Item 1. Business.
General
Harvey Electronics is engaged in the retail sale, service and custom installation of high quality audio, video and home theater equipment. The equipment includes high fidelity components and systems, digital versatile disc players ("DVD"), high definition television ("HDTV"), direct view projection, plasma flat-screen and LCD flat panel television sets, audio/video furniture, digital satellite systems, conventional telephones, service contracts and related accessories. The Company has been engaged in this business in the New York Metropolitan area for seventy-six years. The Company currently operates nine locations; seven Harvey specialty retail stores and two Bang & Olufsen branded stores. There are two Harvey locations in Manhattan and five suburban locations in Paramus, New Jersey; Mt. Kisco, in Westchester; Greenwich, Connecticut; Greenvale/Roslyn, on the north shore of Long Island, and in Eatontown, New Jersey. The Bang & Olufsen branded stores are located in Union Square at Broadway and 21st Street, in Manhattan, and in Greenwich, Connecticut on Greenwich Avenue.
The Company's stores are designed to offer an attractive and pleasing environment and to display its products and custom installation services in realistic home settings commonly known in the industry as "lifestyle home vignettes." Sales personnel are highly trained professionals with extensive product knowledge. This contrasts sharply with a more rushed atmosphere and lesser-trained personnel of mass merchants.
Sale of Common Stock and Warrants in Public Offering
In fiscal 1999, the Company completed an issuance of its common stock and common stock warrants in a public offering (the "Offering"). The Offering was co-managed by The Thornwater Company, L.P., which sold 1,200,000 shares of the Company's common stock of which 1,025,000 shares were sold by the Company and 175,000 shares by Harvey Acquisition Company, LLC ("HAC"). 2,104,500 of Warrants ("Warrants") to acquire additional shares of the Company's common stock were also sold by the Company. The net proceeds from the Offering, approximately $4.1 million, were used to open three new retail stores and for general working capital purposes.
The net proceeds from the Offering were also used to repay temporarily the Company's credit facility of approximately $2.3 million and to retire the principal ($350,000) and interest ($48,000) of a term loan.
Each Warrant is exercisable for one share of common stock at 110% ($5.50 per share) of the Offering price, through March 31, 2003. The Warrants are redeemable (at $0.10 per warrant), at the Company's option, if the closing bid price of the common stock for 20 consecutive trading days exceeds 150% of the Offering price per share or $7.50.
Products
The Company offers its customers a wide selection of high-quality consumer audio, video and home theater products, the distribution of which is limited to specialty retailers (generally referred to in the industry as "esoteric brands"). The Company is one of the country's largest retailers of "esoteric brands" manufactured by Bang & Olufsen, Crestron, Lexicon, Linn, Marantz, McIntosh, NAD, Vienna Acoustics, Sonus Faber, Kef, Krell, Loewe, Martin Logan and Fujitsu. Many of these vendors' products have been sold by the Company for a number of years. The Company believes that it benefits from strong working relationships with these manufacturers. See below, for a discussion about Bang & Olufsen.
For the fiscal year ended October 26, 2002, the Company's audio product sales represented approximately 50% of the Company's net sales and yielded gross profit margins of approximately 40%. The Company's video product sales represented approximately 42% of the Company's net sales and yielded gross profit margins of approximately 29%. The Company also provides installation services for the products it sells. Custom installation, as commonly referred to in the industry includes both equipment sales and labor income. Custom installation of both equipment and related labor accounted for approximately 51% of the Company's net sales in fiscal 2002. The labor portion of custom installation presently represents approximately 8% of net sales, while the equipment portion accounting for 43% of net sales. The Company also sells extended warranties on behalf of third party providers. Sales of extended warranties which yielded a gross profit margin in excess of 57%, and represented approximately 1% of the Company's net sales.
The following table shows, by percentage, the Company's net product sales attributable to each of the product categories for the periods indicated. Audio components include speakers, subwoofers, receivers, amplifiers, preamplifiers, compact disc players, cassette decks, turntables and tuners. The Company also sells digital satellite systems (DSS) which are included in the VCR/DVD/DSS category. Accessories primarily include headphones, surge protectors, blank audio and videotapes and projection screens. The miscellaneous category includes conventional telephones, answering machines, radios and other portable products.
The percentage of sales by each product category is affected by promotional activities, consumer preferences, store displays, the development of new products and elimination or reduction of existing products and, thus, a current sales mix may not be indicative of the future sales mix.
The Company believes that it is well positioned to benefit from advances in technologies because new technologies tend to be expensive when first introduced and the Company's target customers desire and can afford such products. New technologies, such as HDTV, plasma flat-screen and LCD flat panel televisions were recently introduced. The plasma flat-screen or LCD flat panel television allows a small or large screen television to be only four inches wide from front to back. This allows the set to be far less obtrusive and more easily integratable into the home. High definition television has significantly improved picture quality.
The Company intends to continue its recent emphasis on custom installation (representing 51% of net sales in fiscal 2002), which can extend from a single room audio/video system to an entire house with a combined selling price of installation, labor and product from about $5,000 to in excess of $100,000. The Company believes custom installation provides the opportunity to bundle products and increase margins. For example, rather than just selling a television with an approximate gross profit margin of 29%, custom installation enables the Company to sell to the same customer speakers at a margin exceeding 40%, accessories at a margin approximating 48% and installation labor with margins of over 69%. In fiscal 2003, the Company will continue to expand its merchandising efforts to include in-home lighting systems and distributed in-home cabling for the integration of computer networks, entertainment systems and other related services.
Based on customers' desires, custom installation projects frequently expand on-site. A single room home theater, for example, during the course of the installation can grow into a multi-room system with increased margins.
Offering custom installation affords the Company a unique selling opportunity because it may not be available at mass merchants and can generate repeat customers and customer referrals. Due to the complexity of the installation provided by the Company, customers generally remain with the Company, providing the opportunity to sell upgrades to existing customers. The recent introduction of digital video products, network cabling, in-home lighting systems, as well as other emerging technologies, present significant opportunities for such upgrades.
Operations
Supplies, Purchasing and Distribution
The Company purchases its products from approximately eighty manufacturers, ten of which accounted for approximately 63% of the Company's purchases for the fiscal year ended October 26, 2002. These ten manufacturers are Bang & Olufsen, Fujitsu, Loewe, Marantz, Monster Cable, Panasonic, Pioneer Elite, Runco, Sharp and Sony. Fujitsu accounted for more than ten (10%) percent of the Company's purchases for the fiscal year ended October 26, 2002, and Bang & Olufsen, Marantz, Panasonic, Sharp and Sony each accounted for more than five (5%) percent of purchases for such period.
The Company has entered into dealer agreements with primarily all of its vendors. Under each dealer agreement, the Company is authorized to sell the manufacturer's products from specified retail locations to retail customers and cannot sell the products by telephone or mail order. Each agreement is for a term of a year or two, subject to renewal or extension.
The Company believes that competitive sources of supply would be available for many of the Company's products if a current vendor ceased to supply to the Company. However, a loss of a major source of supply of limited distribution products could have an adverse impact on the Company.
Bang & Olufsen ("B&O") products have been sold by the Company since 1980. As B&O focuses on developing B&O licensed stores ("Branded Stores") throughout the world, its products are available only in Branded Stores.
The Company opened its first B&O Branded Store in the Union Square area of lower Manhattan in July 1999. In October 2000, the Company opened its second B&O Branded Store in Greenwich, Connecticut.
These new Branded Stores sell highly differentiated Bang & Olufsen products, including uniquely designed audio systems, speakers, telephones, headphones and accessories. The stores will also sell video products including LCD projectors, HDTV's, DVD players, plasma flat-screen and LCD flat panel televisions, A/V furniture and accessories. The store also offers professional custom installation of multi-room audio and home theater systems.
Due to the Company's strong relationships with many of its suppliers and its volume of purchases, the Company has also been able to obtain additional manufacturers' rebates based on volume buying levels. On occasion, the Company has been able to negotiate favorable terms, such as extended payment terms, additional cooperative advertising contributions or lower prices, on large purchases. In addition to being a member of a consumer electronics industry buying group called Home Theater Specialists of America (HTSA), the Company is also a member of Professional Audio Retailers Association (PARA) and Custom Electronics Design Installation Association (CEDIA), both of which provide the Company with additional training in sales and technology.
Purchases are received at the Company's 11,800 square foot warehouse located in Fairfield, New Jersey. Merchandise is distributed to the Company's retail stores at least twice a week (and more frequently, if needed), using the Company's employees and equipment.
The Company's management information system tracks current levels of sales, inventory, purchasing and other key information and provides management with information which facilitates merchandising, pricing, sales management and the management of warehouse and store inventories. This system enables management to review and analyze the performance of each of its stores and sales personnel on a periodic basis. The central purchasing department of the Company monitors current sales and inventory at the stores on a daily basis. In addition, the Company currently conducts a physical inventory two times a year and between such physical inventories it conducts monthly and daily cycle counts on selected types of inventory. The purchasing department also establishes appropriate levels of inventory at each store and controls the replenishment of store inventory based on the current delivery or replenishment schedule.
The Company historically has not had material losses of inventory and does not experience material losses due to cost and market fluctuations, overstocking or technology. The Company maintains specific and general inventory reserves aggregating $130,000, $105,000 and $60,000, for fiscal years 2002, 2001 and 2000, respectively. The Company's inventory turnover for fiscal years 2002, 2001 and 2000 was approximately 3.4, 3.4, and 3.6 times, respectively.
Sales and Store Operations
Retail sales are primarily made for cash or by major credit cards. Revenues are recorded by the Company when the product or service is delivered or rendered to customers. Customer deposits are recorded as liabilities until the product is delivered, at which time a sale is recorded and the liability for the customer deposit is relieved.
In addition, customers who qualify can obtain longer term financing with a Harvey credit card, which the Company makes available to its customers. The Harvey credit cards are issued by two unrelated finance companies. All transactions with these unrelated finance companies are without recourse to the Company. The Company also periodically, as part of its promotional activities, offers manufacturer, (i.e., Mitsubishi), sponsored financing to its customers.
Each store is operated by a store manager and a senior sales manager. Store managers report to a Vice President of Operations who oversees all sales and store operations, and who is further responsible for sales training and the hiring of all retail employees. Every Company store has in-home audio/video specialists who will survey the job site at a customer's home, design the custom installation and provide a cost estimate. Each store independently services its custom installations through a project manager and experienced installers employed at the store. The Company's stores are aided by the Company's Director of Custom Installation, for more difficult and technical projects. All stores are staffed with professionally trained salespeople and warehouse personnel. Salespeople are paid a base salary plus commission based on gross margins.
All stores have an on-line point of sale computer system which enables the store managers and corporate headquarters to track sales, margins, inventory levels, customer deposits, back orders, merchandise on loan to customers, salesperson performance and customer histories. Store managers perform sales audit functions before reporting daily results to the sales audit group in the main office in Lyndhurst, New Jersey.
Services and Repairs
Products under warranty are delivered to the appropriate manufacturer for repair. Other repairs are sent to the manufacturers or an independent repair company. Revenues from non-warranty services are not material.
The Company offers an extended warranty contract for most of the audio, video and other merchandise it sells, which provides coverage beyond the manufacturer warranty period. Extended warranties are provided by an unrelated insurance company on a non-recourse basis to the Company. The Company collects the retail sales price of the extended warranty contract from customers and remits the customer information and the cost of the contract to the insurance company. Sales of extended warranty contracts represent approximately 1% of the Company's net sales. The warranty obligation is solely the responsibility of the insurance company.
Competition
The Company competes in the New York Metropolitan area with mass merchants, mail order houses, discount stores and numerous other consumer electronics specialty stores. The retail electronics industry is dominated by large retailers with massive, "big box" retail facilities which aggressively discount mass merchandise. These retailers operate on narrow profit margins and high volume, driven by aggressive advertising emphasizing low prices. Nationwide industry leaders are Circuit City and Best Buy. The New York region is dominated by Circuit City, Best Buy, and local chains including P.C. Richard & Son, The Wiz, J&R Music World and 6th Avenue Electronics.
Many of the competitors sell a broader range of electronic products, including computers, camcorders and office equipment, and many have substantially larger sales and greater financial and other resources than the Company. The Company competes by positioning itself as a retailer of high quality limited distribution audio and video products and, more importantly, by offering upscale sophisticated custom installations, which are not generally offered by all of the mass merchants.
Very few, if any, of the audio products sold by the Company, other than Bose and certain Sony products, radios and other portable products, are available at the mass merchants. Of the major video brands sold by the Company, generally only Samsung, Sony, Panasonic and Mitsubishi televisions are sold by the mass merchants. In many of these cases, the Company sells models which are not sold by the mass merchants.
The Company seeks to reinforce its positioning by displaying its products and custom installation services in customized movie theaters built within the home and in lifestyle home vignettes in an attractive and pleasing store environment and by offering personalized service through trained sales personnel who are fully familiar with all of the Company's products. Additionally, the Company differentiates itself by offering programming capabilities that address complex technological integration issues and ultimately give the consumer easy remote control access to multiple devices.
