ITEM 1. BUSINESS
General
Harold's Stores, Inc. and its wholly-owned subsidiaries (collectively "Harold's" or the "Company"), through a chain of ladies' and men's specialty apparel stores in 19 states, offers high-quality, classically inspired apparel to the upscale, quality-conscious consumer primarily in the 30 to 50 year old age group. The stores typically are strategically located in shopping centers and malls with other upscale specialty retailers and are enhanced by specially designed fixtures and visual props, to create an appealing stage for presentation of the Company's distinctive ladies' and men's apparel and accessories. The Company also operates a direct business consisting of catalog and internet. The internet channel began September 2004. During 2004, this represented approximately 1% of the Company's total sales. More than 95% of sales consists of the Company's proprietary designs controlled by Harold's own designers and merchants and sourced by Harold's manufacturing staff from domestic, European and Asian manufacturers. The remainder consists of merchandise selected to complement Harold's merchandise presentation. See "Business - Product Development and Sourcing Programs."
As of January 29, 2005, the Company's 41 stores were comprised of 39 full-price retail stores and two outlet stores to clear markdowns and slow-moving merchandise. Store occupancy costs include base and percentage rent, common area maintenance expense, utilities and depreciation of leasehold improvements.
The Company operates on a 52-53 week year, which ends on the Saturday closest to January 31. References herein to 2005, 2004, 2003 and 2002 refer to the years ended January 28, 2006, January 29, 2005, January 31, 2004 and February 1, 2003, respectively. Each of the years mentioned comprised 52-week years.
Developments in 2004
On February 9, 2004, the Company announced the hiring of a new President and Chief Executive Officer. Hugh W. Mullins, former Chairman and Chief Executive Officer of Neiman Marcus Stores, joined the Company and Clark J. Hinkley announced his retirement as Chief Executive Officer of the Company. An employment agreement was entered into with Mr. Mullins, whereby he receives an annual base salary of $600,000 and received 300,000 shares of common stock options. He also became a member of the Board of Directors of the Company. At the same time, an amendment was made to Mr. Hinkley's employment contract. Mr. Hinkley's base salary remained at the annual rate of $450,000 through June 2004, at which time it was reduced to $250,000 per annum through January 31, 2005. Mr. Hinkley will remain on the Board of Directors of the Company through June 2006.
In order to achieve additional liquidity, on April 29, 2004, the Company announced the completion of an amendment to its existing credit facility with Wells Fargo Retail Finance II, LLC ("WFRF") which increased the Company's borrowing availability under the facility. The amendment increased the Company's maximum inventory advance rate cap from 75% to 80% during non- peak times and from 80% to 85% during peak times. Peak times were amended to include the eight weeks prior to Easter and the eight weeks prior to October 1. The increase in advance rates is expected to increase the availability under the facility by as much as $3 million depending on the level of inventories. Additionally, the amendment extended the term of the credit facility by one year, with a new expiration of February 5, 2007. The amendment also increased the maximum revolver amount from $22 million to the lesser of $25 million or $22 million plus outstanding participant advances. Finally, the amendment provided for an increase of $2 million in the Company's borrowing availability under the facility based upon an increase in the existing loan participation agreement between WFRF and RonHow, LLC, an entity established in July 2003 which is owned and controlled directly or indirectly by Ronald de Waal and W. Howard Lester. Mr. de Waal and Mr. Lester are both major beneficial owners of the Company common stock, and Mr. Lester is also a director of the Company. WFRF has continued to serve as the lending agent for the Company under the credit facility, and the principal covenants and conditions imposed upon the Company pursuant to the WRFR credit facility agreement have not materially changed. RonHow, LLC's right to repayment of any advances under the credit facility that are attributable to its participation is generally subordinate to the repayment rights of the other credit facility lenders. However, the Company may repay these advances provided it meets certain conditions, including the maintenance of an average daily excess availability under the credit facility of at least $2.5 million for the 30 days prior to and 30 days projected immediately following the repayment. The average excess availability requirement is higher than the excess availability otherwise required of the Company under the credit facility. If the Company does not repay the new $2 million loan participation of RonHow during the 18 months subsequent to April 29, 2004, RonHow will have an option at that time to convert any of the incremental $2 million not repaid into shares of authorized but unissued 2003-A Preferred Stock which will be convertible into shares of common stock at a price of $2.524 per share, which was the 20-day average closing price of the Company's common stock for the period ending immediately before closing of the loan amendment. Additionally, if the Company has not repaid the initial $2 million of loan participation by February 2006, the Company will pay an additional 4% fee per annum on the outstanding participation amount up to $2 million. This transaction was approved by the independent directors.
