-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Sumep0DpaWsL8OB7xgXtF6D+MyFzi4AtIFQtXvW6Z26R9XGRLbCGdp35eEDHlsR4 agE6gsYg/+lAPIkXzWUpIQ== 0000908737-00-000123.txt : 20000501 0000908737-00-000123.hdr.sgml : 20000501 ACCESSION NUMBER: 0000908737-00-000123 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 20000129 FILED AS OF DATE: 20000428 FILER: COMPANY DATA: COMPANY CONFORMED NAME: QUALITY STORES INC CENTRAL INDEX KEY: 0000928156 STANDARD INDUSTRIAL CLASSIFICATION: RETAIL-BUILDING MATERIALS, HARDWARE, GARDEN SUPPLY [5200] IRS NUMBER: 421425562 STATE OF INCORPORATION: DE FISCAL YEAR END: 0131 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 333-19613 FILM NUMBER: 613692 BUSINESS ADDRESS: STREET 1: 455 E. ELLIS ROAD CITY: MUSKEGON STATE: MI ZIP: 49441 BUSINESS PHONE: (231) 798-8787 MAIL ADDRESS: STREET 1: 455 E. ELLIS ROAD CITY: MUSKEGON STATE: MI ZIP: 49441 FORMER COMPANY: FORMER CONFORMED NAME: CENTRAL TRACTOR FARM & COUNTRY INC DATE OF NAME CHANGE: 19940810 10-K 1 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 FORM 10-K (Mark One) /X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended January 29, 2000 OR / / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _____________ to ______________ Commission file number 0-24902 QUALITY STORES, INC. (Exact Name of Registrant As Specified In Its Charter) Delaware 42-1425562 (State of Incorporation) (I.R.S. Employer No.) 455 E. Ellis Road, Muskegon, MI 49441 (Address of Principal Executive Offices) (Zip Code) Registrant's telephone number, including area code: (231) 798-8787 Not Applicable (Former Name, Former Address, and Former Fiscal Year, If Changed Since Last Report) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes /X/ No / / Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of April 28, 2000: 100. All of the registrant's stock is held by QSI Holdings, Inc., and is not publicly traded.
QUALITY STORES, INC. INDEX TO ANNUAL REPORT ON FORM 10-K FOR FISCAL YEAR ENDED JANUARY 29, 2000 PAGE PART I. ITEM 1. Business ....................................................................................1 ITEM 2. Properties...................................................................................8 ITEM 3. Legal Proceedings............................................................................8 ITEM 4. Submission of Matters to a Vote of Security Holders..........................................8 PART II. ITEM 5. Market for Registrant's Common Equity and Related Stockholder Matters........................9 ITEM 6. Selected Financial Data.....................................................................10 ITEM 7. Management's Discussion and Analysis of Financial Condition and Financial Disclosure........................................................................11 ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk..................................16 ITEM 8. Financial Statements and Supplementary Data.................................................16 ITEM 9. Changes In and Disagreements With Accountants on Accounting and Financial Disclosure........................................................................16 PART III. ITEM 10. Directors and Executive Officers of the Registrant..........................................17 ITEM 11. Executive Compensation......................................................................20 ITEM 12. Security Ownership of Certain Beneficial Owners and Management..............................23 ITEM 13. Certain Relationships and Related Transactions..............................................23 PART IV. ITEM 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K............................24
-2- PART I Note: Reference herein to fiscal 1999 are references to Quality Stores, Inc.'s, fiscal year ended January 29, 2000. During fiscal 1999, Quality Stores, Inc., changed its fiscal year end from the Saturday nearest to October 31 to the Saturday nearest to January 31. References herein to "fiscal years", other than fiscal 1999, are references to Quality Stores, Inc.'s, 52 or 53-week fiscal year which ended on the Saturday nearest to October 31 in that year. ITEM 1. BUSINESS Overview Quality Stores, Inc., a Delaware corporation [formerly Central Tractor Farm & Country, Inc. ("CT")], together with its primary subsidiaries, including Country General, Inc., and the former Quality Stores, Inc. ("Quality"), (collectively the "Company" or "QSI"), is the largest agricultural specialty retailer in the United States with 361 stores in 31 states as of March 31, 2000. QSI serves the agricultural, hardware, and related needs of rural consumers, especially part-time and full-time farmers, hobby gardeners, skilled trades persons, and do-it-yourself ("DIY") customers. The Company was founded in 1935 and has established itself as a market leader in the agricultural specialty market, having strong name recognition and a loyal customer base. Acquisition of the Company by J.W. Childs On November 27, 1996, the Board of Directors of the Company approved, and the Company entered into, a merger agreement (the "Merger Agreement") with J.W. Childs Equity Partners, L.P. and two of its affiliates (collectively "Childs") that provided for the acquisition of the Company by Childs in a two-stage transaction (the "Acquisition"). The Merger Agreement provided that following the acquisition by Childs of all of the Company shares held by affiliates of Butler Capital Corporation (collectively, "BCC"), an affiliate of Childs would merge with and into the Company (the "Merger") and Childs would acquire the remaining shares of the Company held by public shareholders ("Merger Consideration") for $14.25 per share in cash. The Merger was completed on March 27, 1997. Concurrent with the execution of the Merger Agreement, Childs entered into agreements (the "Securities Purchase Agreements") with BCC and with certain members of the Company's management (the "Management Shareholders") pursuant to which Childs agreed to purchase at a price of $14.00 per share 100% of BCC's shares and 36.4% of the Management Shareholders' shares representing approximately 64.0% and 1.4% of the Company's outstanding common stock, respectively (collectively the "Securities Purchases"). As of January 2, 1997, Childs had consummated the Securities Purchases and paid related expenses utilizing (i) $65.4 million of cash equity and, (ii) $35.1 million of borrowings under an interim margin loan facility (the "Margin Loan Facility"). In connection with the Securities Purchases, the Company entered into a term loan and revolving credit facility (the "Credit Facility") and used a portion of such facilities to refinance existing debt of the Company, including a $16.0 million convertible note held by BCC. The Credit Facility has since been amended. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources". On March 27, 1997, the Company consummated a public offering of $105.0 million aggregate principal amount of Senior Notes. The net proceeds from the offering were used to repay borrowings under the Margin Loan Facility, pay the Merger Consideration, repay a portion of the outstanding borrowings under the Credit facility, and pay fees and expenses of the Acquisition. The Acquisition was accounted for as a purchase. The total purchase price has been allocated to the tangible and intangible assets and the liabilities of the Company based upon their respective fair values. The cost of the Acquisition over the allocated fair value of the underlying tangible net assets is as follows (in thousands): Cost of acquiring the outstanding common stock of the Company from predecessor shareholders $159,393 Fair value of underlying tangible net assets 72,050 -------- Excess of cost of acquisition over the allocated fair value of the underlying tangible net assets $ 87,343 ======== As a result of the Acquisition, the Company is a wholly owned subsidiary of QSI Holding, Inc. [formerly CT Holdings, Inc. ("Holdings")], an affiliate of Childs, and a new basis of accounting has been reflected in the Company's financial statements reflecting the fair values for the Company's assets and liabilities as of March 27, 1997. The financial statements of the Company for periods prior to March 27, 1997, are presented on the historical cost basis of accounting. Acquisitions Effective June 26, 1997, the Company acquired all of the outstanding capital stock of Country General for approximately $138.6 million (including related costs and expenses) in cash (the "Country General Acquisition"). Country General operated a chain of 114 agricultural specialty retail stores. The Company funded the acquisition price in part from a $49.8 million cash equity contribution from Holdings, and the remainder from funds drawn under the amended and restated Credit Facility (see "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources"). The Country General Acquisition was accounted for as a purchase. The purchase price was allocated to the tangible and intangible assets and the liabilities based on fair values, as follows (in thousands): Total purchase price $138,563 Fair value of underlying tangible net assets 86,788 -------- Excess of cost of acquisition over the allocated fair value of the underlying tangible net assets $ 51,775 ======== In January 1999, the Company acquired nine retail stores and certain net operating assets from H.C. Shaw Co., a privately owned specialty retailer doing business as Fisco Farm and Home, for approximately $7.1 million. The transaction was accounted for as a purchase. On May 7, 1999, the Company acquired Quality Stores, Inc. ("Quality") in a transaction in which Quality was merged with and into the Company (the "Merger"). In connection with the Merger, the former shareholders and option holders of Quality Stores received, in the aggregate, $111.5 million in cash and 792,430 shares of common stock of Holdings that had a value of $91.8 million. In connection with the Merger, the Company also repaid approximately $42.1 million in debt owed by Quality Stores. The total purchase price for Quality Stores, including transaction expenses, was approximately $208.0 million. Quality, based in Muskegon, Michigan, had a strong presence in Michigan and Ohio and, at the time of the Merger, operated a chain of 114 stores, with annual sales of approximately $525 million, which offer merchandise oriented to farm and country living, including animal care products, farm and ranch supplies, workwear, and lawn and garden products. In connection with the Merger, the Company changed its name from "Central Tractor Farm & Country, Inc." to "Quality Stores, Inc." and relocated its headquarters to Muskegon, Michigan. The Company will continue to operate stores primarily under the Central Tractor Farm & Country, Country General, Quality Farm & Fleet, Quality Farm & Country, Fisco Farm & Home, and County Post names. The non-cash portion of the Merger consideration was contributed to the Company by Holdings (which, in connection with the Merger, changed its name to QSI Holdings, Inc.). The Company funded the cash portion of the Merger consideration and various fees and expenses associated with the Merger from funds drawn under an amendment and restatement of the Company's Credit Agreement, dated May 7, 1999, with Fleet National Bank, as administrative agent for the banks, financial institutions, and other institutional lenders party thereto (the "New Credit Facility"). Among other things, the amendment and restatement of the New Credit Facility increased the -2- aggregate principal amount of the facility from $150,000,000 to $320,000,000, consisting of a $220,000,000 term loan facility and a $100,000,000 revolving credit facility. The acquisition of Quality Stores has been accounted for as a purchase and the results of operations of Quality Stores have been included in the consolidated financial statements from the date of purchase. The estimated cost of the acquisition over the estimated fair value of the underlying tangible net assets is as follows (in thousands): Cost of acquiring Quality Stores capital stock $208,043 Fair value of underlying tangible net assets acquired 44,074 -------- Excess of cost of acquisition over the allocated fair value of the underlying tangible net assets $163,969 ======== Expansion Plan Since the beginning of fiscal 1997(1), the Company has increased the number of its retail stores from 111 to 350 as of January 29, 2000. In fiscal 1997, the Company opened 3 new stores and acquired 118 stores primarily through the Country General Acquisition. Five stores were closed in 1997. In fiscal 1998, the Company opened 1 new store and closed 14 stores (including 12 stores acquired from Country General, for which the closure was reserved in connection with the acquisition). For the period from November 1998 through January 2000, the Company opened 24 new stores, closed 10 stores, and acquired 122 stores. The integration of the Country General stores into the Company's systems was completed during fiscal 1998, and the integration of the Quality stores will be completed in the first quarter of fiscal 2000. The Company plans to add an additional 25 stores in fiscal 2000, and 40 to 50 per year thereafter, through further penetration of the Northeastern and Midwestern United States markets and through expansion into the Southeastern and Western United States. Management intends to achieve this growth through new store openings and selective acquisitions. On a preliminary basis, the Company has identified potential new markets outside of its existing markets that management believes are attractive candidates for one or more new QSI stores. The number of actual new QSI store openings in the next two years may differ materially from the projections outlined above if the Company makes a major acquisition or is unable to find attractive store locations to rent at reasonable prices, negotiate acceptable lease terms, or acquire small regional farm store chains at reasonable prices. The Company seeks to locate stores in high-traffic shopping districts whenever possible in order to attract customers who prefer to do much of their shopping at one time and place. As with the majority of its existing stores, the Company intends to lease its new stores. The estimated cash required to open a new, leased store (approximately 25,000 to 30,000 square feet of selling space) is $1,100,000, including inventory net of accounts payable and $130,000 in pre-opening expenses. Of these estimated cash expenditures, approximately half is used for initial inventory (net of accounts payable) and the balance is used for capital expenditures, principally leasehold improvements, fixtures and equipment, and pre-opening expenses. The Company also intends to continue to opportunistically relocate existing stores. These relocations reflect, in most cases, the expiration of an existing lease coupled with an opportunity to move to a more demographically and/or physically attractive site. Retail Stores QSI stores focus on agricultural and agricultural related products. The Company segments its merchandising mix into seven key product categories: agricultural products (including tractor parts and accessories), specialty hardware, lawn and garden products, workwear products, rural automotive parts and accessories, pet supplies, and general consumer products. Sale of agricultural and related products represents approximately 50% of QSI's total net sales. - ------------- (1) On August 17, 1999, the Company changed its fiscal year end from the Saturday closest to October 31 to the Saturday closest to January 31, effective as of January 29, 1999. -3- The growth and percentage of total store sales for each retail product category for fiscal 1999, fiscal 1998, and fiscal 1997, and a description of each product category, are set forth below:
Fiscal Year Ended -------------------------------------------- January 29, October 31, November 1, 2000 (1) 1998 1997 (2) -------------------------------------------- Agricultural (including tractor parts and accessories) 21.7% 26.6% 26.8% Specialty Hardware 18.0% 17.6% 17.7% Lawn & Garden and Seasonal 19.6% 17.4% 18.4% Workwear 10.9% 10.2% 9.3% Rural Automotive Parts & Accessories 13.2% 14.3% 14.3% Pet Supplies 8.6% 7.0% 6.6% General Consumer 8.0% 6.9% 6.9% -------------------------------------------- 100.0% 100.0% 100.0% ============================================ (1) Includes Quality from the date of the merger. (2) Includes Country General from the date of acquisition.
