above factors, 1995 operating income as a percentage of net sales was 8.6%, down from 10.5% in 1994 and 9.4% in 1993. Adjusting for the non-recurring compensation expense related to the settlement of the 1993 Stock Option Plan, operating income in 1995 would have totaled 10.3% as a percentage of net sales.
Interest expense as a percentage of net sales increased from 2.7% in 1994 to 4.5% in 1995. This increase results from a combination of increased debt assumed in connection with the 1995 Acquisition and a higher prime lending rate throughout 1995 in comparison to 1994. In conjunction with the 1995 Acquisition, the Company entered into the $120 million 1995 Credit Facility to refinance the existing debt under the pre-acquisition Credit Agreement, provide the additional funding necessary to complete the 1995 Acquisition, and provide working capital and funds for capital expenditures. The 1995 Credit Agreement increased outstanding borrowings at the date of acquisition by approximately $35.5 million. The pre-acquisition Credit Agreement, in place during 1994 and 1993, bore interest based on the prime lending rate. The 1995 Credit Agreement bore interest based on prime through November 1995, at which time the majority of outstanding borrowings were converted to LIBOR based interest rates. The prime lending rate averaged 7% for 1994, but had increased to 9% in 1995.
The effective tax rate increased to 47.5% in 1995 from 43.5% in 1994 and 45.0% in 1993. The increase in the effective tax rate results from proportionately higher non-deductible expenses related to the 1995 Acquisition. The effective tax rate is higher than the statutory rates because of non-deductible amortization expense.
As a result of the above factors, net income as a percentage of sales in 1995 was 2.1%, down from 4.5% in 1994 and 3.6% in 1993.
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary cash requirements are for capital expenditures in connection with both the Company's new store expansion and remodeling program and for working capital needs. The Company's primary sources of funds are cash flow from continuing operations, borrowings under the Credit Agreement and trade accounts payable. The Company's inventory levels typically build throughout the fall, peaking during the Christmas selling season, while accounts receivable peak during December and decrease during the first quarter. Capital expenditures typically occur evenly throughout the first three quarters of each year. The net acquisition of Peebles is included in investing activities.
Operating activities provided net cash of $11.0 million, $13.1 million and $5.8 million in 1995, 1994 and 1993, respectively. Profitable operations continued to be the source of net cash in 1995. In settlement of the 1993 Stock Option Plan, the Company used some $3.1 million of operating cash, which together with the increased cash payments of interest expense primarily account for the decline in net cash generated by operations in 1995 compared to 1994. The Company had working capital of $48.3 million, $49.9 million and $44.3 million in 1995, 1994 and 1993 respectively. Working capital was increased by higher merchandise inventory levels which, exclusive of the Fair Value Adjustment, increased by $2.3 million in 1995. Working capital in 1994 had been increased by $2.9 million due to higher inventory levels. Working capital was decreased by the collection of certain refundable income taxes during 1995.
Net cash used in investing activities, exclusive of the 1995 Acquisition, was $8.1 million, $8.7 million, and $7.5 million in 1995, 1994 and 1993, respectively. These amounts reflect $4.3 million, $2.6 million and $2.6 million of capital expenditures relating to new store openings and $1.8 million, $3.4 million and $1.7 million relating to store remodeling in 1995, 1994 and 1993, respectively. In 1993 and 1994, the Company made capital expenditures of $2.1 million relating to the expansion of the distribution center.
Exclusive of 1995 Acquisition transactions, Peebles used cash to reduce outstanding debt by a net of $.5 million. In the four-month period prior to the 1995 Acquisition, Peebles had funded operating and investing activities with $2.0 million in net proceeds from revolving debt. To facilitate the 1995 Acquisition, the pre-acquisition debt was refinanced, providing the Company $35.5 in net incremental cash and increasing debt by the same amount. In the eight-month period following the 1995 Acquisition, the Company used cash to reduce outstanding debt by a net $2.5 million. In 1994 and 1993, financing activities used cash of $4.1 million and provided cash of $1.7 million, respectively.
In 1996, the Company's capital expenditures are expected to total approximately $10.7 million, which reflect the opening of five new store locations, the relocation of two stores, a space reallocation/remodeling at three stores and an expansion of the distribution center in South Hill. As of March 1996, the Company had signed three new leases all of which are scheduled to open in 1996. The Company expects to continue to lease its stores, and the average new store is anticipated to average approximately 22,500 square feet but may vary depending on the market and real estate availability . Based on historical experience, the Company estimates that the cost of opening a new store will include capital expenditures of approximately $425,000 for leasehold improvements and fixtures and approximately $425,000 for initial inventory, approximately one-third of which is normally financed through vendor credit. Accounts receivable for new stores typically build to 15% of net sales or approximately $300,000 within 24 months of the store opening. The Company may also incur capital expenditures to acquire existing stores. The distribution center expansion is expected to serve the Company's growth to 110 store locations.
The Company finances its operations, capital expenditures, and debt service payments with funds available under the Senior Revolving Facility. The maximum amount available under the Senior Revolving Facility is $65 million less amounts outstanding under letters of credit. The actual amount available is determined by an asset based formula, adjusted for seasonal working capital requirements.
SEASONALITY AND INFLATION
As a retailer offering predominately soft-apparel and selected home accessories, the Company's business is seasonal, although less heavily weighted in the fourth quarter than retailers with comparable offerings of merchandise. Over the past three fiscal years, quarterly sales as a percentage of total sales have been consistent at 21%, 22%, 24% and 33% for the first through fourth quarters, respectively. Peebles' positioning of its stores in small to medium sized communities with limited competition, along with the Company's less-promotional, every day fair value, pricing strategy, produces operations less dependent on the fourth quarter. However, the third and fourth quarters are bolstered by the important back-to-school and Christmas holiday selling seasons.
The Company does not believe that inflation has had a material effect on its results of operations during the past three fiscal years. Peebles uses the retail inventory method applied on a LIFO basis in accounting for its inventories. Under this method, the cost of products sold reported in the financial statements approximates current costs and thus reduces the likelihood of a material impact that increases costs. However, there can be no assurance that the Company's business will not be impacted by inflation in the future.