Internet Website
In fiscal 2000, the Company launched its new website, www.harveyonline.com, to support the continued growth of its exclusive consumer electronics and custom home theater installation showrooms. The website was designed to extend Harvey's extraordinary in-store experience onto the Internet as a vehicle to increase customer traffic at the Company's retail locations. On-line sales, which are insignificant, are available seven days a week, twenty-four hours a day, and are a secondary goal of the website. Harvey customers can order on-line within the Company's trading area in the metropolitan New York marketplace.
Website visitors can experience a video tour of a Harvey showroom and a complete Harvey custom installation transaction from point-of-contact at the retail showroom through the final in-home installation. Visitors to the website are able to leave inquiries, request home theater systems based on budget and room size, reserve equipment or schedule an in-home or in-store consultation with a Harvey professional. Product specification, price and warranty comparisons are also available on the site. The Company's website was designed to further differentiate Harvey from its competitors.
Advertising
The Company believes it has a strong and important brand in its marketplace. The Company strives to promote its superior products and sophisticated services in its advertising campaign to both men and women.
Currently, the Company has radio, direct mail, print advertising and the Internet with www.harveyonline.com, the Company's website, to promote its brand.
The Company currently uses large, frequent print advertising, emphasizing image, products, and technology in the New York Times, New York Times Magazine, Newsday, Bergen Record, Greenwich Times, The Journal News, Asbury Park Press, and the Gannett Suburban News. The Company also distributes direct mail advertising several times a year to reach its customer database of over 70,000. Some of the direct mail promotions are for specific manufacturers, products, or technology, and are supported, in part, by the manufacturers. Radio advertising is currently running on the two most listened to news stations on AM radio, within the Company's market.
All advertising consistently offers attractive financing alternatives on purchases on credit without interest for an extended period of time.
The following table shows the Company's gross advertising costs and net advertising expense as a percentage of net sales for the periods presented. Net advertising expense represents gross advertising cost less market development funds, cooperative advertising and other promotional amounts received from the manufacturers.
The Company has retained an outside advertising agency that is paid a monthly retainer of $17,000 plus approved expenses.
Licenses and Intellectual Properties
The Company owns two registered service marks. "HARVEY ELECTRONICS," issued in June 1982, is registered for International Class 42, which includes retail store services in the field of audio, video, consumer electronics, home theater products and custom installation of home theater products. "Not Your Ordinary Electronics Store", issued in July 2002 is registered for International Class 35, which is for advertising, business management, business administration and office functions. The Company believes that the service mark HARVEY ELECTRONICS has significant value and is important in marketing the Company's products and services.
Employees
As of October 26, 2002, the Company employed approximately 157 full-time employees of which 17 were management personnel, 16 were administrative personnel, 63 were salespeople, 18 were warehouse workers and 43 were engaged in custom installation.
Of the salespeople, warehouse workers, and installation staff, 107 people are covered by a collective bargaining agreement with the Company, which expires August 1, 2003. The Company has never experienced a material work stoppage and believes that its relationships with its employees and the union are satisfactory.
Item 2.
Item 2. Properties
All of the premises the Company presently occupies are leased. Management believes that the Company's facilities are adequate and suitable for its present business. The Company believes that adequate locations are available for its proposed expansion.
The Company leases approximately 3,900 square feet at 205 Chubb Avenue, Lyndhurst, New Jersey, which the Company uses as its corporate office at approximately $30,000 per year. This office space is under lease through January 2006. The Company also leases an 11,800 square foot warehouse in Fairfield, New Jersey at approximately $94,000 per year, pursuant to a lease, which expires November 2005.
The Company leases the following retail premises:
Item 3.
Item 3. Legal Proceedings.
Except as set forth herein, the Company believes that it is not a party to any material asserted legal proceedings other than those arising in the ordinary course of business and which are fully covered by insurance (except for deductible amounts). The Company maintains general liability and commercial insurance in amounts believed to be adequate. However, there can be no assurance that such amounts of insurance will fully cover claims made against the Company in the future.
There are old outstanding disputed tax claims of approximately $52,000 which were made against the Company during its Chapter 11 proceeding. The Company has provided reserves of $40,000 for such taxes, which the Company believes to be adequate. However, there can be no assurance that the reserve will be sufficient to cover these tax claims.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders.
None
Part II
Item 5.
Item 5. Market for Registrants Common Equity and Related Stockholder Matters.
The Company's securities are traded on the NASDAQ SmallCap Market under the symbols "HRVE" for the Common Stock and "HRVEW" for the Warrants to purchase Common Stock.
The outstanding shares of Common Stock are currently held by approximately 1,600 shareholders of record, and the Preferred Stock by five holders of record. The transfer agent and registrar for the Common Stock is Registrar and Transfer Company, 10 Commerce Drive, Cranford, New Jersey 07016.
The following table indicates the quarterly high and low stock prices for fiscal years 2002 and 2001:
High Low ----------------- ---------------- Fiscal Year 2002 - ---------------- January 26, 2002 $1.95 $.65 April 27, 2002 1.65 1.10 July 27, 2002 1.59 .71 October 26, 2002 1.10 .65
Fiscal Year 2001 - ---------------- January 27, 2001 1.625 .75 April 28, 2001 1.50 .75 July 28, 2001 1.50 1.00 October 27, 2001 1.27 .55
The Company has paid no dividends on its common stock for the last two years and does not expect to pay dividends on common stock in the future.
Description of Securities
The total authorized capital stock of the Company consists of 10,000,000 shares of common stock with a par value of $0.01 per share ("Common Stock"), and 10,000 shares of 8.5% Cumulative Convertible Preferred Stock with a par value of $1,000 per share. The following descriptions contain all material terms and features of the securities of the Company and are qualified in all respects by reference to the Company's Certificate of Incorporation and Amended and Restated By-Laws of the Company, copies of which are filed as exhibits.
Common Stock
The Company is authorized to issue 10,000,000 shares of Common Stock with a par value of $0.01 per share. As of January 2, 2003, 3,324,525 shares are outstanding and held by approximately 1,600 shareholders of record.
The holders of Common Stock are entitled to one vote per share on all matters to be voted on by stockholders. There is no cumulative voting with respect to the election of directors, with the result that holders of more than 50% of the shares voted for the election of directors can elect all of the directors. The holders of Common Stock are entitled to receive dividends when, as and if declared by the Board of Directors from sources legally available therefore. In the event of liquidation, dissolution or winding up of the Company, whether voluntary or involuntary, and after payment in full of the amount payable in respect of the Preferred Stock, the holders of Common Stock are entitled, to the exclusion of the holders of the Preferred Stock, to share ratably in the assets of the Company available for distribution to stockholders after payment of liabilities and after provision for each class of stock, if any, having preference over the Common Stock. Holders of Common Stock have no preemptive rights. All outstanding shares are, and all shares to be sold and issued as contemplated hereby, will be fully paid and non-assessable and legally issued. The Board of Directors is authorized to issue additional shares of Common Stock within the limits authorized by the Company's charter and without stockholder action.
Preferred Stock
The Company's Certificate of Incorporation authorizes the issuance of 10,000 shares of 8.5% Cumulative Convertible Preferred Stock ("Preferred Stock") with a par value of $1,000 per share. As of January 2, 2003, 827 shares of Preferred Stock were issued and outstanding and were held by four holders of record.
The Preferred Stock may be issued from time-to-time without stockholder approval in one or more classes or series. A holder of the Preferred Stock is not entitled to vote except as required by law.
Dividends on the Preferred Stock are cumulative from the day of original issuance, whether or not earned or declared. In the event the Board of Directors declares dividends to be paid on the Preferred Stock, the holders of the Preferred Stock will be entitled to receive semiannual dividends at the rate of eighty-five ($85) dollars per share payable in cash on the last business day of June and December in each year. For calendar year 1997, the Company elected to defer payment of the dividends over a three-year period. The preference rate for calendar year 1997 was $105 per share, with interest at the rate of 8.5% per annum. The installments relating to the 1997 dividends have been paid in full by the Company as of October 26, 2002. Total Preferred Stock dividends of $74,151, $107,603 and $110,206 were paid in fiscal years 2002, 2001 and 2000, respectively. In addition, no dividend shall be paid, or declared, or set apart for payment upon, and no other distribution shall at any time be declared or made in respect of, any shares of Common Stock, other than a dividend payable solely in, or a distribution of, Common Stock, unless full cumulative dividends of the Preferred Stock for all past dividend periods and for the then current dividend period have been paid or have been declared and a sum sufficient for the payment thereof has been set apart.
The Preferred Stock shall be redeemable, at the Company's option, in whole or in part, upon payment in cash of the Redemption Price in respect of the shares so redeemed. The "Redemption Price" per share shall be equal to the sum of (i) One Thousand and 00/100 ($1,000.00) Dollars and (ii) all dividends accrued and unpaid on such shares to the date of redemption. If less than all of the outstanding Preferred Stock is to be redeemed, the redemption will be in such amount and by such method (which need not be by lot or pro rata), and subject to such other provisions, as may from time to time be determined by the Board of Directors.
In the event of liquidation, dissolution or winding-up of the Company, whether voluntary or involuntary, resulting in any distribution of its assets to its shareholders, the holders of the Preferred Stock outstanding shall be entitled to receive in respect of each such share an amount which shall be equal to the Redemption Price, and no more, before any payment or distribution of the assets of the Company is made to or set apart for the holders of Common Stock.
Commencing January 1, 2001, the conversion price of the Company's Preferred Stock was $1.2333 and thus convertible into 670,559 shares of Common Stock, (calculated from the closing bid price of the Common Stock over the 45 trading days preceding January 1, 2001). 875 shares of Preferred Stock were originally issued by the Company. In June 2002, 48 shares of Preferred Stock were converted to 38,920 shares of the Company's Common Stock by a preferred shareholder.
If at any time prior to the exercise of the conversion rights afforded the holders of the Preferred Stock, the Preferred Stock is redeemed by the Company, in whole or in part, then the conversion right shall be deemed canceled with respect to such redeemed stock, as of the date of such redemption.
In case of any capital reorganization or any reclassification of the Common Stock, or in case of the consolidation or merger of the Company with or into another corporation, or the conveyance of all or substantially all of the assets of the Company to another corporation, each Preferred Share shall thereafter be convertible into the number of shares of stock or other securities or property to which a holder of the number of shares of Common Stock deliverable upon conversion of such Preferred Stock would have been entitled upon such reorganization, reclassification, consolidation, merger, or conveyance.
Item 6.
Item 6. Selected Financial Data (amounts in thousands, except per share and number of stores data)
Set forth below is selected financial and operating data for each of the five years ended October 26, 2002. The selected statement of operations and balance sheet data for each of the five years ended October 26, 2002 have been derived from our audited financial statements. The information set forth below should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and our financial statements and the notes thereto included elsewhere in this Form 10K.
Balance Sheet Data:
Item 7.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion and analysis contains forward-looking statements which involve risks and uncertainties. When used herein, the words "anticipate," "believe," "estimate," and "expect" and similar expressions as they relate to the Company or its management are intended to identify such forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. The Company's actual results, performance or achievements could differ materially from the results expressed in or implied by these forward-looking statements. Historical results are not necessarily indicative of trends in operating results for any future period. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date the statement was made.
General
The following discussion should be read in conjunction with the Company's audited financial statements for the fiscal years ended October 26, 2002, October 27, 2001 and October 28, 2000, appearing elsewhere in this Form 10-K.
Results of Operations
Fiscal Year Ended October 26, 2002 as Compared to Fiscal Year Ended October 27,
Net Income
The Company's pre-tax income for the fiscal year ended October 26, 2002 significantly increased to $304,000 as compared to a pre-tax loss of $1,250,000 for the fiscal year ended October 27, 2001. Net income for fiscal 2002 increased to $180,000 as compared to a net loss of $1,250,000 for fiscal 2001. Earnings before interest, taxes, depreciation and amortization ("EBITDA") for fiscal 2002 also increased substantially to approximately $1,580,000 as compared to EBITDA of approximately $79,000 for fiscal 2001.
The Company's net loss for fiscal 2001 was materially impacted by the horrific events of September 11, 2001, the total renovation of the Company's flagship store on 45th Street in Manhattan and the general slowdown in retail sales, experienced from the latter part of the third quarter of fiscal 2001.
Net income for fiscal 2002 was negatively impacted by operating losses of approximately $245,000, relating primarily to the Company's website and to a lesser extent from the Company's newest Bang & Olufsen branded store opened in Greenwich, Connecticut in October 2000. The net loss for fiscal 2001 was increased by approximately $650,000 relating to both pre-opening expenses ($140,000) and operating losses ($510,000) from two new stores and the Company's website.