Agricultural Products. QSI stores' agricultural product line consists of approximately 6,000 stock keeping units (SKU's) supplying the needs of the part-time and full-time farmer, including tractor parts, tillage and harvesting parts, fencing materials, and animal health supplies. This product line consists largely of consumable products and other items requiring replacements on a regular basis. This product line accounted for $236.5 million, $156.3 million, and $110.5 million of the Company's total revenue in fiscal years 1999, 1998, and 1997, respectively. Agricultural product sales, as a percentage of total sales, decreased to 21.7% in fiscal 1999, as compared to 26.6% in fiscal 1998. This decrease resulted to the difference in product mix relating from the Quality stores. QSI emphasizes consumable agricultural supplies that are purchased frequently by its customers and does not sell heavy equipment such as tractors or combines. Specialty Hardware. QSI's specialty hardware line consists of approximately 9,000 SKU's with an emphasis on products with agricultural applications. These products accounted for $196.4 million, $103.6 million, and $72.7 million of the Company's total revenue in fiscal years 1999, 1998, and 1997, respectively. QSI stores carry a broad range of high-quality hardware with an emphasis on recognized branded professional products, including hand tools, power tools, mechanical tools, electrical products, including outdoor lighting, security lighting and motors, welders, air compressors, generators, paints (as well as a competitively priced private-label brand), and plumbing supplies. Lawn and Garden and Seasonal Products. QSI's lawn and garden products consist of approximately 2,000 SKU's, including lawn and garden tools, nursery stock, fertilizers, lawn fencing, and weed killers. These products accounted for $214.7 million, $102.1 million, and $75.8 million of the Company's total revenue in fiscal years 1999, 1998, and 1997, respectively. To differentiate itself from other retailers, QSI also stocks a selection of lawn mowers ranging from competitively priced items to full-featured riding lawn mowers. QSI assembles and tests the lawn mowers and sells a full assortment of parts for follow-up service needs. QSI stores offer seasonal bedding plants, trees, and shrubs in their garden centers. QSI stores also offer heating/energy equipment, including stoves, space heaters, and fans. Workwear. QSI's workwear products, including products sold under the Carhartt, Walls, and Iron Age brand names, are targeted at the specialized needs of its outdoor-oriented customers who require high quality functional apparel. This product category consists of approximately 3,000 SKU's, including premium quality insulated outerwear, overalls, flannel shirts, and work jeans. These products accounted for $118.6 million, $59.8 million, and $38.1 million of the Company's total revenue in fiscal years 1999, 1998, and 1997, respectively. The Company has been expanding its workwear line in its stores to include quality non-insulated workwear, bib overalls, twill pants, and hunting clothing. Rural Automotive Parts and Accessories. QSI's rural automotive parts and accessories consist of approximately 4,000 SKU's, including a core selection of automotive parts, batteries, and accessories for rural vehicles, primarily for pick-up trucks and tractors. The products accounted for $144.4 million, $83.9 million, and $58.6 million of the Company's total revenue in fiscal years 1999, 1998, and 1997, respectively. QSI also stocks a small assortment of general automotive items as a convenience to its customers, including oil and lubrication products and anti-freeze. In addition to brand name products, certain of the Company's automotive products are offered under QSI's own private label. -4- Pet Supplies. QSI's pet supplies consist of approximately 1,000 SKU's, including dog and cat foods, wild bird feed, and rabbit supplies. These products accounted for $94.0 million, $40.9 million, and $27.2 million of the Company's total revenue in fiscal years 1999, 1998, and 1997, respectively. The pet supplies sold by QSI include economically priced large sizes, such as 50-pound bags of dog food. Certain of these items are sold under QSI's private label. QSI has been expanding its pet supplies product category. General Consumer Products. QSI's general consumer products line consists of approximately 2,000 SKU's, including farm replicas and collectible toys and sporting goods, including guns and ammunition, hunting accessories, camping items, and outdoor living needs. These products accounted for $87.4 million, $40.6 million, and $28.3 million of the Company's total revenue in fiscal years 1999, 1998, and 1997, respectively. QSI stores also offer seasonal merchandise such as charcoal grills and coolers in the summer. Store Operations QSI's stores are designed primarily to meet the needs of farmers operating small to medium-sized farms (i.e., farms typically under 250 acres) as well as hobby gardeners and DIY customers. Quality operates under six store names: Quality Farm and Country, Quality Farm and Fleet, CT Farm and Country, Country General, Fisco Farm and Home, and County Post. The Company's stores average 21,086 square feet of indoor selling space, ranging from 8,500 to 62,500 square feet. Average sales per store in fiscal 1999 was $3.5 million. In addition to indoor selling space, the Company looks for store sites that have 15,000 to 20,000 square feet of available outdoor selling space. The outdoor selling space is primarily used for displaying lawn and garden products, fencing, tractor accessories, and livestock watering and feed equipment. QSI prototype stores are designed to provide customers with ease in locating desired products and are clean and colorful in order to provide an overall enjoyable shopping environment. The use of informative directional signing adds to the ease of the customer's shopping experience. Plan-o-grams are utilized to set merchandise assortments in the seven core product categories to ensure uniformity of presentation, ease of shopping for the customer and to facilitate inventory management, replenishment and restocking. Each store is managed by a store manager who is responsible for all aspects of the store's operations, including the hiring and training of store associates, work scheduling, inventory control, expense control, and customer service. Typically, the store manager is supported by an assistant manager and core department heads, along with an average of 18 sales associates. Store operations are coordinated through district managers, each of whom is currently responsible for eleven to twenty retail stores. In addition, the Company has developed and implemented consistent store standards, processes and best practices for the chain. The Company has established an internal store management-training program that focuses training on store operations, systems, financial matters, human resources and sales. To support the Company's planned expansion and its management training programs, the Company has implemented a long-range personnel plan that provides for internal promotions, coupled with recruitment of college graduates and hiring of individuals with previous retail experience. Store associates receive training that emphasizes customer service, sales, and product knowledge and store procedures. All QSI store operations management, including district managers, store managers, and assistant managers are compensated based on job performance and participate in an incentive program based on the store/district exceeding a targeted level of profitability. QSI has also established an incentive program for all store associates that focuses on sales and profitability. Other Operations In addition to QSI's retail stores, the Company also distributes an annual catalog. The QSI catalog offers a broad assortment of new, used, and rebuilt tractor parts and agricultural components, including approximately 25,000 SKU's. In fiscal 1999, catalog sales were $7.5 million. The catalog was distributed nationally to approximately 675,000 households in rural and agricultural communities in fiscal 1999. The breadth of this distribution provides the Company with name recognition among agricultural consumers in areas outside of its core geographical markets. As a result of the catalog's broad distribution, QSI anticipates that as it expands, customer familiarity will already have been established. The Company also sells tractor parts and other items to other agricultural retailers and -7- distributors. In recent years, the Company has been reducing the number of products offered and the number of customers served in this manner. In fiscal 1999, the Company generated sales of $2.5 million from such sales. Purchasing and Distribution The Company maintains a staff of 15 merchandise buyers, each of whom is responsible for specific product categories, at its headquarters in Muskegon, Michigan. The purchasing and inventory control process is controlled centrally by the Company's point-of-sale ("POS") and automatic replenishment systems. The Company purchases its merchandise from approximately 2,000 vendors, none of which accounted for more than 10% of the Company's purchases during fiscal 1999. The Company generally maintains multiple sources of supply for its products in order to minimize the risk of supply disruption and to maximize its purchasing power. The Company has no material long-term contractual commitments with any of its vendors. The Company operates two full-line distribution facilities: one in Fostoria, Ohio, with 583,000 square feet, and one in Des Moines, Iowa, with 135,000 square feet. In addition, the Company operates ten satellite distribution facilities, ranging in size from 25,000 to 300,000 square feet, on a hub and spoke network in various regional geographic regions of the country. Corporate Offices and Management Information Systems To facilitate the Company's expansion plan and to maintain consistent store operations, QSI has centralized specific functions of its operations, including accounting, the development of policies and procedures, store layouts, visual merchandise presentation, inventory management, merchandise procurement and allocations, marketing and advertising, human resources and real estate. This centralization effectively utilizes the experience and resources of the Company's senior management and provides a high level of consistency throughout the chain. The Company has invested considerable resources in management information and control systems to ensure world-class customer service and to improve operating efficiencies. These systems provide support for the purchase and distribution of merchandise and help to improve the manner in which QSI stores, the corporate offices, and distribution centers are operated. All QSI stores use the Company's POS system to capture sales information at the SKU level. Through the POS system, the Company can monitor customer purchases and inventory levels with respect to every item of merchandise in each store daily. The Company also has an automated inventory replenishment system which uses POS information, and facilitates the timely replenishment of both the stores and the warehouses. The sales and inventory information used in this system is updated on a daily basis. This system also provides for minimum stocking levels for lower volume items enabling QSI to carry a large number of SKU's at a minimum of inventory carrying expense. Competition The Company faces competition primarily from other chain and single-store agricultural specialty retailers and from mass merchandisers. Some of these competitors have substantially greater financial and other resources than the Company. Currently, most of the Company's stores do not compete directly in the markets of other agricultural specialty retail chains. However, the Company's expansion plans will likely result in some new stores being located in markets currently serviced by one or more of these chains; and there can be no assurance that these chains, certain of which have announced expansion plans, will not expand into the Company's markets. In addition, the Company competes in over half of its markets with mass merchandisers. The Company believes that its merchandise mix and level of customer service currently successfully differentiate it from mass merchandisers and that as a result, the Company has to date not been significantly impacted by competition from mass merchandisers. However, in the past, certain mass merchandisers have modified their product mix and marketing strategies in an effort apparently intended to permit them to compete more effectively in the Company's markets; and it is likely that these efforts will continue. -6- Advertising and Promotions QSI's advertising is focused on its commitment to guaranteeing customer satisfaction. QSI's primary advertising occurs through the weekly distribution of color circulars, the creation and management of customer loyalty programs and local TV advertising. In connection with the company's target marketing and customer loyalty programs, QSI developed the "Thank Q" program to build loyalty in all of its customer segments. The benefits to customers include guaranteed lowest farm prices plus a year-end rebate on everything the customer has purchased during the year, a year-end itemized statement of every purchase made, and bulk discounts. The program also tracks customer purchases, thereby providing a database of the members' purchasing patterns for marketing initiatives. Seasonality Unlike many specialty retailers, the Company has historically generated positive operating income in each of its four fiscal quarters. However, because the Company is an agricultural specialty retailer, its sales necessarily fluctuate with the seasonal needs of the agricultural community. The Company responds to this seasonality by attempting to manage inventory levels (and the associated working capital requirements) to meet expected demand, and by varying its use of part-time employees. Historically, the Company's sales and operating income have been highest in the second quarter (May through July) of each fiscal year due to the farming industry's planting season and the sale of seasonal products. Working capital needs are highest during the first quarter (February through April). The Company expects these trends to continue for the foreseeable future. Employees As of March 31, 2000, QSI had approximately 9,343 employees (approximately 4,563 in full-time and approximately 4,780 in part-time positions). The Company believes its relations with its employees are good. -7- ITEM 2. PROPERTIES As of March 31, 2000, the Company had 361 stores in 31 states as described in the chart below. # of # of State Stores State Stores - ------------------------------------------------------------------------ Alabama 1 North Dakota 5 California 11 Nebraska 46 Colorado 15 New Jersey 3 Delaware 2 New York 26 Georgia 10 Ohio 44 Indiana 19 Oklahoma 2 Iowa 25 Pennsylvania 25 Kansas 8 South Carolina 6 Kentucky 9 South Dakota 11 Maryland 4 Tennessee 3 Massachusetts 1 Virginia 13 Michigan 38 Vermont 1 Minnesota 10 West Virginia 10 Missouri 1 Wisconsin 3 Montana 2 Wyoming 4 North Carolina 3 ----- TOTAL: 361 The Company owns 79 of the stores and leases the remaining 282 stores. The Company owns the distribution center in Fostoria, Ohio, leases the remaining distribution facilities described in Item 1, and leases its corporate headquarters in Muskegon, Michigan. The Company generally negotiates retail store leases with an initial term between five and seven years, with two or three renewal periods of five years each, exercisable at the Company's option. Through January, 2000, the Company paid an average of $4.83 per square foot in retail store occupancy expenses, including rent, taxes, common area charges, repairs and maintenance. Rent expenses generally do not vary based on sales and generally increase 10-15% at the beginning of each option period. Management believes that the Company's properties are generally in good condition and are adequate for their intended uses. ITEM 3. LEGAL PROCEEDINGS The Company has been notified by the U.S. Environmental Protection Agency that it may have potential liability for cleanup costs associated with the cleanup of a dumpsite near Owensburg, Kentucky. To date, the only articles of waste identified as possibly once belonging to the Company are certain empty battery acid containers. The Company believes that any liability it might have as a result of this action would be as a de minimis contributor and will not have a material effect on the Company's financial position, liquidity or results of operations. The Company is not a party to any other legal proceedings, other than routine claims and lawsuits arising in the ordinary course of business. The Company does not believe that such claims and lawsuits, individually or in the aggregate, will have a material adverse effect on the Company's business. Compliance with federal, state and local laws and regulations pertaining to the discharge of materials into the environment, or otherwise relating to the protection of the environment, has not had, and is not anticipated to have, a material effect upon the capital expenditures, earnings or competitive position of the Company. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None -8- PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS Quality Stores, Inc., Common Stock is held entirely by Holdings. See "Item 1. Business - Acquisition of the Company by J.W. Childs". In fiscal 1999, the Company paid cash dividends of $1,542,000 to Holdings. The Company has not previously paid any cash dividends on its common stock. Although the Company may pay limited cash dividends on its common stock, the Company's ability to pay cash dividends is restricted by the New Credit Facility and Senior Notes. -9-
ITEM 6. SELECTED FINANCIAL DATA Successor | Predecessor ---------------------------------------------- | ----------------------------------------- Seven | Fiscal Year Fiscal Year Months | Five Months Fiscal Year Ended Ended Ended | Ended ------------------------- January 29, October 31, November 1, | March 26, November 2, October 28, 2000(5)(7) 1998 1997 | 1997 1996 1995 ---------------------------------------------|------------------------------------------- | Net sales (000's) $1,092,021 $ 587,195 $ 305,122 | $ 106,048 $ 293,020 $ 251,703 Income (loss) from continuing 3,163 9,975 1,365 | (1,247) 8,744 8,185 Operations (000's) | Ratio (deficiency) of earnings to | fixed charges (1) 1.2x 1.8x 1.3x | (1,881) 5.3x 5.8x Number of stores at end of period (2) 350 214 227 | 112 111 66 Comparable store sales per square | foot of indoor selling space (3) 163 180 191(8) | 222 224 Comparable store sales increases | (decreases) (4) 0.8% 4.6% (4.7%)(8) | 1.0% (1.6%) Balance sheet data (at end of period): | (000's) (5) | Working capital $ 191,904 $ 130,484 $ 85,639 | $ 63,803 $ 62,496 Total assets 822,463 418,845 434,235 | 159,238 149,977 Long-term debt, less current portion (6) 388,554 181,075 153,171 | 17,341 16,862 Stockholders' equity 224,627 129,757 119,547 | 90,063 81,277 | | | Three Months Ended | ---------------------------------------- | January 31, 1998 | January 30, 1999 (Unaudited) | ---------------------------------------- | Net sales (000's) $146,147 $144,393 | Income (loss) from continuing $1,485 $590 | Operations (000's) | Ratio (deficiency) of earnings to | fixed charges (1) 1.5x 1.2x | Number of stores at end of period 224 227 | Comparable store sales per square foot | of indoor selling space (3) | Comparable store sales increases | (decreases) (4) 6.1% 2.3% | Balance sheet data (at end of period) | (000's): | Working capital $136,310 $85,501 | Total assets $439,606 $425,210 | Long-term debt, less current portion $190,843 $150,500 | Stockholders' equity $131,242 $120,137 | (1) For purposes of computing this ratio, earnings consist of income before income taxes plus fixed charges. Fixed charges consist of interest expense, amortization of deferred financing costs and 20.0% of the rent expense from operating leases, which the Company believes is a reasonable approximation of the interest factor included in the rent. For the five-month period ended March 26, 1997 earnings were insufficient to cover fixed charges by $1,881. (2) Net of 5 store closings in fiscal 1997, 14 store closings in fiscal 1998 , and 10 store closings in fiscal 1999. (3) Comparable sales per square foot of indoor selling space and calculated by dividing store sales by total indoor selling square footage for stores open and operated by QSI at least twelve months in each fiscal year. (4) Percentage change in store sales as compared to sales for the same stores for the prior year for stores open and operated by QSI for at least twelve months in each year. The 1.0% increase in comparable store sales in 1996 has been adjusted to reflect a comparable 52-week year. Comparable store sales grew 2.9% without such adjustment. The 4.7% decrease in comparable store sales in 1997 has been adjusted to reflect that fiscal year 1996 was a 53 week year. Comparable store sales declined 6.5% without such adjustment. -10- (5) During the fiscal year ended January 29, 2000, the Company acquired Quality in a transaction in which Quality was merged with and into the Company. (6) Excluding, in fiscal 1995, long-term debt from discontinued operations. (7) During fiscal 1999, the Company changed its fiscal year end from the Saturday nearest to October 31 to the Saturday nearest to January 31. (8) Calculations are for the fiscal year ended November 1, 1997.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis of financial condition and results of operations should be read in conjunction with the selected consolidated financial data and the consolidated financial statements of the Company and related notes thereto. Results of Operations The following table sets forth, for the periods indicated, certain items in the Company's Statements of Income expressed as a percentage of net sales. All amounts and percentages for the fiscal year ended November 1, 1997, include the activity for the periods of the seven months ended November 1, 1997, and the five months ended March 26, 1997, on a combined basis.