Beginning in April 2004, the Company significantly reduced its dependence on promotional activities as part of its strategic objectives. This resulted in an increase in the rate of full price selling from 41% in 2003 to 53% in 2004. Despite this decrease in promotional activities, there was an increase in comparable store sales of 1.9% for 2004, compared to an increase of 11.3% for 2003. The Company believes the increases experienced in comparable store sales during 2004 were primarily attributable to customer acceptance of the Company's merchandise offerings. The Company's average sales per square foot for retail stores excluding outlets open during the entire year were $389 and $380 for 2004 and 2003, respectively.
The Company believes its future success will be achieved by increasing sales momentum in its full-line stores by attracting new customers through its direct marketing efforts and by improving sales from existing customers due to increased emphasis on fashion basics to complement the novelty offerings in ladies' apparel for which the Company is well known. During 2004, the Company did not open any new stores in order to focus on reinvigorating the Harold's brand. Conversely, the Company was able to close one unprofitable location. The Company currently plans to resume a modest store expansion program in 2006. The Company's expansion program will continue to focus primarily on markets currently served by the Company and in new markets that represent a geographical progression from existing markets. The Company currently does not plan to open any new stores during 2005 but does plan to relocate a store in Charlotte, NC. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity" for further information.
Retail Merchandising
The Company's merchandise mix in ladies' apparel includes coordinated sportswear, dresses, outerwear, shoes and accessories, in updated classic styles. A fundamental feature of the Company's marketing strategy is the development of original exclusive apparel items. The Company estimates that more than 95% of its ladies' apparel sales are attributable to the Company's product development and proprietary label programs. In 2004 and 2003, ladies' apparel accounted for approximately 81% and 78% of sales, respectively.
The men's apparel product line includes tailored clothing, furnishings, sportswear, outerwear and shoes in updated classic styles. In 2004, the Company's proprietary label apparel accounted for more than 95% of total men's sales. The majority of the men's proprietary label sales are in the Company's Old School Company and Harold Powell Clothing lines. In 2004 and 2003, men's apparel accounted for approximately 19% and 22% of sales, respectively.
The following table sets forth the approximate percentage of sales attributable to the various merchandise categories offered by the Company in the past three years:
2004 2003 2002 (Dollar amounts in thousands)
Ladies' Merchandise Apparel and $65, 73.8% 65,9 71.9% 62,71 69.8% Accessories 954 18 2 Handbags and 1,72 1.9 1,39 1.5 1,954 2.2 Belts 1 2 Shoes 4,60 5.2 4,62 5.1 3,711 4.1 9 9
Men's Merchandise Suits, Sportcoats, Slacks and 7,84 8.8 9,31 10.2 9,773 10.9 Furnishings 5 7 Sportswear and 8,29 9.3 9,47 10.3 10,72 12.0 Accessories 2 9 5 Shoes 906 1.0 948 1.0 871 1.0
Other 30 0.0 - 0.0 35 0.0
Total: $89,3 100.0% 91,68 100.0% 89,781 100.0% 57 3
Company Stores
The Company's stores range in size from 3,000 to 13,402 square feet, with the typical store ranging from 4,000 to 6,000 square feet. The Company's stores generally are open seven days per week and evenings. The following table lists Harold's store locations as of January 29, 2005, with selected information for each location.