The Company's net income for fiscal 2002 includes net advertising expense of $632,000 as compared to $1,206,000 for fiscal 2001. The Company's advertising presence has not materially diminished as the Company's gross advertising expenditures were $2,665,000 and $2,864,000 in fiscal years 2002 and 2001, respectively. Cooperative advertising income in fiscal 2001 was negatively impacted from the shortfall in revenues in the Company's fourth quarter of fiscal 2001, as discussed above.
Results of operations for fiscal years 2002 and 2001 also included depreciation and amortization expense of $917,000 and $989,000, respectively.
The Company recorded an income tax equivalent provision of $124,000 (40.7% effective tax rate) in fiscal 2002. No income tax provision was recorded in fiscal 2001 as the Company reported a net loss.
Revenues
For the year ended October 26, 2002, net sales aggregated $41,507,000, an increase of $4,820,000, or 13.1% from the prior year. Comparable store sales for fiscal 2002 increased over $2.9 million or 8% from fiscal 2001. Management believes that a portion of the increase in the Company's overall and comparable store sales, as compared to fiscal 2001, which was negatively impacted by the events of September 11th, specifically sales in the fourth quarter of fiscal 2001.
Overall net sales benefited significantly from the new Eatontown, New Jersey store opened in April 2001, which has exceeded management's expectations in sales and store profitability. Additionally, overall and comparable store sales for fiscal 2002 benefited from the rebound in sales of our totally renovated flagship store on 45th Street in Midtown, Manhattan and the continued strong sales growth of the Company's Greenvale/Roslyn, Long Island store, the store located within ABC Carpet and Home in lower Manhattan and the Company's Bang & Olufsen retail showroom in Greenwich, Connecticut. Finally, the Company's Harvey stores in Mount Kisco, New York and Greenwich, Connecticut, which had experienced declines in sales for the first six months of fiscal 2002, had also rebounded in sales in the second half of fiscal 2002, as compared to fiscal 2001, primarily due to personnel changes and additional localized advertising efforts, as implemented by management. However, the Company's Paramus, New Jersey store experienced a decline in sales for fiscal 2002 as compared to fiscal 2001. Management has made additional personnel changes in this store and has recently completed the construction of a new in-store theater. These changes coupled with additional planned improvements in fiscal 2003 should, in management's opinion, help to improve sales.
Customer demand continues to be strong for new digital video products including plasma flatscreen, LCD flat panel, high-definition televisions, DVD and related custom home installations. Consumers have embraced plasma and LCD flat screen technologies. The Company's unit sales of these important categories have more than doubled in fiscal 2002 as compared to fiscal 2001. Custom installation projects continue to increase and accounted for approximately 51% of net sales for fiscal 2002, as compared to approximately 43% of net sales for fiscal 2001. Custom installation sales, including both equipment sales and labor income, increased approximately 43% to $21,373,000 for fiscal 2002, as compared to $14,924,000 for fiscal 2001. The Company's custom installation services yield higher gross profit margins and stronger net profitability, as compared to normal retail store sales.
The Company differentiates itself by offering sophisticated custom installation services, including programming capabilities that address complex technological integration issues giving its customers easy remote control operation for a variety of functions. Management believes installations of complete movie theaters in the home as well as distributed audio, network cabling and in-home lighting systems will continue to attract affluent customers to the Company, which should continue to benefit sales, enhance gross margins and improve overall store profitability.
The Company's marketing efforts remained significant in fiscal 2002, which we believe continued to drive sales. In fiscal 2002, these efforts included radio, newspaper, cable and network television, direct mail and catalog advertisements, and the continued promotion of the Company's website. www.harveyonline.com. In fiscal 2003, the Company's advertising expenditures will not be reduced and will be used primarily for radio, print and direct mail advertising. The Company will continue to promote its brand and image to both men and women using the new campaign launched in November 2002, "Harvey. Extraordinary. In Every Way."
Costs and Expenses
Total cost of goods sold for fiscal 2002 increased $2,601,000 or 11.5% from fiscal 2001. This was primarily due to an increase in sales as noted above, offset by an increase in the gross margin.
The gross profit margin for fiscal 2002 increased to 39.4% as compared to 38.5% for fiscal 2001.
The gross profit margin increases were achieved despite a continuing shift in business towards video products, which generally have lower margins. Video product sales for fiscal 2002, accounted for approximately 42% of net sales as compared to approximately 35% of net sales in fiscal 2001, or an increase of approximately 20%. Audio sales declined to 50% of net sales in fiscal 2002 as compared to 58% of net sales in fiscal 2001. The reduction in margin from this shift in product sales was offset by several factors. The new digital and flat screen video products are sold at higher margins (and higher prices) than analog, commodity televisions. Further, the Company has been successful in bundling the sale of new video products with the sale of higher margin audio and home theater components, including furniture, accessories, extended warranties and custom installation labor. Higher margin, custom installation labor income increased by approximately 39% for fiscal 2002 as compared to fiscal 2001, which significantly helped to mitigate the reduction in the gross margin from the increase in video sales.
Selling, general and administrative expenses ("SG&A expenses") increased 4.5% or $678,000 for fiscal 2002, as compared to fiscal 2001.
Comparable, SG&A expenses for fiscal 2002 increased by approximately $304,000 or 2% from fiscal 2001.
The overall increase in SG&A expenses was primarily due to the increase in costs relating to the new Eatontown, New Jersey store, which opened in April 2001. Overall and comparable SG&A expenses also increased from additional payroll and payroll related costs, insurance expense, occupancy costs, credit card fees, incentive bonuses and various other store-operating expenses, offset by reduced net advertising expense.
The Company continues to hire additional custom installation personnel and incur the necessary associated expenses relating to the expansion of its custom installation services.
Interest expense for fiscal 2002 increased 5.6% or $19,000 as compared to fiscal 2001. The overall increase was primarily due to the additional borrowings from the Company's Credit Facility in fiscal 2001, which was used to fund the Company's retail store expansion, renovation and website, offset by a reduction in the overall effective borrowing rate. Additionally, the increased expense is due to amortization of warrants issued to the Company's lender and from the amortization of the commitment fee paid by the Company to its lender, relating to the increase and extension of the Credit Facility. Such amortization was recorded for the entire year in fiscal 2002 as compared to only ten months in fiscal 2001.
In connection with the Company's emergence from its reorganization proceeding, the Company adopted Fresh Start Accounting. Fresh Start Accounting requires that the Company report an income tax equivalent provision when there is book income and pre-reorganization net operating loss carryforwards. This requirement applies despite the fact that the Company's pre-reorganization net operating loss carryforward will be utilized to reduce the related income tax payable. The current and any future year benefit arising from utilization of the pre-reorganization carryforward is not reflected as a reduction of the tax equivalent provision in determining net income, but instead is recorded first as a reduction of reorganization value in excess of amounts allocable to identifiable assets until exhausted, and thereafter as a direct addition to paid-in capital.
For fiscal 2002, the income tax equivalent provision was $124,000 and the reduction of reorganization value in excess of amounts allocable to identifiable assets also amounted to $124,000. The income tax equivalent provision did not affect the Company's cash. No income tax provision was required for fiscal 2001 due to the Company's reported net loss.
Fiscal Year Ended October 27, 2001 as Compared to Fiscal Year Ended October 28,
Net Loss
The Company's net loss for the fiscal year ended October 27, 2001 was $1,250,000 as compared to a net profit of $317,000 for the fiscal year ended October 28, 2000. The net loss for fiscal 2001 included approximately $650,000 of operating losses and pre-opening expenses for two new stores as well as the Company's website. Operating losses of approximately $225,000 related to the Company's new Bang & Olufsen branded store which opened in Greenwich, Connecticut in October 2000. Approximately $260,000 of operating losses related to the new website launched in October 2000. Included in the $260,000 of operating losses is $193,000 of amortization, as website related assets are being amortized to expense over a period of one to three years. Pre-opening expenses, relating to the new Eatontown, New Jersey store opened in April 2001, approximated $140,000. Operating losses for the seven-month period Eatontown was open, approximated $25,000.
The Company's net loss for fiscal 2001 includes net advertising expense of $1,206,000 as compared to $934,000 for fiscal 2000. The Company's gross advertising costs increased to $2,864,000 in fiscal 2001 from $2,701,000 in fiscal 2000.
Results of operations for fiscal years 2001 and 2000 also included depreciation and amortization expense of $989,000 and $647,000, respectively.
The Company's net loss for fiscal 2001 was materially impacted by the horrific events of September 11, 2001, the total renovation of the Company's flagship store on 45th Street in Manhattan and the general slowdown in retail sales, experienced from the latter part of the third quarter.
The fourth quarter of fiscal 2000 included pre-operating expenses of $125,000 relating to the opening of the new Bang & Olufsen store in Greenwich and the October 2000 launch of the Company's new website. In the fourth quarter of fiscal 2000, the Company also recorded occupancy expense of $90,000 relating to additional rent, which was contingent upon actual sales levels achieved for one of the Company's retail stores. Finally, the fourth quarter of fiscal 2000 included incentive bonuses of approximately $125,000.
The Company recorded an income tax equivalent provision recorded within income taxes, which arose from the utilization of pre-reorganization net operating losses for fiscal 2000 of $160,000. This income tax equivalent provision did not require the use of cash. No income tax equivalent provision was necessary for fiscal 2001.
Revenues
For the year ended October 27, 2001, net sales approximated $36.7 million, an increase of over $2.3 million or 6.8% from the prior year. Comparable store sales for fiscal 2001 decreased slightly by approximately $101,000 or less than 1% from fiscal 2000.
Overall net sales increases have been achieved from a base year, fiscal 2000, that resulted in approximately 60% increases over fiscal 1999. Fiscal 2000 increases included the maturation of several retail locations. As noted above, the Company's comparable store sales results for fiscal 2001 were down slightly; however, these sales were competing against very high comparable store sales increases of 52%, from the prior year.
Overall net sales benefited primarily from the new Bang & Olufsen branded store opened in Greenwich, Connecticut in October 2000 and, to a greater extent, from the new Harvey showroom opened in Eatontown, New Jersey in April 2001. To date, sales and operating profitability from the new Eatontown store have exceeded management's expectations, while sales from the new Bang & Olufsen store for fiscal 2001 had been slower than anticipated.
While the Company's overall sales and comparable store sales results through June 2001 were favorable in comparison to certain other electronics retailers, the slowing economy did have a negative impact on third quarter sales, especially in the month of July. The decline in comparable store sales was primarily related to slower sales from the Company's Paramus, New Jersey store and its 45th Street store in Manhattan and from the events of September 11th. The reduction in comparable store sales at Paramus and 45th Street was offset by sales growth from the Company's Harvey showrooms in Greenwich, Connecticut, Mount Kisco, New York, Greenvale, Long Island and from the retail store located within ABC Carpet and Home in Manhattan.
The decline in sales for the Company's 45th Street flagship store in Manhattan was largely due to the extensive renovation at this store. Subsequent to October 2001, sales have rebounded for the 45th Street store, as well as for the Company's Bang & Olufsen branded stores.
Net sales and comparable store sales benefited from increases in custom installation projects including both equipment sales and labor income. These sales were stimulated by strong demand for new digital video technologies such as plasma and LCD flat-screen, high definition and HD-ready televisions, DVD, DSS as well as home theaters. Custom installation sales continue to increase and accounted for approximately 41% of net sales ($14.9 million) for fiscal 2001, as compared to only 33% ($11.4 million) for fiscal 2000.
Sales also have benefited from the Company's increased marketing efforts, including radio, newspaper, cable and network television, direct mail and catalog advertisements. The Company also promoted its new website, www.harveyonline.com which was launched in October 2000 as well as the new Harvey Eatontown and new Bang & Olufsen, Connecticut stores. The Company's website has been successful in generating leads for the retail showrooms; however, as expected, website sales have been insignificant. The Company expects its website to continue to create consumer interest and increase sales leads to its retail stores in fiscal 2002 and beyond.
Costs and Expenses
Total cost of goods sold for fiscal 2001 increased approximately $1.7 million or 8.4% from the prior fiscal year. This was primarily related to the overall increase in net sales as noted above, offset by a small decline in the gross profit margin.
The gross profit margin for fiscal 2001 was 38.5% as compared to 39.4% for the prior fiscal year. The small decrease in the gross profit margin was due primarily to the increased sale of video products, which is driving the Company's overall business and which typically have lower gross margins than audio products. The increase in video sales was primarily due to additional customer demand for new digital technologies such as HDTV, DVD, DSS, plasma and LCD flat-screen televisions. It should be noted that sales of these new products do benefit from higher gross margins and higher overall sales prices as compared to commodity analog televisions and VCR's. Interest in these new video products will also cultivate larger projects including new sales of audio components, speakers, home theater systems, furniture, accessories and custom installation services, which all realize higher margins for the Company. For fiscal 2001, the Company's sales of video products accounted for over 35% of its net sales as compared to 31% in fiscal 2000.