----------------------------------------------- Fiscal Year Ended ----------------------------------------------- January 29, October 31, November 1, 2000 1998 1997 ----------------------------------------------- Net sales 100.0% 100.0% 100.0% Cost of sales 70.9% 69.9% 70.9% ----------------------------------------------- Gross profit 29.1% 30.1% 29.1% Selling, general, and administrative expense 23.0% 22.9% 24.6% Merger integration expenses 1.5% 0.0% 0.0% Amortization of intangibles 0.6% 0.6% 0.6% ----------------------------------------------- Operating income 4.0% 6.6% 3.9% Interest expense 3.2% 3.5% 3.5% ----------------------------------------------- Income before income taxes 0.9% 3.1% 0.4% Income taxes 0.6% 1.4% 0.4% ----------------------------------------------- Net income 0.3% 1.7% 0.0% ===============================================
Fiscal 1999 Compared to Fiscal 1998 Net sales for the fiscal year ended January 29, 2000,(2) were $1,092.0 million, an increase of $504.8 million, or 86.0%, as compared to net sales for the fiscal year ended October 31, 1998, of $587.2 million. The increase was due principally to the acquisition of 122 stores, primarily through the Quality merger. Net sales include $445.5 million of Quality sales since the date of acquisition. In addition, the Company opened 24 new stores subsequent to October 31, 1998, and had an increase in comparable store sales of $4.4 million, or 0.8%. Gross profit for fiscal 1999 was $317.6 million, an increase of $140.6 million, or 79.4%, as compared to $177.0 million for fiscal 1998, principally as a result of the increase in net sales. Gross profit as a percentage of sales decreased to 29.1% for fiscal 1999, as compared to 30.1% for fiscal 1998. The decrease in gross profit percentage was primarily the result of the Quality merger. Quality historically had a lower gross profit percentage than CT. Selling, general, and administrative expenses for fiscal 1999 were $251.4 million, an increase of $116.8 million, or 86.7% over fiscal 1998. This increase was due primarily to costs related to the acquisition and operation of the - ------ (2) Effective for the year ended January 29, 2000, the Company's fiscal year end was changed from the Saturday closest to October 31 to the Saturday closest to January 31. -11- Quality stores and costs related to new store openings. Selling, general, and administrative expenses as a percentage of sales increased to 23.0% in fiscal 1999 as compared to 22.9% in fiscal 1998. This increase is primarily attributable to costs related to new store openings in fiscal 1999. Merger integration expenses for fiscal 1999 were $15.8 million (none in fiscal 1998). The merger integration expenses are attributable to costs related to closing the QSI corporate headquarters in Des Moines, Iowa, and expenses incurred to integrate the CT and Quality operations. These costs include severance and retention costs for employees, costs associated with leased facilities to be closed, and costs to facilitate the integration process. Amortization of intangibles was $6.3 million for fiscal 1999 and $3.6 million in fiscal 1998. The increase is due to amortization of the additional goodwill acquired in the Quality merger. Operating income for fiscal 1999 was $44.0 million, an increase of $5.2 million, or 13.4%, as compared to fiscal 1998. Operating income as a percentage of sales decreased to 4.0% in fiscal 1999 from 6.6% in fiscal 1998. The decrease resulted from the factors affecting net sales, gross profit, selling, general, and administration expenses, merger and integration expenses, and amortization of intangibles discussed above. Interest expense for fiscal 1999 was $34.6 million, an increase of $14.1 million, as compared to $20.5 million for fiscal 1998. This increase was primarily due to the interest expense on the additional debt incurred to fund the Quality merger. Income tax expense for fiscal 1999 was $6.2 million, a decrease of $2.2 million, or 25.8% as compared to $8.4 million for fiscal 1998. Income taxes as a percentage of pretax earnings were 66.3% in fiscal 1999 as compared to 45.7% in fiscal 1998. The increase is due primarily to amortization of goodwill related to the Quality merger, which is not deductible for income tax purposes. Three-Month Period Ended January 30, 1999, Compared to the Unaudited Results for the Quarter Ended January 31, 1998 Net sales for the three-month period ended January 30, 1999, were $146.1 million, an increase of $1.7 million, or 1.2%, as compared to net sales for the quarter ended January 31, 1998, of $144.4 million. This increase was due principally to a comparable store sales increase of 6.1% and to sales derived in 1999 from new stores opened in fiscal 1999 to date, partially offset by $8.1 million of sales derived in 1998 from stores closed in fiscal 1998. Gross profit for the three-month period ended January 30, 1999, was $42.6 million, an increase of $1.0 million or 2.4%, as compared to $41.6 million for the quarter ended January 31, 1998, as a result of the increase in net sales discussed above and an increase in gross profit percentage. Gross profit as a percentage of net sales increased to 29.2% for the three-month period ended January 30, 1999, as compared to 28.8% for the quarter ended January 31, 1998. The increase in the gross profit percentage is attributable to the fuller realization of the increased purchasing power of the company resulting from the acquisition of Country General during fiscal 1997. Selling, general, and administrative (SGA) expenses for the three-month period ended January 30, 1999, were $33.7 million, a decrease of $0.4 million, or 1.2%, as compared to the quarter ended January 31, 1998. SGA expenses as a percentage of net sales improved to 23.1% for the three-month period ended January 30, 1999, as compared to 23.6% for the quarter ended January 31, 1998. This decrease is attributable to completion of the integration of the Country General stores. Amortization of intangibles remained relatively constant at $1.0 million for the three-month period ended January 30, 1999, as compared to $0.9 million for the quarter ended January 31, 1998. Operating income for the three-month period ended January 30, 1999, was $7.9 million, an increase of $1.2 million, or 17.9%, as compared to $6.7 million for the quarter ended January 31, 1998. Operating income as a percentage of net sales increased to 5.4% for the three-month period ended January 30, 1999, from 4.6% for the quarter ended January 31, 1998. The increase was the result of the factors affecting net sales, gross profit, and SGA expenses discussed above. -12- Interest expense was $5.0 million for the three-month period ended January 30, 1999, as compared to $5.3 million for the quarter ended January 31, 1998. The decrease in interest expense is attributable to a lower average debt balance and a decrease in interest rates on the Company's variable rate borrowings. Income taxes for the three-month period ended January 30, 1999, were $1.5 million, an increase of $0.7 million as compared to the quarter ended January 31, 1998. Income tax as a percentage of pretax earnings was 49.7% in 1999, compared to 57.1% in 1998. This decrease is due primarily to amortization of goodwill related to the acquisition of the Company by Childs, which is not deductible for income tax purposes, being spread over a larger pre-tax income base. Net income for the three-month period ended January 30, 1999, was $1.5 million, as compared to $0.6 million for the quarter ended January 31, 1998, as a result of the factors discussed above. Fiscal 1998 Compared to Fiscal 1997 Net sales for the fiscal year ended October 31, 1998 were $587.2 million, an increase of $176.0 million, or 42.8%, as compared to net sales for the fiscal year ended November 1, 1997 of $411.2 million. The increase was due principally to the fact that the Country General stores had a full year of sales in fiscal 1998 compared to four months in fiscal 1997. Net sales includes $257.3 million and $99.4 million of Country General sales in fiscal 1998 and fiscal 1997, respectively. In addition, the Company had an increase in comparable store sales of $13.2 million or 4.6% and had a full year of operations for the 4 stores acquired from Walsh and the 3 stores opened in 1997. The increase in comparable store sales was due primarily to the fact that fiscal year 1998 had warm early spring weather conditions while fiscal year 1997 had a mild winter followed by a cool spring and dry summer in the Northeast where most of the comparable stores are located. Gross profit for fiscal 1998 was $177.0 million, an increase of $57.5 million, or 48.1%, as compared to $119.5 million for fiscal 1997, principally as a result of the increase in net sales. Gross profit as a percentage of sales increased to 30.1% for fiscal 1998, as compared to 29.1% for fiscal 1997. The increase in gross profit percentage is a result of the increased purchasing power obtained as a result of the Country General Acquisition. Selling, general, and administrative expenses for fiscal 1998 were $134.6 million, an increase of $33.4 million, or 33.0%, over fiscal 1997. This increase was due primarily to costs related to the operation of the Country General stores and new stores opened in fiscal 1997 for a full year in fiscal 1998. Selling, general, and administrative expenses as a percentage of sales decreased to 22.9% in fiscal 1998 as compared to 24.6% in fiscal 1997. This decrease is attributable to completion of the integration of the Country General stores and increased sales volume. Amortization of intangibles was $3.6 million for fiscal 1998 and $2.2 million in fiscal 1997. The increase is due to a full year of amortization of the additional goodwill incurred in the Acquisition and the Country General Acquisition. Operating income for fiscal 1998, was $38.8 million, an increase of $22.6 million, or 139.9%, as compared to fiscal 1997. Operating income as a percentage of sales increased to 6.6% in fiscal 1998 from 3.9% in fiscal 1997. The increase resulted from the factors affecting net sales, gross profit, selling, general and administrative expenses and amortization of intangibles discussed above. Interest expense for fiscal 1998 was $20.5 million, an increase of $5.8 million, as compared to $14.7 million for fiscal 1997. This increase was primarily due to a full year of interest expense on the additional debt incurred to fund the Acquisition and the Country General Acquisition. Income tax expense for fiscal 1998, was $8.4 million, an increase of $7.0 million, or 490.3% as compared to $1.4 million for fiscal 1997. Income taxes as a percentage of pretax earnings were 45.7% in fiscal 1998 as compared to 92.3% in fiscal 1997. The decrease is due primarily to amortization of goodwill related to the Acquisition, which is not deductible for income tax purposes, being spread over a larger income base in fiscal 1998. -13- Liquidity and Capital Resources In addition to cash to fund operations, QSI's primary ongoing cash requirements are those necessary for the Company's expansion and relocation programs, including inventory purchases and capital expenditures and debt service. The Company's primary sources of liquidity have been funds provided from operations, borrowings pursuant to the Company's revolving and term credit facilities, short-term trade credit, and additional equity investments. On January 29, 2000, the Company had working capital of $191.9 million, an increase of $61.4 million, as compared to working capital of $130.5 million on October 31, 1998. This increase resulted primarily from the working capital acquired as a result of the Quality merger. On January 29, 2000, the Company's inventories were $365.4 million, an increase of $148.3 million, as compared to $217.1 million at October 31, 1998. On January 29, 2000, the Company's accounts payable were $124.0 million, an increase of $45.7 million, as compared to $78.3 million at October 31, 1998. The increase in the Company's inventory and accounts payable is attributable to the Quality merger. Operating activities of the Company utilized $19.0 million and provided $37.2 million of net cash in fiscal 1999 and 1998, respectively, and used $0.5 million of net cash in fiscal 1997. The decrease in net cash generated in fiscal 1999, as compared to fiscal 1998, resulted primarily from a decrease in accounts payable. The increase in net cash generated in fiscal 1998, as compared to fiscal 1997, resulted primarily from an increase in net income, a larger increase in accounts payable, and a net decrease in inventory compared to a net increase in 1997. The Company's capital expenditures were $35.7 million and $4.8 million for fiscal 1999 and 1998, respectively. The majority of capital expenditures were for store fixtures, equipment and leasehold improvements for new and existing stores. The Company presently expects its capital expenditures for new store openings and for renewal and replacement costs at existing stores and distribution centers in fiscal 2000 to be approximately $43.0 million. During fiscal 1997, the Company was acquired by an affiliate of J.W. Childs Equity Partners, L.P. and thereafter became a wholly owned subsidiary of Holdings. See "--Item 1. Business - Acquisition of the Company by J.W. Childs" and Notes to Consolidated Financial Statements. In connection with the Acquisition, on March 27, 1997, the Company consummated a public offering of $105.0 million aggregate principal amount of 10-5/8% Senior Notes (the "Senior Notes"). The net proceeds of the offering were used to repay borrowings of $35.9 million under the Margin Loan Facility, pay the Merger Consideration of $51.8 million, pay fees and expenses of the Acquisition, and reduce outstanding short-term borrowings. The Senior Notes mature on April 1, 2007, with interest payable semiannually in arrears on April 1 and October 1. The Senior Notes may be redeemed beginning April 1, 2002, at a price of 105.3125% of the principal amount decreasing approximately 1.77% annually thereafter until April 1, 2005, at which time they are redeemable at face value. Furthermore, notwithstanding the foregoing, the Company may redeem up to 35% of the original aggregate principal amount of the Senior Notes at a price of 110% of the principal amount with the net cash proceeds of a public equity offering within 60 days of closing such offering. In addition, effective June 26, 1997, the Company acquired all of the outstanding capital stock of Country General. The acquisition was accounted for as a purchase, and the Company elected to treat the purchase as a purchase of all of the assets of Country General for Federal income tax purposes. See "Item 1. Business - Acquisitions" and Notes to the Consolidated Financial Statements. The Company funded the acquisition price in part from a $49.75 million cash equity contribution from Holdings and the remainder from funds drawn under the amended and restated Credit Facility described below. At January 29, 2000, the Company had a bank credit facility that allowed for borrowings up to $320.0 million, consisting of $220.0 million under two term loan facilities (Tranche A and B) of which $216.9 million was outstanding and a $100.0 million revolving credit facility under which $87.5 million was outstanding. On March 31, 2000, this credit facility was amended to increase total available borrowings to $374.6 million, including $214.6 million under the term loan facilities and $160.0 million of revolving credit debt (collectively, the "Amended Credit Facility"). The Tranche A term loan ($95.6 million) under the Amended Credit Facility is payable in quarterly installments of $5.0 million through October 31, 2004, while the Tranche B term loan ($119.0 million) has quarterly principal installments of $0.4 million through January 31, 2004 that increase to $9.6 million through January 31, 2005, and then to $15.1 million through April 30, 2006. The revolving credit debt is due in full on October 30, 2006. The Company is