Metropolitan Square Area Location Type of Location Footag e Atlanta, GA Lenox Square Regional 6,861 Shopping Center Atlanta, GA Perimeter Center Regional 5,250 Shopping Center Austin, TX Arboretum Market Specialty Center 4,787 Place Austin, TX(1) 8611 N. Mopac Free Standing 13,20 Expressway 0 Baton Rouge, Citiplace Market Specialty Center 5,200 LA Center Birmingham, The Summit Specialty Center 5,500 AL Shopping Center Charlotte, NC Shops on the Park Specialty Center 4,000 Dallas, TX Dallas Galleria Regional 8,079 Shopping Center Dallas, TX Highland Park Specialty Center 7,503 Village Ft. Worth, TX University Park Specialty Center 6,000 Village Greenville, Greenville Mall Regional 5,076 SC Shopping Center Houston, TX Highland Village Specialty Center 6,189 Houston, TX Town and Country Specialty Center 5,883 Village Houston, TX Champions Forest Specialty Center 5,500 Plaza Indianapolis, Keystone Fashion Regional 3,829 IN Mall Shopping Center Jackson, MS The Rogue Compound Free Standing 3,000 Kansas City, Country Club Plaza Specialty Center 4,155 MO Leawood, KS Town Center Plaza Specialty Center 5,000 (Kansas City metro) Littleton, CO Park Meadows Mall Regional 5,465 (Denver Shopping Center metro) Louisville, Mall St. Matthews Regional 4,292 KY Shopping Center Lubbock, TX 8201 Quaker Avenue Specialty Center 3,897 Marietta, GA The Avenue East Specialty Center 5,020 (Atlanta Cobb metro) McLean, VA Tyson's Galleria Regional 5,083 Shopping Center Memphis, TN Poplar Avenue Specialty Center 5,085 Nashville, TN The Mall at Regional 4,814 Greenhills Shopping Center Norman, OK Campus Corner Specialty Center 8,402 Center Norman, OK(1) 575 S. University Free Standing 12,38 Blvd. 2 Oakbrook, IL Oakbrook Center Regional 4,860 (Chicago Shopping Center Metro) Oklahoma 50 Penn Place Specialty Center 13,40 City, OK 2 Omaha, NE One Pacific Place Specialty Center 4,397 Palo Alto, CA Stanford Shopping Regional 4,275 (San Center Shopping Center Francisco Metro) Plano, TX Park and Preston Free Standing 5,525 (Dallas metro) Raleigh, NC Crabtree Valley Regional 5,205 Mall Shopping Center Richmond, VA River Road Specialty Center 5,000 Shopping Center Salt Lake Trolley Square Specialty Center 5,716 City, UT Center San Antonio, Alamo Quarry Specialty Center 5,500 TX Market Southlake, TX Southlake Town Specialty Center 5,462 (Dallas Square metro) St. Louis, MO Plaza Frontenac Specialty Center 4,216 Tulsa, OK Farm Shopping Specialty Center 3,888 Center Tulsa, OK Utica Square Specialty Center 7,686 Wichita, KS The Bradley Fair Specialty Center 5,500 Center
(1) Outlet store
The employee population of a typical full-line Harold's store consists of a store manager, two assistant managers (ladies' and men's), one or two desk associates, and five to seven sales associates, most of whom work on a flex-time basis (20-25 hours per week). The majority of sales associates are generally paid a commission against a draw. Commissions range from 1% to 11% based on the type of product sold and the tenure and productivity of the associate. Store managers are paid a salary plus a performance bonus based on attainment of sales goals, expense control, inventory shrinkage and random store shop scores.
Product Development and Sourcing Programs
The Company's product development and sourcing programs enable it to offer exclusive items not available in competing stores or catalogs. More than 95% of sales are merchandise where the Company has created or controlled the design, demonstrating the Company's commitment to a unique product mix. The Company believes that this unique product mix enables it to compete with, and differentiates it from, larger apparel chains by offering customers an exclusive garment at a price below designers and similar open market merchandise. Direct creation and control of merchandise also enables the Company to offer superior quality and fit as well as improve its initial mark up. The fit and quality of a garment are crucial to the Company's success. The Company believes it has improved these areas which has translated into improved sales. The Company's private label merchandise consists of items developed by the Company and manufactured exclusively for the Company.