The increase in higher margin custom installation labor income (approximately $1.9 million in fiscal 2001 as compared to approximately $1.1 million in fiscal 2000) has helped to mitigate the reduction in the gross margin from the increase in video sales.
Selling, general and administrative expenses ("SG&A expenses") increased 17.7% or approximately $2.3 million for fiscal 2001, as compared to fiscal 2000.
Comparable SG&A expenses for fiscal 2001 increased approximately $945,000 or 7.4%. Comparable SG&A expenses actually decreased in the Company's fourth quarter by $200,000 or 5.7% primarily from a reduction in payroll, bonuses and payroll related expenses as prescribed by management. This was primarily accomplished by a reduction in personnel and the implementation of a one-week non-paid furlough for all Company employees, including officers and other management employees.
The overall increase in total SG&A expense was affected by costs relating to the new Bang & Olufsen and Eatontown stores and additionally from costs relating to the Company's new website. Comparable SG&A expenses increased primarily from additional payroll, commissions and payroll-related items resulting in part from the new three-year union contract, which was completed at the end of fiscal 2000. Comparable SG&A expenses also increased from additional occupancy costs, advertising expenditures, depreciation expense, insurance costs, consulting fees, investor relations costs and various other store-operating expenses. The Company also continued to hire additional custom installation personnel and incur other associated expenses relating to the expansion of its custom installation business. In July 2000, the Company also expanded its warehouse and distribution facility, which increased occupancy costs and other related expenses for all of fiscal 2001.
Interest expense for fiscal 2001 increased 56.1% or approximately $122,000 as compared to fiscal 2000. The increase was primarily due to additional borrowings from the Company's revolving line of credit facility to fund the Company's retail store expansion and renovation. Additionally, the increased expense is due to amortization of warrants issued to the Company's lender and from the amortization of the commitment fee paid by the Company to its lender in December 2000, relating to the increase and extension of the line of credit.
In connection with the Company's emergence from its reorganization proceeding, the Company adopted Fresh Start Accounting. Fresh Start Accounting requires that the Company report an income tax equivalent provision when there is book income and pre-reorganization net operating loss carryforwards. This requirement applies despite the fact that the Company's pre-reorganization net operating loss carryforward will be utilized to reduce the related income tax payable. The current and any future year benefit arising from utilization of the pre-reorganization carryforward is not reflected as a reduction of the tax equivalent provision in determining net income, but instead is recorded first as a reduction of reorganization value in excess of amounts allocable to identifiable assets until exhausted, and thereafter as a direct addition to paid-in capital.
As noted above, for fiscal 2000, the income tax equivalent provision was $185,000 and the reduction of reorganization value in excess of amounts allocable to identifiable assets amounted to $160,000. The income tax equivalent provision did not affect the Company's cash.
Liquidity and Capital Resources
At October 26, 2002 and October 27, 2001, the Company's ratio of current assets to current liabilities was .93 and .84, respectively. The Company had negative working capital of $600,000 and $1,416,000 at October 26, 2002 and October 27, 2001, respectively. However, it is important to note that at October 26, 2002 and October 27, 2001, the Company's outstanding balances on its Credit Facility ($3,119,000 and $3,442,000, respectively) were classified as current liabilities, despite the three-year term of the Company's Credit Facility. The presentation as a current liability is in accordance with EITF 95-22 (See Note 2 to the Financial Statements for details).
The increase in the Credit Facility, in fiscal 2001, was necessary to fund retail store expansion, renovation and the Company's website. The improvement in the current ratio at October 26, 2002 was positively impacted by the Company's pre-tax income. Other factors primarily improving working capital, included the reduction of the Credit Facility and accounts payable and an increase in inventory and accounts receivable, offset by an increase in accrued expenses and other current liabilities.
Net cash provided from operations for fiscal 2002 was $721,000 as compared to net cash used in operations of $263,000 for fiscal 2001. The improvement in cash provided from operations for fiscal 2002 was primarily due to additional pre-tax income ($1,555,000), a decrease in accounts receivable ($50,000) and inventory ($151,000), an increase in accrued expenses, other current liabilities and income taxes ($370,000), offset by a decrease in accounts payable ($563,000) and customer deposits ($530,000).
Net cash used in investing activities was $234,000 for fiscal 2002, as compared to net cash used of $1,727,000 for fiscal 2001. Net cash used for the purchases of property and equipment and website enhancements was $237,000 for fiscal 2002 as compared to $1,734,000 for fiscal 2001. Additions for fiscal 2001 related primarily to furniture, fixtures, computer equipment, website improvements and leaseholds relating to the new store openings and for the renovation of the Company's 45th Street store in Midtown Manhattan.
Net cash used in financing activities was $499,000 for fiscal 2002, as compared to net cash provided from financing activities of $1,984,000 for fiscal 2001. Financing activities for fiscal 2002 included net payments of $323,000, reducing the Credit Facility, preferred stock dividends paid of $74,000, principal payments on capital leases of $81,000 and note payable payments of $22,000. Financing activities for fiscal 2001 included net borrowings of $2,374,000 from the Credit Facility, preferred stock dividend payments of $108,000, payments on capital leases of $198,000, note payable payments of $10,000 and a $75,000 commitment fee relating to the increase and extension of the Credit Facility.
The Company has a three-year revolving line of credit facility ("Credit Facility") with Wells Fargo Retail Finance ("Wells Fargo"), whereby the Company can borrow up to $7 million based upon a lending formula (as defined) calculated on eligible inventory. The Credit Facility expires November 30, 2003. The interest rate on all borrowings under the Credit Facility is one percent (1%) over the prime rate with a minimum interest rate of 8%. Effective January 1, 2002, the minimum interest rate was reduced to 6.5% and will be in effect throughout fiscal 2003. At January 2, 2003, there was approximately $1,958,000 in outstanding borrowings under the Credit Facility, with approximately $3,911,000 available to borrow under the Credit Facility.
The maximum amount of borrowings available to the Company under this Credit Facility is limited by formulas, as prescribed by Wells Fargo. The Company's maximum borrowing availability is equal to 75% of eligible inventory, less existing borrowings and certain reserves established by Wells Fargo.
Pursuant to the Credit Facility, the Company cannot exceed certain advance rates on eligible inventory and must maintain certain levels of net income or loss and minimum gross profit margins. Additionally, the Company's capital expenditures cannot exceed a predetermined amount.
Wells Fargo obtained a senior security interest in substantially all of the Company's assets. The Credit Facility provides Wells Fargo with rights of acceleration upon the breach of certain financial covenants or the occurrence of certain customary events of default. The Company is also restricted from paying dividends on common stock, retiring or repurchasing its common stock, and generally from entering into additional indebtedness (as defined).
The following is a summary of our significant contractual cash obligations for the periods indicated that existed as of October 26, 2002 and is based on information appearing in the Notes to the Financial Statements:
The Company has 2,104,500 redeemable common stock purchase warrants ("Warrants") outstanding from its public offering of common stock and Warrants in fiscal 1998 (the "Offering"). Each outstanding Warrant is exercisable for one share of common stock at 110% ($5.50 per share) of the Offering price through March 31, 2003. The Warrants are also redeemable (at $.10 per Warrant), at the Company's option, if the closing bid price of the common stock for 20 consecutive trading days exceeds 150% of the Offering price per share of $7.50.
The Company has authorized 10,000 shares of 8.5% Cumulative Convertible Preferred Stock ("Preferred Stock") with a par value of $1,000 per share. The conversion price of the Company's preferred stock is $1.2333. 875 shares of Preferred Stock were originally issued by the Company. In June 2002, 48 shares of Preferred Stock were converted to 38,920 shares of the Company's common stock by a preferred shareholder. At October 26, 2002, 827 shares of Preferred Stock were issued and outstanding. The Company's remaining Preferred Stock is convertible into 670,559 shares of common stock.
In fiscal 2001, the Company entered into a ten-year lease for a new 6,500 square foot Harvey showroom in Eatontown, New Jersey. This store opened in April 2001 and is the Company's ninth. Capital expenditures, including inventory, necessary to operate this new retail store approximated $1,500,000.
The Company's expansion plan, if any, for fiscal 2003 has not been developed at this time, as the economic outlook remains uncertain. The Company will, however, make improvements to certain of its Harvey retail showrooms, including additional renovations at its Paramus, New Jersey store and the installation of total movie theaters within certain of its stores. Miscellaneous purchases of equipment and other assets for fiscal 2003 are not expected to be significant.
The Company intends to continue its advertising campaign in fiscal 2003, primarily with print, radio and direct mail.
The Company's website gives its customers access to one of Harvey's upscale retail showrooms or offers its customers a private, in-home consultation through the convenience of the Internet. The anticipated costs of maintaining and improving the website are not expected to be material for 2003.
In March 2001, the Company engaged Porter, LeVay & Rose, Inc. ("PL&R") as its investor relations' advisor. The Company's goal in engaging PL&R was to heighten its visibility as the Company pursued its business strategy and selective expansion. After one year, the Company's Board of Directors decided that the services of an investor relations' advisor would currently not be needed, and as a result, the Company discontinued the services from PL&R effective May 1, 2002.
Net sales and operating results for the Company's first quarter of its fiscal year are positively affected by a strong holiday demand.
Management believes that cash on hand, cash flow from operations and funds made available under the Credit Facility with Wells Fargo, will be sufficient to meet the Company's anticipated working capital needs for at least the next twelve-month period.
Critical Accounting Policies
The accompanying financial statements were prepared in accordance with accounting principles generally accepted in the United States of America. Significant accounting policies are discussed in Footnote 1 to the Financial Statements, Item 8. Inherent in the application of many of these accounting policies is the need for management to make estimates and judgments in the determination of certain revenues, expenses, assets and liabilities. As such, materially different financial results can occur as circumstances change and additional information becomes known. The policies with the greatest potential effect on our results of operation and financial position include:
Revenue Recognition
Revenue is recognized when merchandise is delivered to customers or, in the case of custom installation revenue, when the service has been performed. For the Company, net sales and operating revenues include items related to normal business operations, including the sale of goods to customers and custom installation revenue. Retail sales are recorded at the time of the sale to the customer. Customer installation revenue is recognized when the installation is complete.
Inventory
Inventory is the Company's largest asset class, comprising over 50% of the Company's total assets. The Company's inventory consists of finished goods held for retail sale. Purchase-based volume rebates are credited to inventory or cost of products sold, as appropriate. The Company assesses the market value of its inventory on a regular basis by reviewing, on an item-by-item basis, the realizable value of its inventory, net of anticipated selling costs. If it is management's judgment that the selling price of an item must be lowered below its cost in order for it to be sold, then the carrying value of the related inventory is written down to realizable value. A number of factors would be taken into consideration in assessing realizable value including the quantity on hand, historical sales, technological advances, the existence of a replacement product, and consumer demand and preferences. Depending on market conditions, the actual amount received on sale could differ from management's estimate.
Long-Lived Assets
Long-lived assets such as property, plant and equipment, goodwill, and reorganization value are reviewed for impairment when events or changes in circumstances indicate the carrying value of the assets may not be recoverable. We would recognize an impairment loss when estimated future undiscounted cash flows expected to result from the use of the asset and its value upon disposal are less than its carrying amount. If our estimates regarding future undiscounted cash flows or useful lives were to change, we could be exposed to losses that are material in nature.
Accrued expenses
The Company is constantly required to make estimates of future payments that will be made which relate to the current accounting period. These estimates range from things such as accrued but unpaid wages and bonuses to estimates of pending litigation claims. In establishing appropriate accruals, management must make judgments regarding the amount of the disbursement that will ultimately be incurred. In making such assessments, management uses historical experience as well as any other special circumstances surrounding a particular item. The actual amount paid could differ from management's estimate.
Item 7a.
Item 7a. Quantitative and Qualitative Disclosures About Market Risk
Not applicable.
Item 8.
Item 8. Financial Statements and Supplementary Data
The information required by this item is incorporated by reference to the Company's financial statements.
Item 9.
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure.
The Company changed its independent public accounting firm in fiscal 2002 from Ernst & Young LLP to BDO Seidman, LLP. There were no disagreements between the Company & Ernst & Young LLP.
Part III
Item 10.
Item 10. Directors, Executive Officers, Promoters and Control Persons; Compliance With Section 16(a) of the Exchange Act.
The directors and executive officers of the Company are as follows:
Michael E. Recca became the Chairman of the Board of Directors of the Company in November 1996. Mr. Recca is also a member and manager of Harvey Acquisition Company, LLC, which is a principal shareholder of the Company. Mr. Recca was an employee of Taglich Brothers, D'Amadeo, Wagner & Co., Inc., a NASD registered broker-dealer, through December 31, 1998. From January 2001 through April 2002, Mr. Recca was also a principal in NorthStar Capital, LLC, which was a joint venture with Ruskin, Moscou, Evans & Faltischek, P.C., the Company's corporate counsel. Currently, Mr. Recca is a director of Sky Holdings LTD, and the President of Sky Capital, LLC, a NASD broker dealer.