also required to make mandatory prepayments on the term loan facilities based on the Company's excess cash flow, as defined. -14- Borrowings under the Amended Credit Facility are secured by all assets of the Company and bear interest at the prime or eurodollar rates plus a margin (8.6% to 10% at January 29, 2000). The revolving credit debt is also subject to a 0.5% commitment fee on its unused portion. The Company's long-term borrowing agreements contain covenants which require the Company to maintain certain financial ratios and also restricts, among other things, the payment of dividends, incurrence of additional debt, capital expenditures, mergers and acquisitions, and the disposition of assets. Commercial and standby letters of credit outstanding at January 29, 2000, January 30, 1999 and October 31, 1998, totaled $9.9 million, $6.3 million, and $6.7 million, respectively. In May and June of 1999, the Company entered into interest rate cap transactions (the "Cap Transactions") with a bank to reduce the impact of changes in interest rates on its floating term loan debt. The Cap Transactions had an initial notional amount totaling $105.0 million. The Cap Transactions cap the interest rate on $105.0 million of the Credit Facility at a three-month Libor rate of 7.0%, plus the applicable margin. The Company is exposed to interest rate risk in the event of nonperformance by the counter party to the Cap Transactions. However, the Company does not anticipate nonperformance by the bank. The Company anticipates that its principal uses of cash in the foreseeable future will be working capital requirements, debt service requirements and capital expenditures, as well as expenditures relating to acquisitions. Based upon current and anticipated levels of operations, the Company believes that its cash flow from operations, together with amounts available under the Credit Facility, will be adequate to meet its anticipated requirements in the foreseeable future for working capital, capital expenditures and interest payments. The Company expects that if it were to pursue a significant acquisition, it would arrange prior to the acquisition any additional debt or equity financing required to fund the acquisition. There can be no assurance, however, that the Company's business will continue to generate sufficient cash flow from operations in the future to service its debt, and the Company may be required to refinance all or a portion of its existing debt or to obtain additional financing or to reduce its capital spending. There can be no assurance that any such refinancing would be possible or that any additional financing could be obtained. The inability to obtain additional financing could have a material adverse effect on the Company. Seasonality Unlike many specialty retailers, the Company has historically generated positive operating income in each of its four fiscal quarters. However, because the Company is an agricultural specialty retailer, its sales necessarily fluctuate with the seasonal needs of the agricultural community. The Company responds to this seasonality by attempting to manage inventory levels (and the associated working capital requirements) to meet expected demand, and by varying its use of part-time employees. Historically, the Company's sales and operating income have been highest in the second quarter (May through July) of each fiscal year due to the farming industry's planting season and the sale of seasonal products. Working capital needs are highest during the first quarter (February through April). The Company expects these trends to continue for the foreseeable future. Inflation Management does not believe its operations have been materially affected by inflation. Year 2000 In prior years, he Company discussed the nature and progress of its plans to become Year 2000 ready. In late 1999, the Company completed its remediation and testing of systems. As a result of those planning and implementation efforts, the Company experienced no significant disruptions in mission-critical information technology and non-information technology systems and believes those systems successfully responded to the Year 2000 date change. The Company is not aware of any material problems resulting from Year 2000 issues, either with its products, its internal systems, or the products and services of third parties. The Company will continue to monitor its mission-critical computer applications and those of its suppliers and vendors throughout the fiscal 2000 to ensure that any latent Year 2000 matters that may arise are addressed promptly. Year 2000 remediation costs were not significant. -15- ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Market Risk The market risk inherent in the Company's financial instruments subject to such risks, is the potential market value loss arising from adverse changes in interest rates. The Company's financial instruments subject to market risk are held for purposes other than trading. Interest Rate Cap Agreements The Company uses interest rate cap agreements to reduce exposure to interest rate fluctuations on its term debt. At January 29, 2000, the Company had interest rate cap agreements that provided for an interest rate cap of 7.0 percent, based on the three-month LIBOR rate, which was 5.97 at January 29, 2000, plus the applicable margin. These agreements cover $105.0 million notional amount of debt. At January 29, 2000, $216.9 million of term debt was outstanding. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Included at pages F-1 through F-28. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. -16- PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The following table sets forth the name, age and position of each of the Company's directors, executive officers, and other significant employees. All of the Company's officers are elected annually and serve at the discretion of the Board of Directors. Name Age Position(s) - ---------------------------------------------------------------------------- James T. McKitrick 54 President, Chief Executive Officer, Director Alan L. Fansler 49 Executive Vice-President, Chief Operating Officer, Director John W. Childs 58 Director Steven G. Segal 39 Vice-President, Director Adam L. Suttin 32 Vice-President, Director David C. Bliss 62 Chairman of the Board, Director Jerry D. Horn 62 Director Jeffrey B. Swartz 38 Director William E. Watts 45 Director Habib Y. Gorgi 43 Director Peter Lamm 48 Director Richard C. Dresdale 44 Director John L. Hilt 54 Director G. Dean Longnecker 51 Executive Vice-President, Integration, Director Denny L. Starr 46 Senior Vice-President of Finance, CFO, Secretary Jeffery A. Stanton 49 Senior Vice-President, Merchandising & Marketing James T. McKitrick, President and Chief Executive Officer, joined the Company in July 1992. He has over 30 years experience in retailing, including 20 years at Kmart Corporation. Prior to joining QSI, Mr. McKitrick was President and Chief Executive Officer of Builder's Emporium, a California-based home improvement center chain. Previously, he was with Ames Department Stores from 1987 through 1990, where he held the positions of Executive Vice President, Chairman of Zayre Discount Store Division, and President and Chief Executive Officer of G.C. Murphy Division, a $900 million variety store chain. Mr. McKitrick also served as President and Chief Executive Officer of Warehouse Club, Inc. from 1986 through 1987 and Executive Vice President of Merchandising for T.G.&Y. Stores Company from 1984 through 1986. From 1963 through 1984, Mr. McKitrick was with the Kmart Corporation. Alan L. Fansler, Executive Vice-President and Chief Operating Officer, joined the Company in May, 1999. Prior to May, 1999, Mr. Fansler was employed by Quality for 27 years, where he held several management positions in Store Operations, Marketing, and Human Resources, including Vice-President of Human Resources, Vice-President of Store Operations, Senior Vice-President of Operations, and President and Chief Executive Officer. Mr. Fansler received his B.S. degree from Purdue University in 1972. John W. Childs has been President of J.W. Childs Associates since July, 1995. Prior to that time, he was an executive at Thomas H. Lee Company from May, 1987, most recently holding the position of Senior Managing Director. He is a director of Big V Supermarkets, Inc., Edison Schools, Inc., Chevys, Inc., DESA International, Inc., Pan Am International Flight Academy, Inc., and Beltone Electronics, Inc. Steven G. Segal is Senior Managing Director of J.W. Childs Associates and has been an executive of J.W. Childs Associates since July, 1995. Prior to that time, he was an executive at Thomas H. Lee Company from August, 1987, most recently holding the position of Managing Director. He is a director of Universal Hospital Services, Inc., National Nephrology Associates, Inc., International DiverseFoods, Inc., Big V Supermarkets, Inc., and Jillian's Entertainment Holdings, Inc. and is Chairman of the Board of Empire Kosher Poultry, Inc. -17- Adam L. Suttin is a Managing Director of J.W. Childs Associates and has been an executive of J.W. Childs Associates since July 1995. Prior to that time, he was an executive at Thomas H. Lee Company from August 1989, most recently holding the position of Associate. He is a director of American Safety Razor Company, Empire Kosher Poultry, Inc. and DESA International, Inc. David C. Bliss, Chairman of the Board, joined the Company in May, 1999. Prior to May, 1999, Mr. Bliss was employed by Quality and served as Vice-President and Secretary/Treasurer in 1976 and was appointed to the Board of Directors of Quality at that time. He was promoted to President in 1986, to Chief Executive Officer in 1992, and to Chairman of the Board in 1995. Mr. Bliss is a 1960 graduate of Western Michigan University. Jerry D. Horn was CEO from 1985 to 1991, then Chairman from 1991 to 1999 of General Nutrition Companies, Inc., a 4,500-store vitamin and nutritional supplement retail chain operating under the GNC name. Mr. Horn was President and CEO of Recreational Equipment, Inc., from 1979 to 1984 and has been a Managing Director of J. W. Childs Associates since July, 1995. Jeffrey B. Swartz has been Chief Executive Officer of Timberland Co., a manufacturer and marketer of branded footwear and apparel, since 1998, and has worked for that company in various positions since June, 1986. William E. Watts has been President, Chief Executive Officer, and a Director of General Nutrition Companies, Inc., since October, 1991 and, prior to that, held various positions with its predecessor since 1984. Habib Y. Gorgi is President of the general partners of Fleet Equity Partners VII, L.P., and the general partner of Silverado III, L.P., which is the general partner of Chisholm Partners, and has worked at Fleet Equity Partners since 1986. He is a director of Skyline Chili, Roadrunner Freight Systems, Savage Sports Corporation, Simonds Industries, and FTD Corporation. Mr. Gorgi received a bachelor's degree from Brown University and a master's degree from Columbia University. Peter Lamm is Chairman and Chief Executive Officer of Fenway Partners, Inc., and was a founding partner. Fenway is a New York-based private equity firm for institutional investors with the primary objective of acquiring leading middle-market companies. Prior to founding Fenway, Mr. Lamm was previously Managing Director of Butler Capital Corporation and General Partner of each of the BCC funds. Mr. Lamm serves as a director of a number of Fenway's portfolio companies, including Aurora Foods, Inc., Simmons Company, Delimex Holdings, Inc., Blue Capital Management, LLC, and Iron Age Corporation. Richard C. Dresdale is President of Fenway Partners, Inc., and was a founding partner. Prior to founding Fenway, Mr. Dresdale was employed by Clayton, Dubilier and Rice, Inc., most recently as Principal. Mr. Dresdale serves as a director of a number of Fenway's portfolio companies, including Aurora Foods, Inc., Simmons Company, Delimex Holdings, Inc., and Blue Capital Management, LLC. John L. Hilt is retired from Quality. Prior to his retirement, he held the position of Chairman Emeritus of the Board of Directors. John joined Quality in 1967 and held several positions during his full-time career with the Company. He became President in 1974, was promoted to Chairman of the Board in 1986, and became Chairman Emeritus in December of 1995. Mr. Hilt is a 1967 graduate of Purdue University. G. Dean Longnecker, Executive Vice-President of Integration, joined QSI in 1980 as Controller. Mr. Longnecker was promoted to Executive Vice-President of Finance in 1985, Executive Vice-President, Chief Operating Officer in 1997, and Executive Vice-President of Integration in 1999. Mr. Longnecker was employed at Payless Cashways from 1973 until 1980, most recently as Treasurer. He received a B.S. from Iowa State University in 1970 and C.P.A. in 1972. Denny L. Starr, Senior Vice-President of Finance and Chief Financial Officer, joined the Company in October, 1989 as Assistant Controller. Mr. Starr was promoted to Vice-President and Controller in 1993, Senior Vice-President of Finance in 1996, and Senior Vice-President of Finance and Chief Financial Officer in 1998. In 1999, Mr. Starr terminated his employment and became an independent consultant to the Company. Effective February 1, 2000, Mr. Starr rejoined the Company and was reelected Senior Vice President of Finance and Chief Executive Officer. He previously served as Assistant Controller of The Witten Group, a holding company with operations in manufacturing, real estate, and finance, from 1986 through 1989. He was an Audit Manager with McGladrey & Pullen from 1982 until 1986. Mr. Starr received his B.A. from the University of Iowa in 1982 and C.P.A. in 1982. -18- Jeffery A. Stanton, Senior Vice-President, Merchandising & Marketing, joined the Company in June, 1992. Previously, he was employed by R.R. Donnelly & Sons and Meredith/Burda Corporation from 1985 through 1992, as well as Reichardt's, Inc., a specialty retailer, from 1972 through 1985. Mr. Stanton received a B.B.A. degree from the University of Iowa in 1972. -19- ITEM 11. EXECUTIVE COMPENSATION Summary Compensation Table The following table sets forth compensation earned for all services rendered to the Company during fiscal 1999, fiscal 1998, and fiscal 1997, as applicable, by the Company's Chief Executive Officer and four other executive officers who were employed by the Company as such during fiscal 1999 (collectively, the "Named Executives").
Annual Compensation --------------------------------------------------------- All Other Fiscal Salary (1) Bonus Compensation (2) Name and Principal Position Year ($) ($) ($) - -------------------------------------------------------------------------------------------------------------------------- James T. McKitrick 1999 535,000 286,318 6,742 President, Chief Executive Officer, Director 1998 435,000 224,743 5,000 1997 399,423 -- 9,586 Alan L. Fansler (3) 1999 198,654 147,173 4,520 Executive Vice-President, Chief Operating Officer, Director G. Dean Longnecker 1999 273,000 146,103 1,890 Executive Vice-President, Integration, Director 1998 265,000 136,912 4,587 1997 254,327 -- 2,043 James F. Hurley (3) 1999 146,038 75,995 4,446 Senior Vice-President, Finance, Chief Financial Officer Jeffery A. Stanton 1999 200,000 85,835 3,002 Senior Vice-President, Merchandising & Marketing 1998 145,385 61,998 5,000 1997 108,692 20,300 9,465 - ------------------------------------------------------------------------------------------------------------------------- (1) Includes compensation deferred at the Named Executive's election under the Company's 401(k) Plan. (2) Represents amounts contributed by the Company during each fiscal year, as applicable, to the Named Executive's 401(k) Plan. (3) Mr. Fansler, and Mr. Hurley joined the Company as of May 7, 1999, in connection with the merger of CT and Quality. Mr. Hurley's employment with the Company terminated on January 31, 2000.