An important component of the Company's product development programs is market research of styles and fabrics. The Company's design team shops European and domestic markets for emerging fashion trends and for fabric, artwork and samples for new garment designs. The product development staff adapts and develops fabric designs and garment models. These design models assist the Company in sourcing and in negotiations with mills and vendors. The Company's product development programs allow it to participate directly in the design and manufacturing of an exclusive product without investing in costly manufacturing equipment. The Company's development program is implemented through its offices in New York and Dallas, Texas and its association with independent agents in Hong Kong; Florence, Italy; Istanbul, Turkey; and Porto, Portugal. The Company imports a significant portion of its merchandise directly from the Far East and Italy.
The Company's merchandisers review the developed styles, analyze fashion trends and historical data and select the best pieces to convert into prints and patterns for the next season. Once the new styles are selected, the team then determines the specifications of various styles - detailing a garment's cut, fit, fabric, color and trim. After the specifications have been finalized, the fabric is ordered from domestic and international fabric mills. The finished fabric is then shipped to manufacturers who cut, sew and trim the completed design. Additionally, a growing percentage of merchandise is purchased as finished goods.
The Company's line of leather goods, which are sold in all store locations, is made and sourced through various third parties in Italy and Asia. Additionally, a growing portion of the assortments in selected accessory areas are represented by branded merchandise. Shoes, belts, handbags and small leather goods are often co-designed by the Company's merchandisers and manufacturing partners.
Merchandise Inventory, Replenishment and Distribution
The specialty retail apparel business fluctuates according to changes in customer preferences dictated by fashion and season. These fluctuations affect the inventory owned by apparel retailers, since merchandise usually must be ordered well in advance of the season and sometimes before fashion trends are evidenced by customer purchases. The Company's policy of carrying basic merchandise items in full assortments of sizes and colors requires it to carry a significant amount of inventory. The Company must enter into contracts for the purchase and manufacture of proprietary label apparel well in advance of its selling seasons.
The Company continually reviews its inventory levels in order to identify slow-moving merchandise and broken assortments (items no longer in stock in a sufficient range of styles, colors and sizes) and may use markdowns to clear this merchandise. Markdowns also may be used if inventory exceeds customer demand for reasons of style, seasonal adaptation, changes in customer preference, or if it is determined that the inventory in stock will not sell at its currently marked price. Such markdowns have an adverse impact on earnings. Such impact is dependent upon the extent of the markdowns and the amount of inventory affected. The Company utilizes its outlet stores to dispose of prior season or slow moving merchandise. In addition, in lieu of utilizing outside liquidation resources ("jobbers"), slow moving merchandise is generally cleared periodically through regional off-site discount sales which are promoted under the name "Harold's Warehouse Sale".
The Company operates an 85,000 square foot distribution facility in Norman, Oklahoma capable of processing merchandise for 74 stores. With a modest additional investment, the facility will have the capability of processing merchandise for 138 stores. All of the Company's merchandise is routed through the distribution center from various manufacturers. The majority of merchandise arrives at the distribution center with bar coded tickets placed on the garment by the vendor allowing merchandise to be processed more efficiently. Each item is examined, sorted and boxed for shipment by common carrier to the Company's stores. This process is done in a time sensitive manner in a substantially paperless environment, utilizing computers, bar codes and scanners. Seasonality
The Company's business has historically followed a seasonal pattern, peaking three times per year during early spring (March through April), the early fall (September through October) and holiday (Thanksgiving through Christmas) periods. During 2004, approximately 51% of the Company's sales occurred during the third and fourth quarters. The majority of the Company's cumulative net loss applicable to common stockholders, however, was incurred during the first and second quarters.
Competition
The Company's business is highly competitive. The Company's stores compete with national and local department stores, specialty and discount store chains, catalogers and e-commerce, and independent retail stores which offer similar lines of specialty apparel. Many of these competitors have significantly larger sales volumes and assets than the Company.