Franklin C. Karp began his career in the retail consumer electronics industry over 25 years ago, working then as a salesman for one of the most successful chain operations in the New York metropolitan area. He held various positions in sales management, purchasing and operations. In 1990, Mr. Karp joined Harvey as Merchandise Manager and later as Vice President in charge of merchandising. Mr. Karp was appointed President of Harvey in 1996.
Joseph J. Calabrese, a certified public accountant, joined the Company as Controller in 1989. Since 1991, Mr. Calabrese has served as Vice President, Chief Financial Officer, Treasurer and Secretary of the Company. Mr. Calabrese was elected Executive Vice President and a Director of the Company in 1996. Mr. Calabrese began his career with Ernst & Young LLP in 1981 where for the eight-year period prior to his joining the Company he performed audit services with respect to the Company.
Fredric J. Gruder, has been a director since July 1998. Since December 2001, Mr. Gruder has been a sole practitioner in his own law firm. From July 1999 to December 2001, Mr. Gruder has been of counsel to Dorsey & Whitney LLP. From September 1996 to July 1999, he was a partner in the law firm of Gersten, Savage, Kaplowitz & Fredericks, LLP ("Gersten"), which represented Thornwater Company, L.P. ("Thornwater"), representative of the Company's underwriters in the Offering. From March 1996 through September 1996, Mr. Gruder was of counsel to Gersten, having been a sole practitioner from May 1995 through March 1996. From March 1992 until March 1996, Mr. Gruder served as vice president and general counsel to Sbarro, Inc., then a publicly traded corporation which owns, operates, and franchises Italian restaurants. Prior to this time, Mr. Gruder practiced law in New York for over twenty years, specializing in corporate securities and retail real estate.
William F. Kenny, III has been a director of the Company since 1975. From January 1992 to December 2000, Mr. Kenny was a consultant to Meenan Oil Co., Inc. Prior to 1992, Mr. Kenny was the President and Chief Executive Officer of Meenan Oil Co., Inc. Mr. Kenny has also served as a director of the Empire State Petroleum Association, Petroleum Research Foundation and was the President of the East Coast Energy Council. Mr. Kenny was also the President of the Independent Fuel Terminal Operators Association and the Metropolitan Energy Council.
Jeffrey A. Wurst, a director since February 2000, is a Partner at the law firm of Ruskin Moscou Faltischek, P.C. ("Ruskin"), where he chairs the firm's Financial Services Group. Mr. Wurst began his legal career with Ruskin in 1987. Mr. Wurst is experienced in asset based lending, factoring, commercial finance and bankruptcy matters. Mr. Wurst graduated from the Jacob D. Fuchsburg Law Center of Touro College in 1987 and earned his B.S. and M.A. from Hofstra University. Mr. Wurst's law firm has been involved in the legal representation of the Company since it reorganized under the bankruptcy laws in 1996.
Michael A. Beck has been Vice President of Operations of the Company since April 1997. From June 1996 until such date he was the Company's Director of Operations and from October 1995 until April 1996 he served as Director of Operations for Sound City, a consumer electronics retailer. Mr. Beck was a store manager for the Company from August 1989 until October 1995. Mr. Beck holds a BA in Psychology from Merrimack College.
Roland W. Hiemer is an executive officer of the Company and Director of Inventory Control. Mr. Hiemer has been with the Company for eleven years. He started with the Company as a salesman and advanced to Senior Sales Manager for the Paramus store in 1991. He was further promoted to Inventory Control Manager in 1991. In 1997, he was promoted to Director of Inventory Control and in 2001, Mr. Hiemer was promoted to Merchandise Manager. Mr. Hiemer holds a BA in Business Administration from Hofstra University.
Committees of the Board of Directors
The Board of Directors has an Audit Committee and a Compensation and Stock Option Committee.
Audit Committee. The function of the Audit Committee includes making recommendations to the Board of Directors with respect to the engagement of the Company's independent auditors and the review of the scope and effect of the audit engagement. The Company's Audit Committee is governed by a written charter approved by the Board of Directors. William F. Kenny, III, Fredric J. Gruder and Jeffrey A. Wurst were the members of the Audit Committee in fiscal 2002.
Compensation and Stock Option Committee. The function of the Compensation and Stock Option Committee is to make recommendations to the Board with respect to the compensation of management employees and to administer plans and programs relating to stock options, pension and other retirement plans, employee benefits, incentives, and compensation. Fredric J. Gruder, William F. Kenny, III and Jeffrey A. Wurst were the members of the Compensation and Stock Option Committee in fiscal 2002.
Item 11.
Item 11. Executive Compensation.
The following table sets forth the cash compensation paid by the Company, as well as any other compensation paid to or earned by the Chairman of the Company, the President of the Company and those executive officers compensated at or greater than $100,000 for services rendered to the Company in all capacities during the three most recent fiscal years.
Summary Compensation Table
Severance Agreements
In fiscal year 2000, the Company's Board of Directors approved and the Company entered into substantially similar Amended and Restated Severance Agreements (each an "Amended Severance Agreement") with each of Michael E. Recca, Franklin C. Karp, Joseph J. Calabrese, and Michael A. Beck, executives of the Company.
Each Amended Severance Agreement provides that in the event the executive is terminated for any reason other than for cause, as defined in the agreement, and in the event of a change in control (as defined), such as a merger, sale or disposition of assets, change in the constitution of the Board of Directors or the current Chairman, the assignment to the executive of a position inconsistent with the executive's current position or relocation of the corporate office (as defined), or in the event of a potential change in control (as defined), or disability (as defined), and within one hundred eighty (180) days from the day of one of the foregoing events the executive is terminated for reasons other than for cause or the executive terminates his employment for any reason, the respective executive shall receive, among other things:
i. a cash amount equal to the higher of: (x) the executive's base salary prior to termination or the event giving rise to the change in control, potential change in control or disability, or (y) the executive's base salary prior to the event giving rise to the executive's right to terminate his employment for any reason;
ii. a cash payment equal to the higher of: (x) twelve (12) months of the executive's highest monthly car allowance or monthly average travel reimbursement in effect within the six (6) month period immediately prior to termination or the change in control, potential change in control or disability, not to exceed twelve thousand and 00/100 ($12,000) dollars, or (y) twelve (12) months of the executives highest monthly car allowance or monthly average travel reimbursement in effect within the six (6) month period immediately prior to the date the executive terminates his employment for any reason, not to exceed twelve thousand and 00/100 ($12,000) dollars; and
iii. the maximum /highest benefits which the executive was receiving at any time during a two-year period prior to termination, relating to health insurance, accident insurance, long-term care, life insurance and disability, which shall continue for one (1) year beyond the date of termination of the executive's employment.
Roland W. Hiemer's severance agreement provides that in the event the Company is sold or merged with another company, involved in a corporate reorganization, or if a change of the current management takes place, and Mr. Hiemer, for the foregoing reasons, is terminated or asked to accept a position other than that of a senior officer requiring similar responsibilities to those that he currently performs, or if the current corporate office is moved to a new location which is more than thirty miles Lyndhurst, New Jersey, as a result of a reorganization or change in ownership or control, and he declines the new position or relocation, the Company or its successor in control will be obligated, and continue, to pay him at the same salary and car allowance, if any, he had most recently been earning, for a period of six months. In addition, he will be fully covered under the Company's benefit plans, including, without limitation, the Company's medical, dental, life and disability insurance programs, during the six-month period.
If, following termination of Mr. Hiemer as described in the preceding paragraph, Mr. Hiemer obtains employment at a lesser compensation than Mr. Hiemer's compensation by the Company, the Company will pay Mr. Hiemer the difference between the two salaries for the remainder of the six month period, plus continued coverage of the Company's benefit plans for the same period. The severance agreement for Mr. Hiemer also provides that in the event he is terminated for any other reasons, except conduct that is materially injurious to the Company or conviction of any crime involving moral turpitude, the Company will be obligated and continue to pay Mr. Hiemer at the same salary he has most recently been earning, for a period following termination of three months plus full coverage of the Company's benefits for the same period.
Compensation Committee Report on Executive Compensation
The Compensation and Stock Option Committee ("Compensation Committee") of the Board of Directors establishes the Company's general compensation policies as well as the compensation plans and specific compensation levels for executive officers. It also administers our employee stock option plan for executive officers.
The Compensation Committee believes that the compensation of the Company's executive officers should be influenced by performance. Base salary levels, and any salary increases are approved by the Compensation Committee. In fiscal 2002, 2001 and 2000, additional compensation in the form of cash bonuses and stock options were made in accordance with a quarterly and annual bonus plan, as approved by the Compensation Committee. The Compensation Committee believes that the executive officers salaries during these years did not exceed levels in the industry for similarly-sized businesses. Severance agreements exist for all executive officers.
As previously mentioned, stock option grants have been part of the bonus plan for executive officers. The Compensation Committee viewed these option grants as an important component of its long-term, performance-based compensation philosophy. Since the value of an option bears a direct relationship to the Company's stock price, the Compensation Committee believes that options motivate executive officers to manage the Company in a manner that will also benefit stockholders. As such, options were granted, only if performance levels were achieved, at the current market price. One of the principal factors considered in granting options to an executive officer was the executive officer's ability to influence the companies long-term growth and profitability. As only a limited number of options remain available for grant, no options are expected to be granted to executive officers in fiscal 2003.
With respect to the base salary granted to Mr. Karp, the Company's President, the Compensation Committee made a favorable assessment of the Company's actual operating results for fiscal 2002, as compared to the Company's goals and from the performance of Mr. Karp on various accomplishments for fiscal 2002. The Compensation Committee also considered Mr. Karp's relative position as compared to his peers in the industry. Based on these factors, Mr. Karp's salary was increased to $160,000 in fiscal 2002. During fiscal 2002, as a result of the Company achieving its performance objectives, a total of 50,000 stock options were also granted to Mr. Karp.
During 2002, a total of 205,000 options were granted to the Company's executive officers.
Stock Option Plan
In April 1997, the Company adopted a stock option plan, which currently covers 1,000,000 shares of the Common Stock. At October 26, 2002, options currently outstanding aggregating 989,100 and 10,900 options are available for grant. Options may be designated as either (i) incentive stock options ("ISOs") under the Internal Revenue Code of 1986, as amended (the "Code") or (ii) non-qualified stock options. ISOs may be granted under the Stock Option Plan to employees and officers of the Company. Non-qualified options may be granted to consultants, directors (whether or not they are employees), employees or officers of the Company (collectively "Options"). In certain circumstances, the exercise of Options may have an adverse effect on the market price of the Common Stock. The Stock Option Plan was approved by the Company's shareholders in fiscal 1998.
The Stock Option Plan is intended to encourage stock ownership by employees of the Company, so that they may acquire or increase their proprietary interest in the Company and to encourage such employees and directors to remain in the employ of the Company and to put forth maximum efforts for the success of the business. Options granted under the Stock Option Plan may be accompanied by either stock appreciation rights ("SARS") or limited stock appreciation rights (the "Limited SARS"), or both.
The Plan is administered by the Compensation Committee as the Board may establish or designate. The Compensation Committee shall be comprised of not less than two members, and all of who shall be outside directors. The members of the Compensation and Stock Option Committee are William F. Kenny III, Jeffrey A. Wurst and Fredric J. Gruder, outside directors.
The Compensation and Stock Option Committee, within the limitation of the Stock Option Plan, shall have the authority to determine the types of options to be granted, whether an Option shall be accompanied by SARS or Limited SARS, the purchase price of the shares of Common Stock covered by each Option (the "Option Price"), the persons to whom, and the time or times at which, Options shall be granted, the number of shares to be covered by each Option and the terms and provisions of the option agreements.
The maximum aggregate number of shares of Common Stock as to which Options, Rights and Limited Rights may be granted under the Stock Option Plan to any one optionee during any fiscal year of the Company is 100,000, as approved and amended by the shareholders in fiscal 2000.
With respect to the ISOs, in the event that the aggregate fair market value, determined as of the date the ISO is granted, of the shares of Common Stock with respect to which Options granted and all other option plans of the Company, if any, become exercisable for the first time by any optionee during any calendar year exceeds $100,000, Options granted in excess of such limit shall constitute non-qualified stock options for all purposes. Where the optionee of an ISO is a ten (10%) percent stockholder, the Option Price will not be less than 110% of the fair market value of the Company's Common Stock, determined on the date of grant, and the exercise period will not exceed five (5) years from the date of grant of such ISO. Otherwise, the Option Price will not be less than one hundred (100%) percent of the fair market value of the shares of the Common Stock on the date of grant, and the exercise period will not exceed ten (10) years from the date of grant. Options granted under the Plan shall not be transferable other than by will or by the laws of descent and distribution, and Options may be exercised, during the lifetime of the optionee, only by the optionee or by his guardian or legal representative.