Employment Arrangements with Executive Officers Mr. McKitrick's Employment Agreement provides for a base salary of $535,000 subject to the annual increases as determined by the Board of Directors (which increases must at least equal increases in the consumer price index). Mr. McKitrick is eligible for a cash bonus if the Company achieves certain operation cash flow targets, which bonuses are not subject to any ceilings contained in the Employment Agreement. Mr. McKitrick's Employment Agreement provides for a severance payment equal to his base salary for 18 months if his employment is terminated (other than in the case of death, disability, or for cause) or if he is not reelected as President and Chief Executive Officer or Chairman, not subject, however, to reduction for any compensation earned from during such 18-month period from other businesses. Mr. Fansler's Employment Agreement provides for a base salary of $275,000 subject to the annual increases as determined by the Board of Directors (which increases must at least equal increases in the consumer price index). Mr. Fansler is eligible for a cash bonus if the Company achieves certain operation cash flow targets, which bonuses are not subject to any ceilings contained in the Employment Agreement. Mr. Fansler's Employment Agreement -20- provides for a severance payment equal to his base salary for 12 months if his employment is terminated (other than in the case of death, disability, or for cause) or if he is not reelected as Executive Vice-President and Chief Operating Officer. Mr. Longnecker's Employment Agreement provides for a base salary of $273,000 subject to the annual increases as determined by the Board of Directors (which increases must at least equal increases in the consumer price index). Mr. Longnecker is eligible for a cash bonus if the Company achieves certain operation cash flow targets, which bonuses are not subject to any ceilings contained in the Employment Agreement. Mr. Longnecker's Employment Agreement provides for a severance payment equal to his base salary for 12 months if his employment is terminated (other than in the case of death, disability, or for cause). Mr. Hurley's Employment Agreement provided for a base salary of $200,000 subject to the annual increases as determined by the Board of Directors (which increases must at least equal increases in the consumer price index). Mr. Hurley was eligible for a cash bonus if the Company achieves certain operation cash flow targets, which bonuses are not subject to any ceilings contained in the Employment Agreement. Mr. Hurley's Employment Agreement provided for a severance payment equal to his base salary for 12 months if his employment was terminated (other than in the case of death, disability, or for cause) or if he was not reelected as Senior Vice-President of Finance, Chief Financial Officer. Mr. Stanton's Employment Agreement provides for a base salary of $200,000 subject to the annual increases as determined by the Board of Directors (which increases must at least equal increases in the consumer price index). Mr. Stanton is eligible for a cash bonus if the Company achieves certain operation cash flow targets, which bonuses are not subject to any ceilings contained in the Employment Agreement. Mr. Stanton's Employment Agreement provides for a severance payment equal to his base salary for 12 months if his employment is terminated (other than in the case of death, disability, or for cause) or if he is not reelected as Senior Vice-President. The Employment Agreements also contemplate that certain members of management will participate in stock option plans of Holdings. Allocations of options among the management group are to be made in the first instance by the Chief Executive Officer of the Company, subject to ratification by Holdings' Board of Directors. A portion of such allocations was made during fiscal years 1999 and 1998. The management stock options are subject to accelerated vesting based on the Company's achievement of certain operating cash flow targets. The following table provides certain information concerning options to purchase Holdings common stock during fiscal 1999 to each Named Executive Officer of the Company. -21-
Options Granted in Last Fiscal Year Potential Realizable Value At Assumed Annual Rates Of Stock Price Appreciation For Individual Grants Option Term ---------------------------------------------------------------------------------------- Number of Percent Of Exercise Shares Total Options or Expiration Name Granted Granted Base Price Date 5% 10% - ------------------------------------------------------------------------------------------------------------------- James T. McKitrick 7,185 12.35% $115.80 June 7, 2009 $523,255 $1,326,030 Alan L. Fansler 8,636 14.85% $115.80 June 7, 2009 $628,925 $1,593,821 Jeffery A. Stanton 2,297 3.95% $115.80 June 7, 2009 $167,282 $423,924 James F. Hurley 4,318 7.42% $115.80 June 7, 2009 $314,462 $796,909
Additionally, the Employment Agreements contemplate that Messrs. McKitrick and Longnecker will receive additional stock options which vest if the Company is sold within six years after the effective time of the Merger and the realized value of the common equity of the original investment group in Holdings should equal or exceed ten times the value thereof at the time of the Merger. Mr. McKitrick's and Mr. Longnecker's options under this program are to acquire 12,750 and 7,650 shares of common stock of Holdings. In addition various other executives of the Company have employment agreements that contain, among other items, one-year severance provisions under certain circumstances as well as various bonus provisions. -22- ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT As of January 29, 2000, Holdings holds 100% of the outstanding stock of the Company. All outstanding options were repurchased in connection with the Acquisition or exchanged for options to acquire shares of Holdings common stock. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Two of the Company's suppliers, Iron Age Corporation ("Iron Age") and DESA International, Inc. ("DESA"), are controlled by certain stockholders of Holdings. Iron Age is a manufacturer and distributor of work boots and protective footwear. DESA is a manufacturer and marketer of zone heating/home comfort products and specialty tools. The Company believes that the terms of its purchases from Iron Age and DESA are at least as favorable to the Company as could be obtained from other suppliers. In fiscal 1999, the Company's purchases from Iron Age and DESA totaled $21.6 million. For fiscal 1999, the three-month period ended January 30, 1999, and fiscal 1998, Childs was paid an annual management and consulting services fee of approximately $240,000 $60,000, and $240,000 respectively, under a five-year agreement, annually renewable thereafter, requiring annual payments of $240,000, subject to limitations of the Company's debt agreements. In addition, during fiscal 1999, the three-month period ended January 30, 1999, and 1998, Fenway Partners, a stockholder of Holdings, was paid an annual management fee of $120,000, $30,000, and $120,000 respectively. In connection with the consummation of the Acquisition and subsequent employee stock purchases, Holdings loaned amounts to certain employees of the Company to partially fund their investment in Holdings common stock. The loans, which totaled $362,000 at January 29, 2000, are due in ten years and bear interest at an interest rate of 8.5%. Additionally, Messrs. Bliss, McKitrick, Fansler, Hurley, Stanton, and Longnecker are parties to a Stockholders Agreement dated as of May 7, 2000, applicable to all shares of Holdings common stock or vested options to acquire such common stock held now or hereafter acquired by them. The Stockholders Agreement, among other terms, permits Holdings to "call" their shares and vested options on their termination of employment for any reason. Additionally, if either Mr. McKitrick, Mr. Bliss, Mr. Fansler, Mr. Hurley, Mr. Stanton, or Mr. Longnecker is terminated for any reason other than for cause or without good reason (as those terms are defined in the Stockholders Agreement), he has the right to "put" his shares or vested options to Holdings. Depending on the circumstances, the price for shares of Holdings common stock purchased in connection with a call or put under the Stockholders Agreement will range from cost to seven times EBITDA. The put and call features of the Stockholders Agreement terminate on completion of a public offering of Holdings common stock with aggregate net proceeds of $50.0 million or more. In February 2000, the Company sold the land, buildings, and certain fixtures and equipment for three stores to be opened in fiscal 2000 to a limited liability company whose principal members are Messrs. McKitrick and Fansler. The sales price of $7.0 million was equal to the Company's cost for the assets. The Company then entered into a twelve-year lease agreement with this same company for the use of these stores. The total minimum lease payments under the lease agreements range from $0.8 million in fiscal 2000 to $1.0 million in fiscal 2011. The Company believes the terms of the lease agreements to be as favorable to the Company as could be obtained from other sources. -23- PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) Documents filed as part of this Report: 1. Financial Statements. See the Index to Financial Statements appearing at page F-1. 2. Financial Statement Schedules. The following Consolidated Financial Statement Schedule is included at page F-28: Schedule II - Valuation and Qualifying Accounts No other Financial Statement Schedules have been presented since the required information is not present or not present in amounts sufficient to require submission of the schedule, or because the information required is included in the consolidated financial statements or the notes thereto. 3. Exhibits. The following exhibits are filed with this Annual Report on Form 10-K or incorporated herein by reference. 3(i) Certificate of Incorporation, as amended, filed as exhibit 3.1 to the Company's Quarterly Report on Form 10-Q for the quarter ended May 1, 1999, and incorporated herein by reference. 3(ii) Bylaws of the Company, filed as exhibit 3(ii) to the Company's Registration Statement on Form S-1 (File #33-82620) originally filed on August 9, 1994 and incorporated herein by reference. 4.1 Form of Common Stock Certificate of the Company, filed as exhibit 4.1 to the Company's Registration Statement on Form S-1 (File #33-82620) originally filed on August 9, 1994 and incorporated herein by reference. 4.2 Indenture relating to the Senior Notes, the form of which was filed as exhibit 4.4 to Amendment No. 3 to the Company's Registration Statement on Form S-1 (File No. 333-19613) originally filed on March 19, 1997 and incorporated herein by reference. 10.1 Employment Agreement between the Company and James T. McKitrick dated as of September 16, 1994, filed as exhibit 10.5 to the Company's Registration Statement on Form S-1 (File #33-82620) originally filed on August 9, 1994 and incorporated herein by reference. 10.2 Employment Agreement between the Company and Dean Longnecker dated as of September 16, 1994, filed as exhibit 10.6 to the Company's Registration Statement on Form S-1 (File #33-82620) originally filed on August 9, 1994 and incorporated herein by reference. 10.3 Asset Purchase Agreement By and Between Central Tractor Farm & Country, Inc., (the "Buyers") and Big Bear Farm Stores, Inc. (the "Sellers") dated May 22, 1996, filed as exhibit 10.15 to the Company's 10-Q originally filed on September 9, 1996 and incorporated herein by reference. 10.4 Agreement Plan of Merger dated November 27, 1996 by and among Central Tractor Farm & Country, Inc., J.W. Childs Equity Partners, L.P., JWC Holdings I, Inc., and JWC Acquisition I, Inc., filed as an exhibit to the Company's 8-K originally filed on December 3, 1996 and incorporated herein by reference. 10.5 Securities Purchase Agreement dated as of November 27, 1996 by and among Central Tractor Farm & Country, Inc., J.W. Childs Equity Partners, L.P., JWC Holdings I, Inc., and JWC Acquisition I, Inc., filed as an exhibit to the Company's 8-K originally filed on December 3, 1996 and incorporated herein by reference. 10.6 Securities Purchase Agreement, dated as of November 6, 1996, by and among Mezzanine Lending Associates I, L.P., Mezzanine Lending Associates II, L.P., Mezzanine Lending Associates III, L.P., Senior Lending Associates I, L.P., BCC Industrial Services, JWC Acquisition I, Inc., J.W. Childs Equity Partners, L.P., Central Tractor Farm & Country, Inc. filed as an exhibit to JWCAC's Schedule 13D originally filed on December 9, 1996 and incorporated herein by reference. -24- 10.7 Letter Agreement, dated as of November 27, 1996 between JWC Acquisition I, Inc. and Mr. James T. McKitrick, filed as an exhibit to JWCAC's Schedule 13D originally filed on December 9, 1996 and incorporated herein by reference. 10.8 Letter Agreement, dated as of November 27, 1996 between JWC Acquisition I, Inc. and Mr. G. Dean Longnecker, filed as an exhibit to JWCAC's Schedule 13D originally filed on December 9, 1996 and incorporated herein by reference. 10.9 Credit Agreement dated as of December 23, 1996 among the Company, Holdings, JWCAC, certain banks, financial institutions and other institutional lenders listed therein, Fleet, as administrative agent, and NationsBank, as co-agent, filed as exhibit 10.22 to the Company's 10-K originally filed on January 31, 1997 and incorporated herein by reference. 10.10 Stock Purchase Agreement, dated June 26, 1997 by and between the Company and ConAgra, Inc. and the Amended and Restated Credit Agreement, dated as of July 3, 1997, filed as exhibits to the Company's 8-K filed on July 3, 1997 and incorporated herein by reference. 10.11 Letter Amendment, dated as of February 18, 1998, to Amended and Restated Credit Agreement, filed as exhibit 10.1 to the Company's 10-Q originally filed on September 15, 1998 and incorporated herein by reference. 12 Statement Regarding Computation of Ratio of Earnings to Fixed Charges 21 Subsidiaries of the Company 27 Financial Data Schedule 99 Important Factors Regarding Forward-Looking Statements (b) Reports on Form 8-K Filed During the Last Quarter of Fiscal 1999 None (c) See Item 14(a)(3) of this report. (d) See Item 14(a)(2) of this report. -25- Quality Stores, Inc. and Predecessor Consolidated Financial Statements Fiscal year ended January 29, 2000, period of three months ended January 30, 1999, fiscal year ended October 31, 1998, periods of seven months ended November 1, 1997 and five months ended March 26, 1997 Contents Report of Independent Auditors............................................F-2 Consolidated Balance Sheets .............................................F-3 Consolidated Statements of Income ........................................F-5 Consolidated Statements of Changes in Stockholder's Equity ...............F-6 Consolidated Statements of Cash Flows.....................................F-7 Notes to Consolidated Financial Statements................................F-9 F-1 Report of Independent Auditors The Board of Directors Quality Stores, Inc. We have audited the accompanying consolidated balance sheets of Quality Stores, Inc. (Successor), a wholly owned subsidiary of QSI Holdings, Inc., as of January 29, 2000, January 30, 1999, and October 31, 1998, and the related consolidated statements of income, changes in stockholder's equity, and cash flows of the Successor for the fiscal year ended January 29, 2000, the three-month period ended January 30, 1999, the fiscal year ended October 31, 1998 and the seven-month period ended November 1, 1997, and its Predecessor for the five-month period ended March 26, 1997. Our audits also included the financial statement schedule listed in the index at Item 14a. These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Quality Stores, Inc. at January 29, 2000, January 30, 1999, and October 31, 1998, and the consolidated results of operations and cash flows of the Successor for the fiscal year ended January 29, 2000, the three-month period ended January 30, 1999, the fiscal year ended October 31, 1998 and the seven-month period ended November 1, 1997, and the Predecessor for the five-month period ended March 26, 1997, in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therin. ERNST & YOUNG LLP Chicago, Illinois April 11, 2000 F-2
Quality Stores, Inc. Consolidated Balance Sheets (In Thousands of Dollars, Except Share and Par Value) January 29 January 30 October 31 2000 1999 1998 ------------------------------------------------ Assets Current assets: Cash and cash equivalents $ 11,029 $ 5,144 $ 6,971 Trade and other receivables, less allowances of $1,275 in 2000 and $386 in 1999 and 1998 7,742 4,597 4,648 Recoverable income taxes from parent 4,827 2,345 3,134 Inventory 365,383 234,868 217,064 Other current assets 5,408 2,876 3,010 -------------------------------------------- Total current assets 394,389 249,830 234,827 Property, improvements, and equipment: Land 4,242 1,821 1,821 Buildings and improvements 75,696 21,111 19,461 Furniture and fixtures 65,410 31,121 27,590 Automobiles and trucks 2,332 701 703 -------------------------------------------- 147,680 54,754 49,575 Less accumulated depreciation and amortization 24,213 9,140 7,948 -------------------------------------------- 123,467 45,614 41,627 Goodwill, net of amortization of $12,430 in 2000, $5,974 in 1999 and $5,080 in 1998 293,895 135,605 134,037 Other intangibles, net of amortization of $3,886 in 2000, $1,853 in 1999 and $1,537 in 1998 10,712 8,557 8,354 -------------------------------------------- Total assets $822,463 $439,606 $418,845 ============================================ F-3 January 29 January 30 October 31 2000 1999 1998 ------------------------------------------------ Liabilities and stockholder's equity Current liabilities: Accounts payable $124,012 $ 85,359 $ 78,322 Accrued payroll and bonuses 10,937 4,728 8,272 Other accrued expenses 43,880 16,664 14,084 Deferred income taxes 1,285 1,768 506 Current portion of long-term debt and capital lease obligations 22,371 5,001 3,159 ---------------------------------------------- Total current liabilities 202,485 113,520 104,343 Long-term debt, less current portion 388,554 190,843 181,075 Capital lease obligations, less current portion 1,103 1,370 1,011 Deferred income taxes 5,694 2,631 2,659 Stockholder's equity: Common stock, $.01 par value: 3,000 authorized shares; 100 shares issued and outstanding -- -- -- Additional paid-in capital 209,377 119,155 119,155 Retained earnings 15,250 12,087 10,602 ---------------------------------------------- Total stockholder's equity 224,627 131,242 129,757 ---------------------------------------------- Total liabilities and stockholder's equity $822,463 $439,606 $418,845 ============================================== See accompanying notes.