Important factors in competing successfully in the retail industry include the following: depth of selection in sizes and colors and styles of merchandise, merchandise procurement and pricing, ability to anticipate fashion trends and customer preferences, inventory control, reputation, quality of private- label merchandise, store design and location, marketing and customer service. Given the large number of companies in the retail industry, the Company cannot estimate the number of its competitors or its relative competitive position.
In addition, the success of the Company's operations depends upon a number of factors relating to economic conditions and general consumer spending. If current economic conditions worsen and consumer spending is restricted, the Company's growth and profitability could be negatively impacted.
Customer Credit
The Company's stores accept the proprietary "Harold's" credit card, and Visa, MasterCard, Discover and the American Express credit cards. Credit card sales as a percent of total sales were 84% in 2004, 84% in 2003 and 73% in 2002. In 2004, 32% of total sales were made with the Harold's credit card and 52% were made with third-party credit cards. The Company maintains a credit department for customer service, credit authorizations, credit investigation, billing and collections. As of January 29, 2005, the provision for bad debts from Company credit card sales was approximately 0.6% of Harold's proprietary credit card sales for 2004. The Company's bad debt experience from the Harold's proprietary credit card has been relatively stable from year to year.
Harold's has offered customers its proprietary credit card since 1974. The Company believes that providing its own credit card enhances customer loyalty while providing customers with additional credit at costs to the Company significantly lower than those charged by outside credit card companies (i.e. Visa, MasterCard, Discover and American Express). At January 29, 2005, the Company had approximately 22,885 active credit accounts and the average cardholder had a credit limit of $1,600 and an outstanding balance of $316. Charges by holders of the Company's credit card during 2004 totaled approximately $35,457,000. Finance charge revenue is netted against selling, general and administrative expenses and was approximately $1,142,000, $1,140,000, and $1,152,000, in 2004, 2003, and 2002, respectively.
Advertising
The Company maintains an in-house marketing department, which produces and designs in-house the Company's direct mail pieces and e-commerce website. In 2004, the Company spent approximately $4,313,000 (4.8% of sales) on advertising and direct mail production costs as compared to approximately $4,190,000 (4.6% of sales) in 2003. These expenditures include the production and mailing costs associated with the Company's catalog. The marketing department is also involved in the production of annual reports to the Company's stockholders, sales training materials, internal marketing materials, and all corporate logos and labeling.
Management Information Systems
The Company's management information systems are located at an Administrative Office in Norman, Oklahoma and at its Corporate Office in Dallas, Texas. These systems consist of a full range of retail, financial and merchandising systems, including credit, inventory distribution and control, sales reporting, accounts payable, budgeting and forecasting, financial reporting, merchandise reporting and distribution. The Company uses an integrated point-of-sale ("POS") inventory and management system to control merchandising and sales activities. This system automatically polls each location every 24 hours and provides a detailed report by merchandise category the next morning. Management evaluates this information daily and implements merchandising controls and strategies as needed. The POS system provides personnel scheduling and time keeping capabilities, as well as, a customer profile function to better identify and track consumer demographics.
The Company utilizes software from JDA, a computerized merchandise planning and allocation system, which interacts with the Company's AS400 and Island Pacific Systems software. JDA facilitates seasonal planning and allocation by department and store, and provides certain data for financial planning.
In 2003, the Company completed the implementation of CommercialWare's order management system and in 2004 the Company replaced its in-house developed warehouse management system with Manhattan Associates warehouse management system. These two initiatives were undertaken to facilitate a return to Direct channel business, including internet sales, and to make necessary improvements to the Company's distribution center operations. In addition to being able to take orders online and at the Company's call center, sales associates can conduct customer searches for merchandise no longer available in their store using an in-house developed system available at each cash register.