In fiscal 2002, the Company's Compensation and Stock Option Committee approved two grants of incentive stock options aggregating 205,000, to the Company's officers to purchase the Company's Common Stock at exercise prices from $1.15 - $1.35 per share. The fiscal 2002 incentive stock options are exercisable immediately.
In fiscal 2001, the Company's Compensation and Stock Option Committee approved three grants of incentive stock options aggregating 262,500, to the Company's officers and outside directors, to purchase the Company's common stock at exercise prices from $.8125-$1.375 per share. The fiscal 2001 incentive stock options are exercisable immediately.
In fiscal 2000, the Company's Compensation Committee approved three grants of incentive stock options aggregating 172,500, to the Company's officers, to purchase the Company's common stock at exercise prices from $1.75-$1.925 per share. The fiscal 2000 incentive stock options are exercisable immediately.
The following table sets forth information relating to the 205,000 options granted in the fiscal year ended October 26, 2002, all of which were granted to the named executive officers and directors:
The following table sets forth information concerning the excercise of stock options by the named executives and directors during the Company's fiscal year ended October 26, 2002, the number of options owned by the named executives and directors and the value of any in-the-monry unexcercised stock options as of October 26, 2002.
PERFORMANCE GRAPH
The following graph shows a 55-month comparison of the cumulative total return to shareholders for the Company, The Russell 2000 Index and a peer group of substantially larger electronics companies. The graph assumes that the value of investment in the Company's common stock and in each index was $100 on April 2, 1998 (the date the Company completed its public offering of common stock on common stock warrants), including the reinvestment of dividends, if any. The Company's fiscal year is either a 52 or 53-week year with the fiscal year ending on the Saturday closest to October 31. All fiscal years presented in the performance graph include 52 weeks.
[GRAPH OMITTED]
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management.
The following table sets forth certain information with respect to the beneficial ownership of shares of Common Stock as of October 26, 2002, based on information obtained from the persons named below, by (i) each person known to the Company to beneficially own more than 5% of the outstanding shares of Common Stock, (ii) each executive officer and director of the Company, and (iii) all officers and directors of the Company as a group:
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Securities Exchange Act of 1934 requires the Company's officers and directors, and persons who own more than ten percent of the Company's common stock, to file reports of ownership and changes in ownership on Forms 3,4 and 5 with the Securities and Exchange Commission and Nasdaq. Officers, directors and greater than ten percent shareholders are required by Securities and Exchange Commission regulations to furnish the Company with copies of all Section 16(a) forms they file.
To the Company's knowledge, based solely on its review of the copies of such forms received by it, and written representations from certain reporting persons that no Forms 5 were required for those persons, the Company believes that during the fiscal year ended October 26, 2002, all Section 16(a) filing requirements applicable to its officers, directors and greater than ten percent beneficial owners were complied.
Item 13.
Item 13. Certain Relationships and Related Transactions.
From April 1, 1998 through April 30, 2000, Mr. Recca received $7,917 per month, representing a director's fee in the annual amount of $95,000, in his capacity as the Chairman of the Board of Directors of the Company. Effective May 1, 2000, Mr. Recca was placed on the Company's payroll at an annual salary of $120,000, plus all Company sponsored benefits.
In December 2000, $23,000 was paid to Recca & Co. Inc., of which Mr. Recca is the sole shareholder. Amounts paid relate to management fees and other miscellaneous amounts from fiscal 1998.
From January 2001 to April 2002, Mr. Recca had also been a principal of NorthStar Capital, LLC which was a joint venture between certain of the partners of Ruskin Moscou Faltischeck, P.C. ("Ruskin"), the Company's corporate counsel and Mr. Recca. Since April 2002, Mr. Recca has been a director of Sky Holdings LTD, and the President of Sky Capital, LLC, a NASD broker dealer.
Jeffrey A. Wurst, Director, is also a Senior Partner with Ruskin. At October 26, 2002 and October 27, 2001, the Company had amounts payable to Ruskin of approximately $26,000 and $25,000, respectively. The Company also paid legal fees to Ruskin of $81,000, $64,000 and $127,000, in fiscal years 2002, 2001 and 2000, respectively.
At October 28, 2000, the Company had a receivable of approximately $45,000 due from Mr. E.H. Arnold, a member of HAC and a holder of Preferred Stock. This amount was subsequently collected by the Company in December 2000.
Dividends paid to preferred stockholders aggregated $74,000, $108,000 and $110,000 for fiscal years 2002, 2001 and 2000, respectively.
In fiscal 1999, the Company signed a consulting agreement with a previous member of its underwriter. Pursuant to the terms of the two-year agreement, the consultant received an annual fee of $75,000 for fiscal 1999. This agreement was terminated by the Company effective February 29, 2000. In August 2000, the consultant was again engaged by the Company, pursuant to a consulting agreement, at $5,000 per month. At December 15, 2000, the agreement was terminated by the Company. The consultant received fees aggregating $5,000 and $40,000 in fiscal years 2001 and 2000, respectively.
Item 14.
Item 14. Controls and Procedures
The Company's President and Chief Financial Officer (its principal executive office and principal financial officer, respectively) have concluded, based on their evaluation as of a date within 90 days prior to the filing date of this report, that the Company's disclosure controls and procedures are effective to ensure that information required to be disclosed by the Company in the reports filed or submitted by it under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms, and include controls and procedures designed to ensure that information required to be disclosed by the Company in such reports is accumulated and communicated to the Company's management, including the President and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
There were no significant changes in the Company's internal controls or in other factors that could significantly affect these controls subsequent to the date of such evaluation including any corrective actions with regard to significant deficiencies and material weaknesses.
Item 15.
Item 15. Exhibits, Financial Statement Schedule and Reports on Form 8-K.
(a)--List of Financial Statements and Financial Statement Schedule and Exhibits:
(1) List of Financial Statements:
Balance Sheets - October 26, 2002 and October 27, 2001
Statements of Operations - Fiscal years ended October 26, 2002, October 27, 2001 and October 28, 2000
Statements of Shareholders' Equity - Fiscal years ended October 26, 2002, October 27, 2001 and October 28, 2000
Statements of Cash Flows - Fiscal years ended October 26, 2002, October 27, 2001 and Octobeer 28, 2000
Notes to Financial Statements
(2) List of Financial Statements Schedule:
Schedule II - Valuation and Qualifying Accounts
All other schedules for which provision is made in the applicable accounting regulation of the Securities Exchange Commission are not required under the related instructions or are inapplicable and therefore have been omitted.
(3) The following exhibits are hereby incorporated by reference from the corresponding exhibits filed under the Company's Form SB-2 under Commission File #333--42121:
(b) --Reports on Form 8-K:
On November 25, 2002, the Company filed Form 8-K with the Securities and Exchange Commission, announcing compliance with NASDAQ Listing Qualifications.
Signatures
In accordance with Section 13 or 15(d) of the Exchange Act, the Registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Harvey Electronics, Inc.
By: /s/ Franklin C. Karp -------------------- Franklin C. Karp, President
Dated: January 24, 2003
In accordance with the Exchange Act, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dated indicated.
Item 8. Financial Statements and Supplementary Data
Harvey Electronics, Inc.
Index to Financial Statements and Supplemental Data
Report of Independent Certified Public Accountants
The Board of Directors and Shareholders Harvey Electronics, Inc.
We have audited the accompanying balance sheet of Harvey Electronics, Inc. as of October 26, 2002, and the related statements of operations, shareholders' equity and cash flows for the year then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Harvey Electronics, Inc. at October 26, 2002, and the results of its operations and its cash flows for the year then ended, in conformity with accounting principles generally accepted in the United States of America.
s/BDO Seidman, LLP - ----------------------------- BDO Seidman, LLP Melville, New York December 20, 2002
Report of Independent Auditors
The Board of Directors and Shareholders Harvey Electronics, Inc.
We have audited the accompanying balance sheet of Harvey Electronics, Inc. as of October 27, 2001 and the related statements of operations, shareholders' equity and cash flows for the years ended October 27, 2001 and October 28, 2000. Our audit also included the financial statement schedule listed in the index at Item 15(a). 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 audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Harvey Electronics, Inc. at October 27, 2001 and the results of its operations and its cash flows for the years ended October 27, 2001 and October 28, 2000, 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, present fairly in all material respects the information set forth therein.
s/Ernst & Young LLP --------------------------------- Melville, New York December 28, 2001
See notes to financial statements.
Harvey Electronics, Inc.
Statements of Operations
See notes to financial statements.
Harvey Electronics, Inc.
Statements of Shareholders' Equity
See notes to financial statements.
Harvey Electronics, Inc. Statements of Cash Flows
See notes to financial statements.
1. Description of Business and Summary of Significant Accounting Policies
Description of Business
The Company is a specialty retailer and custom installer of high quality audio/video consumer electronics and home theater products in the Metropolitan New York area. Revenues from retail sales are recognized at the time goods are delivered to the customer or, for certain installation services, when such services are performed and accepted by the customer. The Company's fiscal year ends the Saturday closest to October 31. The fiscal years ended October 26, 2002, October 27, 2001 and October 28, 2000 each consist of 52 weeks.
Net sales and operating results for the Company's first quarter of its fiscal year are positively affected by a strong holiday demand.
Accounting Estimates
The preparation of the financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the financial statements and accompanying notes. Actual results could differ from those estimates.
Long-Lived Assets
In accordance with Financial Accounting Standards Board Statement of Financial Accounting Standards ("SFAS") No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," when impairment indicators are present, the Company reviews the carrying value of its assets in determining the ultimate recoverability of their unamortized values using future undiscounted cash flows expected to be generated by the assets. If such assets are considered impaired, the impairment loss recognized is measured by the amount by which the carrying amount of the asset exceeds the estimated fair value. No such impairment exists at October 26, 2002. Assets to be disposed of are reported at the lower of the carrying amount or fair value, less cost to sell.
1. Description of Business and Summary of Significant Accounting Policies (continued)
The Company evaluates the periods of amortization continually in determining whether later events and circumstances warrant revised estimates of useful lives. If estimates are changed, the unamortized cost will be allocated to the increased or decreased number of remaining periods in the revised lives.
Stock-Based Compensation
SFAS No. 123, "Accounting for Stock-Based Compensation," defines a fair value method of accounting for the issuance of stock options and other equity instruments. Under the fair value method, compensation cost is measured at the grant date based on the fair value of the award and is recognized over the service period, which is usually the vesting period. Pursuant to SFAS No. 123, companies are encouraged, but are not required, to adopt the fair value method of accounting for employee stock-based transactions. Companies also are permitted to continue to account for such transactions under Accounting Principles Board Opinion ("APB") No. 25, "Accounting for Stock Issued to Employees," as the Company has elected to do, but are required to disclose in the financial statement footnotes, pro forma net income and per share amounts as if the Company had applied the new method of accounting for all grants made since 1996. SFAS No. 123 also requires increased disclosures for stock-based compensation arrangements. The Company follows the disclosure requirements of SFAS No. 123 (see Note 4).
Segment Disclosures
SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information," establishes standards for the way that public business enterprises report information about operating segments in annual financial statements and requires that those enterprises report selected information about operating segments in interim financial reports. SFAS No. 131 also establishes standards for related disclosure about products and services, geographic areas, and major customers. The Company operates in one business segment.
Inventories
Inventories, consisting of finished goods, are stated at the lower of cost (average-cost method, which approximates the first-in, first-out method) or market value.
1. Description of Business and Summary of Significant Accounting Policies (continued)
Depreciation and Amortization
Property and equipment are stated at cost less accumulated depreciation and amortization. Depreciation of property and equipment, including equipment acquired under capital leases, is calculated using the straight-line method over the estimated useful lives of the related assets, ranging from three to ten years. Amortization of leasehold improvements is calculated using the straight-line method over the shorter of the lease term or estimated useful lives of the improvements.
Internet Website
The Company follows the provisions of EITF 00-2, "Accounting for Website Development Costs", which provides guidance or how an entity should account for website development costs. In accordance with EITF 00-2, costs incurred in the website application and infrastructure development stage relating to the acquisition or development of software or the development of graphics for internal use, should be accounted for under the provisions of Statement of Position ("SOP") 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use" and capitalized. As such, and in accordance with SOP 98-1, the Company capitalized approximately $26,000, $73,000 and $343,000 for fiscal years 2002, 2001 and 2000, respectively, relating to the development of their website. These costs are being amortized on a straight-line basis over a period of one to three years.
Income Taxes
The Company follows the liability method in accounting for income taxes as described in SFAS No. 109, "Accounting for Income Taxes." Under this method, deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. Deferred income taxes reflect the net effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes (see Note 6).