F-4
Quality Stores, Inc. and Predecessor Consolidated Statements of Income (In Thousands of Dollars, Except Share and Par Value) Successor | Predecessor --------------------------------------------------------------- | --------------- Period of Period of | Period of Fiscal year three months Fiscal year seven months | five months ended ended ended ended | ended January 29 January 30 October 31 November 1 | March 26 2000 1999 1998 1997 | 1997 --------------------------------------------------------------- | --------------- | Net sales $1,092,021 $ 146,147 $ 587,195 $ 305,122 | $ 106,048 Cost of sales 774,455 103,521 410,179 216,342 | 75,281 --------------------------------------------------------------- | --------------- Gross profit 317,566 42,626 177,016 88,780 | 30,767 | Selling, general, and | administrative expenses 251,385 33,742 134,623 72,142 | 29,045 Merger integration expenses 15,820 -- -- -- | -- Amortization of intangibles 6,327 972 3,552 1,753 | 415 --------------------------------------------------------------- | --------------- Operating income 44,034 7,912 38,841 14,885 | 1,307 | Interest expense 34,637 4,959 20,466 11,463 | 3,188 --------------------------------------------------------------- | --------------- Income (loss) before income taxes 9,397 2,953 18,375 3,422 | (1,881) | Income taxes (credit) 6,234 1,468 8,400 2,057 | (634) --------------------------------------------------------------- | --------------- Net income (loss) $ 3,163 $ 1,485 $ 9,975 $ 1,365 | $ (1,247) =============================================================== | =============== | Ratio (deficiency) of earnings to | fixed charges 1.2x 1.5x 1.8x 1.3x | $ (1,881) =============================================================== | =============== See accompanying notes.
F-5
Quality Stores, Inc. and Predecessor Consolidated Statements of Changes in Stockholder's Equity (In Thousands of Dollars) Stock Additional Retained Total Common Warrant Paid-In Earnings Stockholder's Stock Outstanding Capital (Deficit) Equity ------------------------------------------------------------------------------- Predecessor Balances at November 2, 1996 $106 $665 $ 69,709 $19,583 $ 90,063 Exercise of stock options -- -- 252 -- 252 Net loss -- -- -- (1,247) (1,247) ------------------------------------------------------------------------------- Balances at March 26, 1997 $106 $665 $ 69,961 $18,336 $ 89,068 =============================================================================== Successor Initial capitalization of the Company after the Merger on March 27, 1997 $ -- $ 69,170 $ (738) $ 68,432 Net income -- -- 1,365 1,365 Capital contribution from parent -- 49,750 -- 49,750 ----------------- ------------------------------------------------ Balances at November 1, 1997 -- 118,920 627 119,547 Net income -- -- 9,975 9,975 Capital contribution from parent -- 235 -- 235 ----------------- ------------------------------------------------ Balances at October 31, 1998 -- 119,155 10,602 129,757 Net income -- -- 1,485 1,485 ------------------------------------------------ ---------------- Balances at January 30, 1999 -- 119,155 12,087 131,242 Net income -- -- 3,163 3,163 Capital contribution from parent -- 91,764 -- 91,764 Dividend to parent -- (1,542) -- (1,542) ---------------- ------------------------------------------------ Balances at January 29, 2000 $ -- $209,377 $15,250 $224,627 ================ ================================================ See accompanying notes.
F-6
Quality Stores, Inc. and Predecessor Consolidated Statements of Cash Flows (In Thousands of Dollars) Successor | Predecessor ----------------------------------------------------------- | ------------- Period of Period of | Period of Fiscal year three months Fiscal year seven months | five months ended ended ended ended | ended January 29 January 30 October 31 November 1 | March 26 2000 1999 1998 1997 | 1997 ----------------------------------------------------------- | ------------- | | Operating activities | Net income (loss) $ 3,163 $ 1,485 $ 9,975 $ 1,365 | $ (1,247) Adjustments to reconcile net income | (loss) to net cash provided by (used | in) operating activities: | Depreciation and amortization 13,713 1,317 5,221 2,716 | 1,490 Amortization of intangibles 6,327 1,229 4,604 2,253 | 414 Deferred income taxes 4,397 1,234 6,417 1,871 | 1,328 Changes in operating assets and | liabilities: | Trade and other receivables 1,271 839 2,616 (871) | 144 Recoverable income taxes | from parent (3,678) 789 (621) (1,119) | (1,885) Inventory 5,177 (9,609) 5,053 1,957 | (11,894) Other current assets 788 665 126 946 | (924) Accounts payable (50,115) 2,065 10,307 1,895 | 1,468 Other current liabilities (21) (1,666) (6,478) 1,139 | (1,524) ----------------------------------------------------------- | ------------- Net cash provided by (used in) | operating activities (18,978) (1,652) 37,220 12,152 | (12,630) | Investing activities | Purchases of property, improvements, | and equipment (35,681) (3,997) (4,842) (3,816) | (2,419) Acquisition of Central Tractor Farm | & Country, Inc. (Predecessor) -- -- -- (155,963) | -- Other business acquisitions, net of | cash acquired (111,502) (6,020) (1,568) (136,995) | -- Other 2,200 (538) 394 206 | (1,348) ----------------------------------------------------------- | ------------- Net cash used in investing activities (144,983) (10,555) (6,016) (296,568) | (3,767) F-7 Successor | Predecessor ----------------------------------------------------------- | ------------- Period of Period of | Period of Fiscal year three months Fiscal year seven months | five months ended ended ended ended | ended January 29 January 30 October 31 November 1 | March 26 2000 1999 1998 1997 | 1997 ----------------------------------------------------------- | ------------- | | Financing activities | Borrowings under revolving line of | credit $ 401,696 $ 91,180 $ 273,645 $ 206,106 | $ 113,119 Repayments on revolving line of credit (358,196) (79,255) (302,320) (170,650) | (91,494) Proceeds from issuance of long-term | debt 221,309 -- -- 155,000 | 8,000 Payments on long-term debt (88,147) (1,500) (3,000) (8,000) | (16,000) Payments on capitalized lease | obligations (284) (45) (171) (101) | (69) Proceeds from issuance of | common stock and capital | contributions -- -- 235 115,489 | 252 Cash of Central Tractor Farm & | Country, Inc. at date of acquisition -- -- -- 1,220 | -- Payment of dividend (1,542) -- -- -- | -- Deferred financing costs (4,990) -- -- (8,764) | -- Other -- -- -- 1,494 | -- ----------------------------------------------------------- | ------------- Net cash provided by (used in) | financing activities 169,846 10,380 (31,611) 291,794 | 13,808 ----------------------------------------------------------- | ------------- Net increase (decrease) in cash and cash | equivalents 5,885 (1,827) (407) 7,378 | (2,589) | Cash and cash equivalents at beginning | of period 5,144 6,971 7,378 -- | 3,809 ----------------------------------------------------------- | ------------- Cash and cash equivalents at end of | period $ 11,029 $ 5,144 $ 6,971 $ 7,378 | $ 1,220 =========================================================== | ============= | Supplemental cash flow information | Interest payments $ 28,124 $ 1,941 $ 19,838 $ 10,294 | $ 1,746 Net income taxes paid 4,504 225 355 327 | 412 Note payable issued in acquisition of | Fisco Farm and Home -- 1,084 -- -- | -- Capital contribution of common stock | received from parent used to | consummate Quality Stores, Inc. | acquisition 91,764 -- -- -- | -- See accompanying notes
F-8 Quality Stores, Inc. and Predecessor Notes to Consolidated Financial Statements Fiscal year ended January 29, 2000, period of three months ended January 30, 1999, fiscal year ended October 31, 1998, periods of seven months ended November 1, 1997 and five months ended March 26, 1997 (In Thousands of Dollars, Except Share and Par Value) 1. Basis of Presentation and Acquisition of the Company Quality Stores, Inc. (the Company), formerly known as Central Tractor Farm & Country, Inc., is a wholly-owned subsidiary of QSI Holdings, Inc. (QSI Holdings), formerly known as CT Holding, Inc., an affiliate of J. W. Childs Equity Partners, L.P. (Childs). As a result of the acquisition of the Company discussed below, effective March 27, 1997, a new basis of accounting has been reflected in the Company's consolidated financial statements reflecting the fair values for the Company's assets and liabilities at that date (Successor). The consolidated financial statements of the Company for periods prior to March 27, 1997, are presented on the historical cost basis of accounting (Predecessor). A line has been placed in the financial statements to distinguish between the different basis of accounting used for the Predecessor and Successor periods. On November 27, 1996, the Board of Directors of the Company approved, and the Company entered into, a merger agreement (the Merger Agreement) with Childs, QSI Holdings and its subsidiary, JWC Acquisition I, Inc., that provided for the acquisition of the Company by QSI Holdings in a two-stage transaction. The Merger Agreement provided that following the acquisition of all of the Company's common stock held by affiliates of Butler Capital Corporation (collectively BCC), QSI Holdings' subsidiary would merge with and into the Company (the Merger) and QSI Holdings would acquire the remaining shares of common stock of the Company held by public shareholders. The Merger was completed on March 27, 1997. Concurrent with the Merger closing, the Company consummated a public offering of $105.0 million aggregate principal amount of Senior Notes. The net proceeds from the offering and proceeds from common stock issued by QSI Holdings were used to pay the Merger consideration, repay certain outstanding borrowings, and pay fees and expenses of the acquisition. F-9 Quality Stores, Inc. and Predecessor Notes to Consolidated Financial Statements (continued) (In Thousands of Dollars, Except Share and Par Value) 1. Basis of Presentation and Acquisition of the Company (continued) The acquisition of the Company was accounted for as a purchase. The purchase price for the common stock was $159.4 million, including related costs and expenses, of which $156.0 million was paid in cash and $3.4 million in common stock and stock options of QSI Holdings was issued. Transaction costs included $1.7 million paid to Childs in consideration for services regarding the planning, structuring and negotiation of the acquisition and related financings. The purchase price was allocated to the tangible and intangible assets and the liabilities of the Company based on fair values as follows: Accounts receivable and other assets $ 9,990 Inventory 124,284 Property, improvements, and equipment 25,387 Goodwill 87,343 Bank line of credit (23,554) Accounts payable and accrued expenses (51,809) Long-term debt and capitalized lease obligations (9,442) Deferred income taxes (2,806) ---------------- $159,393 ================ 2. Summary of Significant Accounting Policies Principles of Consolidation and Business The consolidated financial statements include the Company and its wholly owned subsidiaries. All intercompany transactions are eliminated in consolidation. The Company operates nationally in a single business segment consisting of agricultural specialty retail stores located primarily in the Midwest, Northeast, and Southeast United States. F-10 Quality Stores, Inc. and Predecessor Notes to Consolidated Financial Statements (continued) (In Thousands of Dollars, Except Share and Par Value) 2. Summary of Significant Accounting Policies (continued) Fiscal Year End The Company currently operates on a 52 or 53-week fiscal year ending on the Saturday nearest to January 31. Prior to the fiscal year ended January 29, 2000, the Company operated on a 52 or 53-week fiscal year ending on the Saturday nearest to October 31. The three month transition period ended January 30, 1999 presented herein results from this change in fiscal years. 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. Cash and Cash Equivalents The Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents. Trade Receivables The majority of the Company's sales are cash or credit card sales. Limited sales are made on account and the Company generally does not require collateral on such sales. Concentrations of credit risk with respect to trade receivables are limited due to the large number of the Company's customers and their geographic dispersion. The allowance for doubtful accounts is based on a current analysis of receivable delinquencies and historical loss experience. F-11 Quality Stores, Inc. and Predecessor Notes to Consolidated Financial Statements (continued) (In Thousands of Dollars, Except Share and Par Value) 2. Summary of Significant Accounting Policies (continued) Inventory Substantially all inventory is recorded at the lower of cost or market using the last in, first out (LIFO) method. The Company reviews its inventory for slow-moving, obsolete or otherwise unsalable items and records any estimated losses to be incurred as such inventory is identified. If the first in, first out method of inventory valuation had been used, inventories would have been approximately $6.0 million lower than reported at January 29, 2000, January 30, 1999, and October 31, 1998. Property, Improvements, and Equipment Property, improvements, and equipment are recorded on the basis of cost. Depreciation is computed primarily using the straight-line method over the estimated useful lives of the respective assets as follows: buildings and improvements from 10 to 39 years; leasehold improvements (not in excess of underlying lease terms) from 5 to 20 years; furniture and fixtures from 5 to 15 years; and automobiles and trucks from 3 to 10 years. Certain long-term lease transactions have been accounted for as capital leases. The related assets are amortized on a straight-line basis over the lesser of their estimated useful life or the respective terms of the leases. Goodwill and Other Intangibles Goodwill is being amortized utilizing the straight-line method over 40 years. Other intangibles consist primarily of deferred financing costs that are amortized over the term of the related debt. The Company reviews the recoverability of unamortized amounts of intangibles annually and evaluates any related impairment based on an analysis of estimated undiscounted cash flows. Management has determined that no impairment of intangibles currently exists. F-12 Quality Stores, Inc. and Predecessor Notes to Consolidated Financial Statements (continued) (In Thousands of Dollars, Except Share and Par Value) 2. Summary of Significant Accounting Policies (continued) Deferred Income Taxes Deferred income tax assets and liabilities are determined by applying currently enacted tax laws and rates to the cumulative temporary differences between the carrying value of assets and liabilities for financial reporting and income tax purposes. Deferred income tax expense or credit is based on the net change in deferred income tax assets and liabilities during the period. Financial Instruments and Risk Management The Company's financial instruments consist of cash and cash equivalents, trade and other receivables, accounts payable, and long-term debt. The Company's estimate of the fair value of these financial instruments approximates their carrying amounts at the respective consolidated balance sheet dates, except for long-term debt which has an estimated fair value that is $8.4 million lower than its carrying value at January 29, 2000. Fair value was determined using quoted market prices for the Company's long-term debt and discounted cash flow analyses for all other instruments. The Company does not hold or issue financial instruments for trading purposes. In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) No. 133, Accounting for Derivative Instruments and Hedging Activities, which is effective for fiscal years beginning after June 15, 2000. SFAS No. 133 requires companies to record derivative instruments on the balance sheet at fair value and establishes accounting rules for changes in fair value that result from hedging activities. The Company currently engages in limited hedging