Income (Loss) Per Share
Basic and diluted income (loss) per share are calculated in accordance with SFAS No. 128, "Earnings Per Share." The basic and diluted income (loss) per common share for the fiscal years ended October 26, 2002, October 27, 2001 and October 28, 2000 were computed based on the weighted-average number of common shares outstanding. Common equivalent shares relating to stock options aggregating 88,476 were included in the weighted average number of common shares outstanding for fiscal 2002 for the diluted earnings per share computation. No common equivalent shares. 1. Description of Business and Summary of Significant Accounting Policies (continued) relating to stock options or warrants were included in the weighted average number of shares outstanding for the basic or diluted loss per share computation for fiscal year 2001 as their effect was anti-dilutive. For fiscal 2000, common equivalent shares relating to stock options aggregating 63,474 were included in the weighted average number of common shares outstanding for the diluted earnings per share computation.
Commencing January 1, 2001, the conversion price of the Company's preferred stock was $1.2333. In June 2002, 48 shares of preferred stock were converted to 38,920 shares of the Company's common stock by a preferred shareholder. As a result, 13,969 shares of common stock were included in the weighted average number of common shares outstanding for the diluted earnings per share computation for fiscal 2002. Common equivalent shares (670,559 in fiscal 2002 and 709,479 in fiscals 2001 and 2000), relating to the conversion of the remaining outstanding preferred stock, were not included in the weighted average number of common shares outstanding of the diluted earnings per share calculation, as their effect was antidilutive.
In June 2002, 15,000 warrants to purchase the Company's common stock were exchanged for 2,772 shares of common stock, effected under a cash-less exercise. As a result, 1,025 shares were included in the weighted average number of common shares outstanding for the diluted earnings per share computation for fiscal 2002.
Options and warrants aggregating 3,066,457, 3,361,233 and 2,240,600, were excluded from the computation for fiscal years 2002, 2001 and 2000, respectively, as their effect would have been antidilutive.
Cash Equivalents
The Company considers all highly liquid investments purchased with a maturity of three months or less to be cash equivalents.
Fair Value of Financial Instruments
The recorded amounts of the Company's cash and cash equivalents, accounts receivable, revolving line of credit facility, accounts payable and accrued liabilities approximate their fair values principally because of the short-term nature of these items.
Concentration of Credit Risk
The Company's operations consist of the retail sale, service and custom installation of high quality audio, video and home theater equipment in the New York Metropolitan area. The Company performs credit evaluations of its customers' financial condition and payment history but does not require collateral. Generally, accounts receivable are due within 30 days and credit losses have historically been immaterial.
1. Description of Business and Summary of Significant Accounting Policies (continued)
Advertising Expense
In accordance with SOP 93-7, "Reporting of Advertising Costs," the Company's advertising expense, net of cooperative advertising allowances, is charged to operations when the advertising takes place. Advertising expense for the years ended October 26, 2002, October 27, 2001 and October 28, 2000 was approximately $632,000, $1,206,000 and $934,000, respectively. Prepaid advertising for print advertisements not run and broadcast advertisements not aired at October 26, 2002 and October 27, 2001 was approximately $29,000 and $53,000, respectively.
Reorganization Value and Fresh Start Reporting
The Company adopted Fresh Start Reporting in accordance with SOP 90-7, "Financial Reporting by Entities in Reorganization under the Bankruptcy Code," when it emerged from a Chapter 11 proceeding on December 26, 1996. At that time, Fresh Start Reporting resulted in changes to the balance sheet, including valuation of assets and liabilities at fair market value, elimination of the accumulated deficit and valuation of equity based on the reorganization value of the ongoing business.
The reorganization value of the Company was determined based on the consideration received from Harvey Acquisition Company LLC. (HAC) to obtain its principal ownership in the Company. A carrying value of $318,000 was assigned to the Preferred Stock (see Note 5). Subsequent to the Reorganization Date, the Company issued an additional 51,565 shares of Common Stock to InterEquity Capital Partners, L.P., a pre-reorganization subordinated secured debtholder, as authorized by the Court, for an approved finders fee. The excess of the reorganization value over the fair value of net assets and liabilities ($986,440 and $1,164,440, net of amortization at October 26, 2002 and October 27, 2001, respectively) is reported as "Reorganization value in excess of amounts allocable to identifiable assets" and was amortized over a 25-year period, prior to the adoption of SFAS No. 142 (see below). Amortization expense of $54,000, $60,000 and $66,000 was recorded for fiscal years 2002, 2001 and 2000, respectively.
Reclassification
Certain items in the fiscal 2001 and 2000 financial statements have been reclassified to conform to fiscal 2002 presentation.
Recent Accounting Pronouncements
1. Description of Business and Summary of Significant Accounting Policies (continued)
In June 2001, the Financial Accounting Standards Board issued SFAS No. 141, "Business Combinations," and SFAS No. 142, "Goodwill and Other Intangible Assets", effective for fiscal years beginning after December 15, 2001. Under the new rules, goodwill and other intangible assets deemed to have indefinite lives will no longer be amortized but will be subject to annual impairment tests in accordance with the Statement. Other intangible assets will continue to be amortized over their useful lives. In addition, Statement 141, eliminates the pooling-of-interest method of accounting for business combinations. The Company will adopt SFAS No. 141 and 142 beginning in the first quarter of fiscal 2003. During fiscal 2003, the Company will perform the first of the required impairment tests of goodwill and indefinite lived intangible assets as of October 27, 2002. Management does not expect that there will be a material effect on the Company's financial position and results of operations due to this pronouncement. The total net amount of goodwill, including reorganization value in excess of amounts allocable to identifiable assets at October 26, 2002 was $1,111,440. Amortization expense of net goodwill was $60,000 for the year ended October 26, 2002.
In June 2001, the FASB issued SFAS No. 143 "Accounting for Asset Retirement Obligations. "SFAS No. 143 required the fair value of a liability for an asset retirement obligation to be recognized in the period that it is incurred if a reasonable estimate of fair value can be made. The associated asset retirement costs are capitalized as part of the carrying amount of the long-lived asset. SFAS No. 143 is effective for fiscal years beginning after June 15, 2002. The adoption of SFAS No. 143 by the Company is not expected to have a material impact on the Company's financial position, results of operations or cash flows.
In August 2001, the Financial Accounting Standards Board issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," which addresses financial accounting and reporting for the impairment or disposal of long-lived assets and supersedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of," and the accounting and reporting provisions of APB Opinion No 30, "Reporting the Results of Operations," for a disposal of a segment of a business. SFAS No. 144 is effective for fiscal years beginning after December 15, 2001, with earlier application encouraged. The Company expects to adopt SFAS No. 144 as of October 27, 2002, the first day of fiscal 2003, and management does not expect, the adoption of SFAS No. 144 to have a material effect on the Company's financial position and results of operations.
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13 and Technical Corrections". Among other things, this statement rescinds FASB Statement No. 4, "Reporting Gains and Losses from Extinguishment of Debt" which requires all gains and losses from extinguishment of debt to be aggregated and, if material, classified as an extraordinary item, net of related income tax effect. As a result, the criteria in APB Opinion No. 30, "Reporting the Results of Operations - Reporting the Effects of
Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions, " will now be used to classify those gains and losses. The adoption of SFAS No. 145 by the Company is not expected to have a material impact on the Company's financial position or results of operations.
In July 2002, the FASB issued SFAS No. 146 "Accounting for Costs Associates with Exit or Disposal Activities". SFAS No. 146 provides new guidance on the recognition of costs associated with exit or disposal activities. The standard requires companies to recognize costs associated with exit or disposal activities when they are incurred rather than at the date of commitment to an exit or disposal plan. SFAS No. 146 supercedes previous accounting guidance provided by EITF Issue No. 94-3 "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring). "EITF Issue No. 94-3 required recognition of costs at the date of commitment to an exit or disposal plan. SFAS No. 146 is to be applied prospectively to exit or disposal activities initiated after December 31, 2002. The impact of the adoption of SFAS No. 146 is not expected to have a material impact on the Company's financial position and results of operations.
In December 2002,. The Financial Accounting Standards Board (the "FASB") issued Statement of Financial Accounting Standards Board ("SFAS") No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure - an amendment of FASB Statement No. 123 ." SFAS No. 148 amends SFAS No. 123, "Accounting for Stock-Based Compensation," to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect on the method used on reported results. The disclosure requirements apply to all companies for fiscal years ending after December 15, 2002. Due to the recent release of this pronouncement, management has not yet determined the impact it will have on the Company's financial statements.
2. Amendments and Extension of Revolving Line of Credit Facility
In fiscal 1998, the Company entered into a three-year revolving line of credit facility with Paragon Capital L.L.C., currently Wells Fargo Retail Finance ("Wells Fargo"), whereby the Company could borrow up to $3,300,000 based upon a lending formula (as defined) calculated on eligible inventory.
In fiscal 2000, the Company entered into a Second Amendment to its revolving line of credit facility ("Amended Agreement") with Wells Fargo. The Amended Agreement includes a three-year extension enabling the Company to borrow up to $3,500,000 based upon a lending formula calculated on eligible inventory, as defined. The interest rate on borrowings up to $2.5 million was
2. Amendments and Extension of Revolving Line of Credit Facility (continued)
reduced to three quarters of 1% (.75%) over the prime rate. The rate charged on outstanding balances over $2.5 million was also reduced to 1% above the prime rate. Additionally, the Amended Agreement provides for an annual facility fee of $17,500 and reduced maintenance fees of $1,500 per month.
In fiscal 2001, the Company entered into the Third Amendment to its revolving line of credit facility ("Third Amended Agreement"). The Third Amended Agreement increased the amount available under the credit facility to $7.0 million, again based on a lending formula calculated on eligible inventory, as defined, and extended the credit facility through November 30, 2003. The new interest rate on all borrowings was fixed at one percent (1%) over the prime rate (6.5% at October 26, 2002) with a minimum interest rate of 8%. However, effective January 1, 2002, the minimum interest rate was reduced to 6.5% and will be in effect throughout fiscal 2003. Prepayment fees also exist under the Third Amended Agreement. A commitment fee of $75,000 (being amortized over the three years) was also paid by the Company in fiscal 2001. The balance outstanding under the revolving line of credit facility at October 26, 2002 and October 27, 2001 was $3,119,000 and $3,442,000, respectively and is presented as a current liability in accordance with EITF 95-22, "Balance Sheet Classification of Borrowings Outstanding under Revolving Credit Agreements that include both a Subjective Acceleration clause and a Lock-Box Arrangement", since the Company's daily receipts are used to reduce the outstanding balance under the revolving credit facility.
Wells Fargo has a senior security interest in all of the Company's assets. The amended line of credit facility provides Wells Fargo with rights of acceleration upon the occurrence of certain customary events of default including, among others, the event of bankruptcy. The Company is restricted from paying dividends on common stock, retiring or repurchasing its common stock and entering into additional indebtedness (as defined). The line of credit facility also contains certain financial covenants. No covenant defaults existed at October 26, 2002.
In connection with the Third Amended Agreement, Wells Fargo received an additional warrant to purchase 100,000 shares of the Company's common stock, subject to adjustment, which is currently exercisable at a price of $2.00 per share and expires November 30, 2003. Wells Fargo also received an extension of an existing warrant to purchase 125,000 shares of common stock, subject to adjustment, which is currently exercisable at a price of $5.50 per share and also expires November 30, 2003. In accordance with EITF 96-18, "Accounting for Equity Instruments that are Issued to Other than Employees for Acquiring, or in Conjunction with Selling, Goods or Services," the Company recorded the fair value of the warrants $75,000) in fiscal 2001 (net book value of $27,000 and $52,000 included in Other Assets in the accompanying balance sheets as of October 26, 2002 and October 27, 2001, respectively), which is being amortized over a three-year period.
3. Sale of Common Stock and Warrants in Public Offering
In April 1998, the Company completed an issuance of its common stock and common stock warrants in a public offering (the "Offering"). The Offering was co-managed by The Thornwater Company, L.P. (the "Underwriter") which sold 1,200,000 shares of the Company's common stock, of which 1,025,000 shares were sold by the Company and 175,000 shares were sold by HAC, and 2,104,500 of Warrants ("Warrants") to acquire additional shares of the Company's common stock. The net proceeds from the Offering, which approximated $4.1 million, were used to temporarily repay amounts borrowed under the Wells Fargo credit facility (approximately $2.3 million) and to retire the principal ($350,000) and interest ($48,000) of a term loan, with the balance of the proceeds used to open three new retail stores and for general working capital purposes.
Each Warrant is exercisable for one share of common stock at 110% ($5.50 per share) of the Offering price for a period of three-years expiring on March 31, 2003. The Warrants also are redeemable (at $.10 per warrant) at the Company's option, through March 31, 2003 if the closing bid price of the common stock for 20 consecutive trading days exceeds 150% of the Offering price per share or $7.50 per share.
4. Stock-Based Compensation
Stock Option Plan
The Company's Board of Directors and shareholders approved the Harvey Electronics, Inc. Stock Option Plan ("Stock Option Plan") in fiscal 1998. The Stock Option Plan provides for the granting of up to 1,000,000 shares of incentive and non-qualified common stock options and stock appreciation rights to directors, officers and employees. All options are exercisable at times as determined by the Board of Directors not to exceed ten years from the date of grant.
Common equivalent shares relating to stock options aggregating 88,476 were included in the weighted average number of common shares outstanding for the diluted earnings per share computation.
In fiscal 2002, the Company's Compensation and Stock Option Committee approved two grants of incentive stock options aggregating 205,000 to the Company's officers to purchase the Company's Common Stock at exercise prices from $1.15 - $1.35 per share. The fiscal 2002 incentive stock options are exercisable immediately.
In fiscal 2001, the Company's Compensation and Stock Option Committee approved three grants of incentive stock options aggregating 262,500, to the Company's officers and outside directors, to purchase the Company's common stock at exercise prices from $.8125-$1.375 per share. The fiscal 2001 incentive stock options are exercisable immediately.
4. Stock-Based Compensation (continued)
In fiscal 2000, the Company's Compensation and Stock Option Committee of the Board of Directors ("Compensation Committee") approved three grants of incentive stock options aggregating 172,500, to the Company's officers, to purchase the Company's common stock at exercise prices from $1.75-$1.925 per share. The fiscal 2000 incentive stock options are exercisable immediately.
In fiscal years 2002, 2001 and 2000, the Company reserved 197,500, 262,500 and 172,500 shares of common stock, respectively, for issuance in connection with stock options. The following table summarizes activity in stock options during fiscal 2001 and 2000:
At October 26, 2002, October 27, 2001 and October 28, 2000, all outstanding options are exercisable. The weighted-average fair value of options granted during the fiscal years ended October 26, 2002, October 27, 2001 and October 28, 2000 was $1.11, $.76 and $1.43, respectively.
4. Stock-Based Compensation (continued)
Exercise prices for options outstanding as of October 26, 2002, are as follows:
At October 26, 2002 and October 27, 2001, the Company has reserved shares of common stock for issuance under common stock options, warrants and preferred stock of approximately 3,780,000 and 3,576,000, respectively.
The alternative fair value accounting provided for under SFAS No. 123, requires use of option valuation models that were not developed for use in valuing employee stock options. Under APB 25, because the exercise price of the Company's Stock Options equals or exceeds the market price of the underlying stock on the date of grant, no compensation expense is recognized.
The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options, which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility.
Because the Company's employee stock options have characteristics significantly different from
4. Stock-Based Compensation (continued)
those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not provide a reliable single measure of the fair value of its stock options.
Pro forma information regarding net (loss) income and net loss per share (basic and diluted) is required by SFAS No. 123, which also requires that the information be determined as if the Company had accounted for its stock options granted under the fair value of that statement.
The fair value of these options was estimated at the date of grant using the Black-Sholes option pricing model with the following assumptions for fiscal years 2002, 2001 and 2000: risk-free interest rate ranging from 4.44%-5.02%, 4.88%-5.47% and 6.20%-6.36%, respectively; no dividend yield; volatility factor of the expected market price of the Company's common stock of 1.00, 0.938 and 0.897, respectively; and a weighted-average expected life of the options of 9.39 years, 7 years and 6.57 years, respectively.
For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting period. The Company's pro forma information for fiscal year 2002, 2001 and 2000 are as follows:
5. 8.5% Cumulative Convertible Preferred Stock
The Company's Preferred Stock has no voting rights and is redeemable at the option of the Company's Board of Directors, in whole or in part, at face value plus any accrued dividends. The carrying value of the Preferred Stock is $379,982, and $402,037 at October 26, 2002 and October 27, 2001, respectively.
In the event of liquidation of the Company, the holders of the Preferred Stock shall receive preferential rights and shall be entitled to receive an aggregate liquidation preference of $827,000 plus any outstanding dividends, prior to any distributions to common shareholders. The holders of the Preferred Stock shall receive a semiannual
5. 8.5% Cumulative Convertible Preferred Stock (continued)
8.5% cumulative dividend ($85 per share or $70,295 annually), payable on the last business day in June and December. The Company had elected to defer the fiscal 1997 dividends, at a preference rate of $105 per share annually ($91,875) plus interest at 8.5% per annum over a three-year period. All installments relating to the 1997 dividends have been paid by the Company as of October 27, 2001.
Commencing on January 1, 2001, the Preferred Stock is convertible at $1.2333 or 709,479 shares of common stock (calculated from the average closing price of the Company's Common Stock for the preceding 45-day trading period). 875 shares of Preferred Stock were originally issued by the Company. In June 2002, 48 shares of Preferred Stock were converted to 38,920 shares of the Company's common stock by a preferred shareholder. At October 26, 2002 and October 27, 2001, 827 and 875 shares of Preferred Stock, respectively were issued and outstanding. The Company's remaining Preferred Stock is convertible into 670,559 shares of common stock.
Cumulative Preferred Stock dividends payable of $23,432 and $24,792 are outstanding and classified as a current liability at October 26, 2002 and October 27, 2001, respectively. Dividends aggregating $72,777, $74,376 and $74,376 were recorded as a charge to accumulated deficit in fiscal years 2002, 2001 and 2000, respectively.
6. Income Taxes
Fresh Start Accounting requires the Company to report an income tax equivalent provision when there is book taxable income and a pre-reorganization net operating loss carryforward. This requirement applies despite the fact that the Company's pre-reorganization net operating loss carryforward would eliminate (or reduce) the related income tax payable. The current and future year benefit related to the carryforward is not reflected in net income, but instead is recorded as an adjustment to reorganization value in excess of amounts allocable to identifiable assets. During the year ended October 26, 2002, the Company recorded an income tax equivalent provision of $124,000 and reduced Reorganization Value in Excess of Amounts Allowable to Identifiable Assets by the same amount. There was no provision (benefit) for income taxes during the year ended October 27, 2001. During the year ended October 28, 2000, the income tax equivalent provision and the associated adjustment to reorganization value amounted to $160,000. The income tax equivalent provisions did not affect the Company's tax liability.
6. Income Taxes (continued)
The provision for income taxes for the years ended October 26, 2002, October 27, 2001 and October 28, 2000 consists of the following:
The effective income tax rate differed from the Federal statutory rate as follows:
The Company has deferred tax assets and deferred tax liabilities as presented in the table below. The net deferred tax assets are subject to a valuation allowance, which was approximately $1,758,000, $1,886,000 and $1,483,000 at October 26, 2002, October 27, 2001 and October 28, 2000, respectively.
6. Income Taxes (continued)
Deferred tax assets and liabilities as of October 26, 2002 and October 27, 2001 prior to the allocation of the valuation allowance consisted of the following:
At October 26, 2002, the Company has available net operating loss carryforwards of approximately $3,300,000, which expire in various years through fiscal 2021. Of this amount, approximately $900,000 relates to pre-reorganization net operating loss carryforwards. Under section 382 of the IRS code, it is estimated that these pre-reorganization net operating loss carryforwards and other pre-reorganization tax attributes will be limited to approximately $150,000 per year. A full valuation allowance has been provided on the net deferred tax asset due to uncertainty regarding the future utilization of the deferred tax assets.
7. Pension and Profit Sharing Plan
The Company maintains the Harvey Electronics, Inc. Savings and Investment Plan (the "Plan") which includes profit sharing, defined contribution and 401(k) provisions and is available to all eligible employees of the Company. There were no contributions to the Plan for fiscal 2002, 2001 and 2000.
8. Commitments and Contingencies
Commitments
The Company's financial statements reflect the accounting for equipment leases as capital leases by recording the asset and the related liability for the lease obligation. Capital lease additions of approximately $47,000, $99,000 and $241,000 were recorded during fiscal 2002, 2001 and 2000, respectively. The Company leases stores and warehouse facilities under operating leases, which provide, in certain cases, for payment of additional rentals based on a percentage of sales over a fixed amount. Future minimum rental commitments, by year and in the aggregate, for equipment under capital and noncancelable operating leases with initial or remaining terms of one-year or more consisted of the following at October 26, 2002:
Total rental expense for operating leases was approximately $2,783,000, $2,535,000 and $2,123,000 for fiscal years 2002, 2001 and 2000, respectively. Certain leases provide for the payment of insurance, maintenance charges, electric and taxes and contain renewal options.
Contingencies
The Company is a party in certain legal actions, which arose in the normal course of business. The outcome of these legal actions, in the opinion of management, will not have a material effect on the Company's financial position, results of operations or liquidity.
9. Other Information
Accrued Expenses and Other Current Liabilities
Consulting Agreements
In fiscal 2001, the Company engaged Mesa Partners, Inc. ("Mesa") under a consulting agreement. Mesa was engaged to provide consulting services relating to the integration of computer networks, entertainment systems and other related services. In connection with the consulting agreement with Mesa, and a related addendum, the Company issued a warrant to purchase 15,000 shares of the Company's common stock, exercisable at any time at $3.00 per share. The warrant has a three-year term and was issued as partial compensation for services rendered by Mesa. The fair value of the warrant of approximately $8,000, was amortized to expense in fiscal 2001 as the Company elected to terminate this agreement in fiscal 2001. Additionally, as was required by the consulting agreement, Mesa was paid a fee of $20,000 a month plus related expenses. For fiscal 2001, the Company recorded consulting fees of approximately $70,000 relating to Mesa.
Effective fiscal 1999, the Company signed a consulting agreement with a previous member of its underwriter. Pursuant to the terms of the two-year agreement, the consultant received an annual fee of $75,000 in fiscal 1999. This agreement was terminated by the Company in fiscal 2000. In the latter part of fiscal 2000, the consultant was again engaged by the Company, pursuant to a consulting agreement, at $5,000 per month. In fiscal 2001, the agreement was terminated by the Company. The consultant received fees aggregating $5,000 and $40,000 in fiscal years 2001 and 2000, respectively.
Investor Relations Advisor
On fiscal 2001, the Company engaged Porter, LeVay & Rose ("PL&R") as its investor relations advisor. In connection with the agreement, the Company is required to and will issue a warrant to purchase 60,000 shares of the Company's common stock, exercisable immediately at various exercise prices ranging from $1.25-$2.50. The warrant's fair value of approximately $15,000 was amortized to expense ($5,000 in fiscal 2002 and $10,000 in fiscal 2001). In June 2002, 15,000 warrants to purchase the Company's common stock were exchanged for 2,772 shares of common
9. Other Information (continued)
stock, effected under a cash-less exercise, by PL&R. Additionally, the Company paid PL&R a $5,000 monthly fee for its services. For the year ended October 27, 2001, the Company recorded an investor relations expense of $54,000, relating to PL&R.
Union Contract
The Company is party to a collective bargaining agreement with a union which covers certain sales, warehouse and installation employees. This agreement expires on August 1, 2003.
Fourth Quarter Adjustments
The fourth quarter of fiscal 2002 and 2000 included incentive bonuses of approximately $73,000 and $125,000, respectively. No significant fourth quarter bonuses were recorded in fiscal 2001.
The fourth quarter of fiscal 2000 included pre-operating expenses of $125,000 relating to the opening of the Company's Bang & Olufsen store in Greenwich, CT and the October 2000 launch of the Company's new website. In the fourth quarter of fiscal 2000, the Company also recorded occupancy expense of $90,000 relating to additional rent, which was contingent upon actual sales levels achieved for one of the Company's retail stores.
Other
A Director of the Company also is a Senior Partner in a law firm providing the Company with legal services. At October 26, 2002 and October 27, 2001, the Company had $26,000 and $25,000, respectively, payable to this law firm. The Company paid legal fees to this law firm of approximately $81,000, $64,000 and $127,000 in fiscal years 2002, 2001 and 2000, respectively.
During fiscal year 2001, $23,000 was paid to a company affiliated with the Company's Chairman of the Board of Directors relating primarily to management fees from fiscal 1998. Additionally, the Chairman of the Board of Directors was also a principal in a Company, which was a joint venture with a law firm providing legal services to the Company.
At October 27, 2001, the Company recorded a note payable to a real estate broker of approximately $22,000 classified as a current liability.
10. Retail Store Expansion
During fiscal year 2000, the Company entered into a ten-year lease for a new 6,500 square foot Harvey showroom in Eatontown, New Jersey. This new store opened in April 2001. Since this time, results of operations from this new store have been included in the Company's results of operations. Pre-opening expenses have been included in the Company's results of operations for the year ended October 27, 2001. This is the Company's ninth store and is the fifth opened since its public offering, completed in April 1998.
11. Quarterly Financial Data (Unaudited)
Schedule II - Valuation and Qualifying Accounts
Harvey Electronics, Inc.
Report of Independent Certified Public Accountants
The Board of Directors and Shareholders Harvey Electronics, Inc.
The audit referred to in our report dated December 20, 2002 relating to the financial statements of Harvey Electronics, Inc. included the audit of the financial statement Schedule II - Valuation and Qualifying Accounts for the year ended October 26, 2002. The financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion on this financial statement schedule based on our audit.
In our opinion, such financial statement schedule presents fairly, in all material respects, the information set forth therein.
BDO Seidman, LLP Melville, New York December 20, 2002