activities that require use of derivative instruments and has not completed all of the complex analyses necessary to determine the effect of adopting SFAS No. 133 on its consolidated financial position or future results of operations. F-13 Quality Stores, Inc. and Predecessor Notes to Consolidated Financial Statements (continued) (In Thousands of Dollars, Except Share and Par Value) 2. Summary of Significant Accounting Policies (continued) Interest Rate Cap Agreements The fee paid in connection with interest rate cap agreements is being amortized over the term of the agreements. Any amounts to be received by the Company under the agreements are recognized in the period that they become known. Revenue Recognition Revenue is recognized at the point of purchase and payment by the customer for cash and credit card sales. Revenue associated with layaway merchandise is deferred until such time as full payment is received. Sales on account result in revenue at the time the related goods are released or shipped to the customer. Catalogs, Sale Flyers, and Advertising Costs The direct cost of printing and mailing the Company's annual mail order catalog is deferred and amortized against mail order revenues over the year the catalog is in use. The direct cost of printing and distributing sale flyers is deferred and amortized over the life of the flyer which is generally two weeks or less. Other advertising costs are expensed as incurred. Unamortized amounts relating to the costs of the annual catalog and periodic sale flyers were not significant at January 29, 2000, January 30, 1999, and October 31, 1998, respectively. Advertising expenses were $29.1 million, $3.9 million, $15.1 million, $7.8 million, and $3.3 million for fiscal 1999, the three-month period of 1999, fiscal 1998, and the seven-month and five-month periods of 1997, respectively. Store Opening Costs Direct costs incurred in setting up and opening new stores are expensed as incurred. Reclassifications Certain amounts previously reported in prior periods have been reclassified to conform with the presentation used in fiscal 1999. F-14 Quality Stores, Inc. and Predecessor Notes to Consolidated Financial Statements (continued) (In Thousands of Dollars, Except Share and Par Value) 3. Business Acquisitions Quality Stores, Inc. On May 7, 1999, Central Tractor Farm & Country, Inc. (CT) acquired Quality Stores, Inc. (Quality) in a transaction in which Quality was merged with and into CT. At the completion of the acquisition, the name of the surviving corporation was changed to Quality Stores, Inc. (the Company). In connection with the acquisition, the former shareholders and option holders of Quality received, in the aggregate, $111.5 million in cash and 792,430 shares of common stock of CT's parent company that was contributed to CT and had a value of $91.8 million. In addition, CT repaid $42.1 million in debt owed by Quality. The total purchase price for Quality, including $4.7 million of transaction expenses, was $208.0 million. Quality, based in Muskegon, Michigan, has a strong retail presence in Michigan and Ohio and, at the time of the acquisition, operated 114 stores offering merchandise oriented to farm and country living, including animal care products, farm and ranch supplies, workwear, and lawn and garden products. The acquisition of Quality was accounted for as a purchase. The purchase price has been allocated to the tangible and intangible assets and the liabilities based on fair values as follows: Accounts receivable and other assets $ 12,693 Inventory 135,692 Property, leaseholds and equipment 57,485 Deferred income taxes 1,817 Goodwill 163,969 Accounts payable and accrued expenses (121,504) Long-term debt (42,109) ------------------ $208,043 ================== In connection with the acquisition of Quality, the Company initiated a plan to relocate its corporate headquarters to Muskegon, Michigan. This plan included the closing of the CT headquarters in Des Moines, Iowa and the termination of certain CT employees. Liabilities of $4.0 million for estimated exit costs and $3.6 million for the cost of severance payments to terminated employees were recorded as of the plan's approval date. At January 29, 2000, $2.9 million of exit costs and $1.1 million of severance F-15 Quality Stores, Inc. and Predecessor Notes to Consolidated Financial Statements (continued) (In Thousands of Dollars, Except Share and Par Value) 3. Business Acquisitions (continued) payments had been incurred and charged against the respective liabilities. Other merger integration costs of $8.2 million (primarily store and computer system conversion costs) that were attributable to fiscal 1999 were expensed as incurred. The exit plan is expected to be completed during the first quarter of fiscal 2000. Fisco Farm and Home Effective December 31, 1998, the Company acquired substantially all assets and assumed certain liabilities of The H. C. Shaw Company, doing business as Fisco Farm and Home (Fisco), a chain of nine agricultural specialty retail stores, for $6.0 million in cash and a $1.1 million note payable over a four-year period. The acquisition of Fisco was accounted for as a purchase. The purchase price was allocated to the tangible and intangible assets and the liabilities based on fair values as follows: Accounts receivable and other assets $1,319 Inventory 8,195 Leaseholds and equipment 756 Goodwill 3,245 Accounts payable and accrued expenses (6,411) ------------------ $7,104 ================== Country General, Inc. Effective June 26, 1997, the Company acquired all of the outstanding capital stock of Country General, Inc. (Country General) for $138.6 million in cash, including $1.6 million related to post closing adjustments finalized during fiscal 1998. Country General operates a chain of 114 agricultural specialty retail stores. The Company funded the acquisition price in part from a $49.8 million cash equity contribution from its parent and bank debt. F-16 Quality Stores, Inc. and Predecessor Notes to Consolidated Financial Statements (continued) (In Thousands of Dollars, Except Share and Par Value) 3. Business Acquisitions (continued) The acquisition of Country General was accounted for as a purchase. The final purchase price was allocated to the tangible and intangible assets and the liabilities based on fair value as follows: Accounts receivable and other assets $ 5,824 Inventory 99,790 Property, leaseholds, and equipment 17,174 Goodwill 51,775 Deferred income taxes 9,229 Accounts payable and accrued expenses (45,229) ------------------ $138,563 ================== The final purchase price allocation included reserves of $4.9 million for the estimated cost to close twelve acquired stores and $2.2 million for the cost of severance payments to identified employees in connection with the closing of Country General's corporate headquarters. As of October 31, 1998, the store closing process and the termination of employees at Country General's closed corporate headquarters had been completed. At January 29, 2000, January 30, 1999, and October 31, 1998, the remaining reserve for lease costs pertaining to closed stores was $2.2 million, $3.0 million, and $3.4 million, respectively. The results of operations of Quality, Fisco, and Country General are included in the accompanying consolidated statements of income from the respective dates of purchase. F-17 Quality Stores, Inc. and Predecessor Notes to Consolidated Financial Statements (continued) (In Thousands of Dollars, Except Share and Par Value) 3. Business Acquisitions (continued) Pro Forma Results of Operations Pro forma results of operations presented below are based on the historical results of operations of the Company, adjusted to give effect to the acquisition of Quality described above and the debt financing arrangements relating to the acquisitions, as though this acquisition had occurred at the beginning of the periods presented. The acquisition of Fisco has not been included in the three-month period of 1999 and fiscal 1998 amounts below because its operating results would not materially affect the pro forma calculations. Fiscal year Period of three Fiscal year ended months ended ended January 29 January 30 October 31 2000 1999 1998 ------------------------------------------------------ Net sales $1,235,423 $285,282 $1,093,896 Operating income 46,375 15,303 49,711 Net income 1,477 1,087 5,051 4. Long-Term Debt Long-term debt consists of the following obligations: January 29 January 30 October 31 2000 1999 1998 -------------------------------------------- 10.625% Senior Notes $ 105,000 $105,000 $ 105,000 Term loans 216,900 45,500 47,000 Revolving credit obligations 87,500 44,000 32,075 Other notes payable 1,281 843 -- -------------------------------------------- 410,681 195,343 184,075 Less current portion 22,127 4,500 3,000 -------------------------------------------- $ 388,554 $190,843 $ 181,075 ============================================ F-18 Quality Stores, Inc. and Predecessor Notes to Consolidated Financial Statements (continued) (In Thousands of Dollars, Except Share and Par Value) 4. Long-Term Debt (continued) The Senior Notes mature on April 1, 2007, and may be redeemed beginning April 1, 2002 at a price of 105.3125% of the principal amount decreasing 1.77% annually thereafter until April 1, 2005 at which time they are redeemable at face value. Furthermore, notwithstanding the foregoing, the Company may redeem up to 35% of the original aggregate principal amount of the Senior Notes at a price of 110% of the principal amount with the net cash proceeds of a public equity offering within 60 days of closing such an offering. At January 29, 2000, the Company had a bank credit facility that allowed for borrowings up to $320.0 million, consisting of $220.0 million under two term loan facilities (Tranche A and B) of which $216.9 million was outstanding and a $100.0 million revolving credit facility under which $87.5 million was outstanding. On March 31, 2000, this credit facility was amended to increase total available borrowings to $374.6 million, including $214.6 million under the term loan facilities and $160.0 million of revolving credit debt (collectively, the "Amended Credit Facility"). The Tranche A term loan ($95.6 million) under the Amended Credit Facility is payable in quarterly installments of $5.0 million through October 31, 2004, while the Tranche B term loan ($119.0 million) has quarterly principal installments of $0.4 million through January 31, 2004 that increase to $9.6 million through January 31, 2005, and then to $15.1 million through April 30, 2006. The revolving credit debt is due in full on October 30, 2006. The Company is also required to make mandatory prepayments on the term loan facilities based on the Company's excess cash flow, as defined. Borrowings under the Amended Credit Facility are secured by all assets of the Company and bear interest at the prime or eurodollar rates plus a margin (8.6% to 10% at January 29, 2000). The revolving credit debt is also subject to a 0.5% commitment fee on its unused portion. The Company's long-term borrowing agreements contain covenants which require the Company to maintain certain financial ratios and also restricts, among other things, the payment of dividends, incurrence of additional debt, capital expenditures, mergers and acquisitions, and the disposition of assets. F-19 Quality Stores, Inc. and Predecessor Notes to Consolidated Financial Statements (continued) (In Thousands of Dollars, Except Share and Par Value) 4. Long-Term Debt (continued) Commercial and standby letters of credit outstanding at January 29, 2000, January 30, 1999 and October 31, 1998, totaled $9.9 million, $6.3 million, and $6.7 million, respectively. In fiscal 1999, the Company entered into interest rate cap agreements (the Cap Agreements) with a bank to reduce the impact of changes in interest rates on its floating term loan debt. The Cap Agreements have a notional amount of $105.0 million, mature in 2001 and cap the Eurodollar rate on the notional amount at 7%, plus the applicable margin. The Company is exposed to interest rate risk in the event of nonperformance by the counterparty to the Cap Agreements; however, the Company does not anticipate nonperformance by the bank. 5. Leases The Company has entered into certain long-term capital lease agreements for the use of warehouses, certain retail store facilities and computer equipment. The net carrying value of the assets recorded under capital leases was $0.8 million, $1.0 million, and $0.6 million at January 29, 2000, January 30, 1999, and October 31, 1998, respectively. The Company also has entered into certain noncancelable operating leases for the use of real estate, automobiles and trucks, and office equipment. Aggregate rental expense for operating leases amounted to $23.6 million, $3.9 million, $16.2 million, $9.3 million, and $4.1 million for fiscal 1999, the three-month period of 1999, fiscal 1998, and the seven-month and five-month periods of 1997, respectively. F-20 Quality Stores, Inc. and Predecessor Notes to Consolidated Financial Statements (continued) (In Thousands of Dollars, Except Share and Par Value) 5. Leases (continued) At January 29, 2000, future minimum rental payments due under all noncancelable leases with a term greater than one year are as follows: Capital Operating Leases Leases ----------------------------- Fiscal 2000 $ 442 $ 28,606 Fiscal 2001 442 21,658 Fiscal 2002 442 16,887 Fiscal 2003 243 13,864 Fiscal 2004 93 9,435 Thereafter 45 14,766 ----------------------------- Total minimum lease payments 1,707 $105,216 ============ Less amount representing interest 360 -------------- Present value of minimum lease payments 1,347 Less current portion 244 -------------- $1,103 ============== 6. Stock Options QSI Holdings has stock option arrangements with various officers and other members of Company management which are accounted for under the provisions of APB Opinion No. 25 and related interpretations. No compensation expense has been recognized by QSI Holdings or the Company in connection with these stock option arrangements because the fair market value of the underlying stock award on the measurement date equals the exercise price of the related options. Under SFAS No. 123, certain pro forma information is required as if QSI Holdings had accounted for stock options under the alternative fair value method and the resulting compensation expense was recorded by the Company. Pro forma net income of the Company under the alternative fair value method for fiscal 1999, the three-month period of 1999, and fiscal 1998 is $2.9 million, $1.4 million, and $9.7 million, respectively. Pro forma results for the seven-month period of 1997 would not have differed from amounts reported because no stock option compensation expense would have been recognized during that period. F-21 Quality Stores, Inc. and Predecessor Notes to Consolidated Financial Statements (continued) (In Thousands of Dollars, Except Share and Par Value) 7. Income Taxes The Company's results of operations are included in the consolidated income tax returns of its parent. Income tax expense (credit) included in the consolidated statements of income have been calculated as if the Company filed a separate return. The components of income tax expense (credit) are as follows:
Successor | Predecessor ---------------------------------------------------------------------- | ---------------- Fiscal year Period of three Fiscal year Period of seven | Period of five ended months ended ended months ended | months ended January 29 January 30 October 31 November 1 | March 26 2000 1999 1998 1997 | 1997 ---------------------------------------------------------------------- | ---------------- Current: | Federal $ 1,082 $ 234 $ -- $ 148 | $(1,541) State 755 -- 200 38 | (421) ---------------------------------------------------------------------- | ---------------- 1,837 234 200 186 | (1,962) Deferred 4,397 1,234 8,200 1,871 | 1,328 ---------------------------------------------------------------------- | ---------------- $ 6,234 $ 1,468 $ 8,400 $ 2,057 | $ (634) ====================================================================== | ================
A reconciliation of the Company's income tax expense (credit) to the amount computed by applying the statutory federal income tax rate to income (loss) before income taxes is as follows:
Successor | Predecessor ---------------------------------------------------------------------- | ---------------- Fiscal year Period of three Fiscal year Period of seven | Period of five ended months ended ended months ended | months ended January 29 January 30 October 31 November 1 | March 26 2000 1999 1998 1997 | 1997 ---------------------------------------------------------------------- | ---------------- Income tax at federal | statutory rate $ 3,195 $ 1,004 $ 6,248 $ 1,163 | $ (639) | State income taxes, | net of federal 873 194 1,214 306 | (79) income tax effect | Nondeductible | goodwill 1,742 192 766 391 | 72 amortization | Other, net 424 78 172 197 | 12 ---------------------------------------------------------------------- | ---------------- $ 6,234 $ 1,468 $ 8,400 $ 2,057 | $ (634) ====================================================================== | ================
F-22 Quality Stores, Inc. and Predecessor Notes to Consolidated Financial Statements (continued) (In Thousands of Dollars, Except Share and Par Value) 7. Income Taxes (continued) Significant components of the Company's deferred income tax liabilities and assets are as follows:
January 29 January 30 October 31 2000 1999 1998 ----------------------------------------- Deferred income tax liabilities: Tax over book depreciation $ (5,732) $ (3,457) $ (3,392) Cost basis differences in inventory due to LIFO and uniform capitalization (14,123) (6,411) (5,623) Other (1,271) (1,128) (742) ----------------------------------------- Total deferred income tax liabilities (21,126) (10,996) (9,757) Deferred income tax assets: Net operating loss carryforward 372 1,325 1,105 Capital loss carryforward -- 920 920 Alternative minimum tax credit carryforward 750 -- -- Accounts receivable and inventory valuation allowances 2,667 2,232 2,274 Compensation and employee benefit accruals 2,259 1,320 1,319 Accrued store closing costs 2,551 1,209 1,374 Insurance and other reserves 4,439 -- -- Other 1,109 511 520 ----------------------------------------- 14,147 7,517 7,512 Less valuation allowance for capital loss carryforward -- (920) (920) ----------------------------------------- Total deferred income tax assets 14,147 6,597 6,592 ----------------------------------------- Net deferred income tax liabilities $ (6,979) $ (4,399) $ (3,165) =========================================
The Company has a net operating loss carryforward of $0.9 million that will expire in 2011. The alternative minimum tax credit carryforward is available indefinitely to offset future income taxes payable. The capital loss carryforward expired in fiscal 1999. F-23 Quality Stores, Inc. and Predecessor Notes to Consolidated Financial Statements (continued) (In Thousands of Dollars, Except Share and Par Value) 8. Profit Sharing Plan The Company has a profit sharing plan covering all employees who meet certain eligibility requirements. The plan provides for discretionary employer contributions and allows voluntary participant contributions. The Company recognized expense in connection with this plan of $1.0 million, $0.2 million, $0.7 million, and $0.1 million for fiscal 1999, the three-month period of 1999, and the seven-month and five-month periods of 1997, respectively. No profit sharing expense was recognized in fiscal 1998. 9. Transactions with Related Parties For fiscal 1999, the three-month period of 1999, fiscal 1998, and the seven-month period of 1997, Childs was paid a management and consulting services fee of $0.2 million, $0.1 million, $0.2 million and $0.1 million, respectively, under a five-year agreement that is renewable annually thereafter. In addition, during fiscal 1999, the three-month period of 1999 and fiscal 1998, Fenway Partners, a stockholder of QSI Holdings, was paid a quarterly management fee of $0.03 million. The Company purchases inventory from two suppliers that are controlled by stockholders of QSI Holdings. Purchases from these suppliers aggregated approximately $21.6 million, $1.4 million, $5.0 million and $6.1 million for fiscal 1999, the three-month period of 1999, fiscal 1998, and the combined seven-month and five-month periods of 1997, respectively. In February 2000, the Company sold the land, buildings, and certain fixtures and equipment for three stores to be opened in fiscal 2000 to a company owned and managed by certain of the Company's executive officers. The sales price of $7.0 million was equal to the Company's cost for the assets. The Company then entered into a twelve-year lease agreement with this same company for the use of these stores. The total minimum lease payments under the lease agreements range from $0.8 million in fiscal 2000 to $1.0 million in fiscal 2011. F-24 Quality Stores, Inc. and Predecessor Notes to Consolidated Financial Statements (continued) (In Thousands of Dollars, Except Share and Par Value) 10. Guarantee of Senior Notes The Senior Notes described in Note 4 are guaranteed jointly and severally, fully, and unconditionally by each of the Company's wholly owned subsidiaries. Summarized financial information for the Company's wholly owned subsidiaries that guarantee the Senior Notes is as follows:
January 29 January 30 October 31 2000 1999 1998 -------------------------------------------- Balance sheet data Current assets: Trade and other receivables $ 6,654 $ 2,742 $ 3,437 Inventory 233,771 106,674 104,777 Other current assets 14,674 2,257 3,569 -------------------------------------------- Total current assets 255,099 111,673 111,783 Property, improvements, and equipment, net 94,988 15,390 15,598 Other noncurrent assets, principally goodwill and other intangibles 211,094 51,735 52,170 -------------------------------------------- $561,181 $178,798 $179,551 ============================================ Current liabilities, principally accounts payable accrued expenses $122,848 $ 26,912 $ 28,159 Noncurrent liabilities, principally amounts due to affiliates 275,019 6,613 5,262 Stockholder's equity 163,314 145,273 146,130 -------------------------------------------- $561,181 $178,798 $179,551 ============================================
F-25 Quality Stores, Inc. and Predecessor Notes to Consolidated Financial Statements (continued) (In Thousands of Dollars, Except Share and Par Value) 10. Guarantee of Senior Notes (continued)
Period of Fiscal Year three months Fiscal year ended ended ended January 29 January 30 October 31 2000 1999 1998 --------------------------------------------------- Income statement data Net sales $ 694,418 $ 63,914 $ 257,342 Cost of sales 491,579 45,469 178,918 --------------------------------------------------- Gross profit 202,839 18,445 78,424 Selling, general, and administrative and other expenses 175,399 13,961 53,151 --------------------------------------------------- Operating income 27,440 4,484 25,273 Interest expense 20,083 2,167 9,167 --------------------------------------------------- Income before income taxes 7,357 2,317 16,106 Income taxes 5,418 972 6,488 --------------------------------------------------- Net income $ 1,939 $ 1,345 $ 9,618 =================================================== Cash flow data Net cash flows provided by (used in): Operating activities $ (9,598) $ (743) $ 2,586 Investing activities, principally capital expenditures (23,713) (112) (3,575) Financing activities, principally change in amounts due to affiliates 39,465 1,355 (5,192)
F-26 Quality Stores, Inc. and Predecessor Notes to Consolidated Financial Statements (continued) (In Thousands of Dollars, Except Share and Par Value) 11. Quarterly Results of Operations (Unaudited) The following is a tabulation of the Company's unaudited quarterly results of operations for fiscal 1999 and 1998:
First Second Third Fourth Quarter Quarter Quarter Quarter ------------------------------------------------------------- Fiscal year ended January 29, 2000 Net sales $ 159,136 $ 330,830 $ 287,085 $ 314,970 Gross profit 47,227 96,153 84,336 89,850 Operating income 7,897 17,329 6,982 11,826 Net income (loss) 997 4,376 (2,400) 190 Ratio of earnings to fixed charges 1.4x 1.8x 0.8x 1.1x Fiscal year ended October 31, 1998 Net sales $ 144,393 $ 143,717 $ 167,859 $ 131,226 Gross profit 41,619 42,501 51,146 41,750 Operating income 6,659 8,168 15,696 8,318 Net income 590 1,375 6,597 1,413 Ratio of earnings to fixed charges 1.2x 1.4x 3.1x 1.6x
F-27 SCHEDULE II QUALITY STORES, INC. Valuation and Qualifying Accounts Allowance For Trade Receivables ------------------- Balance at November 2, 1996 $ (50,000) Credited to expense 4,700 ----------- Balance at March 26, 1997 (45,300) Debited to expense (54,436) Write-off of uncollectible accounts 49,736 Acquired from Country General, Inc. (336,000) ----------- Balance at November 1, 1997 (386,000) Debited to expense (174,279) Write-off of uncollectible accounts 174,279 ----------- Balance at October 31, 1998 (386,000) Debited to expense (24,365) Write-off of uncollectible accounts 24,365 ----------- Balance at January 30, 1999 (386,000) Debited to expense (585,954) Write-off of uncollectible accounts 272,407 Acquired from Quality Stores, Inc. (575,453) ----------- Balance at January 29, 2000 $(1,275,000) =========== F-28 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. QUALITY STORES, INC. DATED: April 28, 2000 By: /s/ James T. McKitrick James T. McKitrick, President and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the date indicated. DATED: April 28, 2000 /s/ James T. McKitrick President and Chief Executive Officer, Director James T. McKitrick (Principal Executive Officer) /s/ Denny L. Starr Senior Vice-President, Finance and Chief Denny L. Starr Financial Officer (Principal Financial and Accounting Officer) /s/ Alan L. Fansler Executive Vice-President and Chief Operating Alan L. Fansler Officer, Director ______________________ Director John W. Childs /s/ Steven G. Segal Director Steven G. Segal ______________________ Director Adam L. Suttin /s/ David C. Bliss Chairman of the Board, Director David C. Bliss /s/ Jerry D. Horn Director Jerry D. Horn ______________________ Director Jeffrey B. Swartz /s/ William E. Watts Director William E. Watts /s/ Habib Y. Gorgi Director Habib Y. Gorgi /s/ Peter Lamm Director Peter Lamm /s/ Richard C. Dresdale Director Richard C. Dresdale ______________________ Director John L. Hilt /s/ G. Dean Longnecker Executive Vice-President, Integration, Director G. Dean Longnecker EX-12 2
EXHIBIT 12 QUALITY STORES, INC. SCHEDULE REGARDING COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES (in thousands) Successor | Predecessor ------------------------------------------------------------|------------- Fiscal Year Three Months Fiscal Year Seven Months | Five Months Ended Ended Ended Ended | Ended January 29, January 30, October 31, November 1, | March 26, 2000 1999 1998 1997 | 1997 ------------------------------------------------------------|------------- | | | Income before income taxes $9,397 $2,953 $18,375 $3,422 | $(1,881) ===========================================================|============== Fixed charges: | Interest expense $34,637 $4,959 $20,466 $11,463 | $3,188 Portion of rent expense representing interest 4,730 715 2,920 1,860 | 814 -----------------------------------------------------------|-------------- | Total fixed charges $39,367 $5,674 $23,386 $13,323 | $4,002 ===========================================================|============== | Earnings before income taxes and fixed charges $48,764 $8,627 $41,761 $16,745 | $2,121 ===========================================================|============== | Ratio (deficiency of earnings to fixed charges) 1.2x 1.5x 1.8x 1.3x | $(1,881) ===========================================================|==============
EX-21 3 EXHIBIT 21 SUBSIDIARIES OF THE COMPANY Entity State of Organization ----------------------------------------------------------- Country General, Inc. Delaware Quality Stores Services, Inc. Michigan QSI Transportation, Inc. Michigan Quality Farm & Fleet, Inc. Michigan Quality Investments, Inc. Michigan Vision Transportation, Inc. Ohio EX-27 4 FDS --
5 This schedule contains summary financial information extracted from the audited financial statements of Quality Stores, Inc. at and for the period ended January 29, 2000 and is qualified in its entirety by reference to such financial statements. 1,000 YEAR Jan-29-2000 Jan-31-1999 Jan-29-2000 11,029 0 9,017 1,275 365,383 394,389 147,680 24,213 822,463 202,485 389,657 0 0 0 224,627 822,463 1,092,021 1,092,021 774,455 774,455 273,532 586 34,637 9,397 6,234 3,163 0 0 0 3,163 0 0
EX-99 5 EXHIBIT 99 IMPORTANT FACTORS REGARDING FORWARD-LOOKING STATEMENTS The following factors, among others, could cause the Company's actual results and performance to differ materially from those contained in forward-looking statements made in this report and presented elsewhere by or on behalf of the Company from time to time. Ability to Achieve Future Growth The Company's ability to profitably open stores in accordance with its expansion plan and to increase the financial performance of its existing stores will be a significant factor in achieving future growth. The Company's ability to profitably open stores will depend, in part, on matters not completely within the Company's control including, among other things, locating and obtaining store sites that meet the Company's economic, demographic, competitive and financial criteria, and the availability of capital on acceptable terms. Further, increases in comparable store sales will depend, in part, on the soundness and successful execution of the Company's merchandising strategy. Seasonality The Company is an agricultural specialty retailer, and consequently its sales fluctuate with the seasonal needs of the agricultural community. The Company responds to this seasonality by attempting to manage inventory levels (and the associated working capital requirements) to meet expected demand, and by varying to a degree its use of part-time employees. Historically, the Company's sales and operating income have been highest in the third quarter of each fiscal year due to the farming industry's planting season and the sale of seasonal products. Weather, Business Conditions and Government Policy Unseasonable weather and excessive rain, drought, or early or late frosts may affect the Company's sales and operating income. In addition, the Company's sales volume and income from operations depend significantly upon expectations and economic conditions relevant to consumer spending and the farm economy. Regional Economy The majority of the Company's existing stores are located in the Northeastern United States, the Midwestern United States and the Southeastern United States. As a result, the Company's sales and profitability are largely dependent on the general strength of the economy in these regions. Competition The Company faces competition primarily from other chain and single-store agricultural specialty retailers, and from mass merchandisers. Some of these competitors have substantially greater financial and other resources than the Company. Currently, most of the Company's stores do not compete directly in the markets of other agricultural specialty retail chains. However, the Company's expansion plans will likely result in new stores being located in markets currently serviced by one or more of these chains, and there can be no assurance that these chains, certain of which have announced expansion plans, will not expand into the Company's markets. In addition, the Company competes in over half of its markets with mass merchandisers. The Company believes that its merchandise mix and level of customer service currently successfully differentiate it from mass merchandisers and that as a result, the Company has to date not been significantly impacted by competition from mass merchandisers. However, in the past certain mass merchandisers have modified their product mix and marketing strategies in an effort apparently intended to permit them to compete more effectively in the Company's markets; and it is likely that these efforts will continue. -----END PRIVACY-ENHANCED MESSAGE-----