Information Available on our Website
Our corporate internet address is www.harolds.com. Our website provides a hyperlink to a third party website through which our annual, quarterly and current reports, amendments to those reports, as well as other documents we file electronically with the Securities and Exchange Commission ("SEC") are available free of charge. We believe these reports are made available as soon as reasonably practicable after we electronically file them with, or furnish them to, the SEC. We do not provide any information directly to the third-party website, and we do not check its accuracy. Copies of these reports can also be obtained from the SEC's website at www.sec.gov.
Trademarks, Service Marks, and Copyrights
"Harold's", "Harold Powell", "Old School", "Old School Clothing Company", "OSCC Bespoke" and other trademarks either have been registered, or have trademark applications pending, with the United States Patent and Trademark Office and with the registries of various foreign countries. The Company files U.S. copyright registration on the original design and artwork purchased or developed by the Company.
The Company's three Houston stores bear the name "Harold Powell" rather than "Harold's" to avoid confusion with an existing local men's apparel store which operates in Houston under the name "Harold's" with prior usage in this market predating the Company's federal registration.
Employees
On March 15, 2005, the Company had approximately 341 full-time and 347 part-time employees. Additionally, the Company hires temporary employees during the peak late summer and holiday seasons. None of the Company's employees belong to any labor union and the Company believes it has good relations with its employees.
Certain Additional Business Risk Factors
We must improve our financial performance and become consistently profitable.
For six years through 2003, the Company reported operating losses and deficit cash flows from operating activities. During this period, we experienced restructuring resulting in store closings and reductions of personnel. In 2004 we employed a new Chief Executive Officer and we experienced significantly improved financial results reporting a $95,000 operating profit (before preferred dividends) but continued to report a net loss applicable to common shares of $1.4 million. In addition, we have limited cash flow from operating activities to finance expansion or additional investment. Our future success depends upon our ability to improve our financial performance and become consistently profitable. While we believe our strategic initiatives that are in place will result in ongoing improvements in financial performance, there can be no assurance that we will achieve sustained profitability and cash flow.
Our performance may depend on our ability to respond to changes in customer demands and fashion trends in a timely manner.
We have historically experienced fluctuations in customer response to our merchandise assortments. Our future performance depends on our ability to consistently anticipate, assess and react to the changing demands of our customer base. If we fail to anticipate fashion trends, select the right merchandise assortment, maintain appropriate inventory levels and creatively present merchandise in a way that is appealing to our customer base on a consistent basis, our sales could decline significantly, and we could then be required to mark down certain merchandise to significantly lower prices to sell excess inventory, which would result in lower gross margins. As a private label merchandiser, we assume certain risks, including long product lead times and high initial purchase commitments, that amplify the consequences of any miscalculation that we might make in anticipating fashion trends or interpreting them for our customers. We can provide no assurance that we will be able to identify and offer merchandise that appeals to our customer-base or that the introduction of new merchandise categories will be successful or profitable.
Our ability to anticipate and effectively respond to changing fashion trends depends in part on our ability to attract and retain key personnel in our design, merchandising, marketing and other functions. Competition for this personnel is intense, and we cannot be sure that we will be able to attract and retain a sufficient number of qualified personnel in future periods. Also see the section entitled "Employees" above in this Item 1.
Our future success will depend upon brand awareness and the effectiveness of our marketing programs.
Our future success will depend upon our ability to effectively define, evolve and promote our brand. In order to achieve and maintain significant brand name recognition, we will need to increase investments in the development of the brand through various means, including customer research, advertising and promotional events, direct mail marketing and internet marketing. We can provide no assurance that the marketing strategies we implement and the investments we make will be successful in building significant brand awareness or attracting new customers.
Our business is highly competitive and depends on consumer spending patterns.
The specialty retail industry is highly competitive. We compete with national and local department stores, specialty and discount store chains, independent retail stores and internet businesses that market similar lines of merchandise. We face a variety of competitive challenges including:
- anticipating and quickly responding to changing consumer demands; - maintaining favorable brand recognition and effectively marketing our products to consumers in several diverse market segments; - developing innovative, high-quality products in sizes, colors and styles that appeal to consumers of varying age groups and tastes; - sourcing merchandise efficiently; - competitively pricing our products and achieving customer perception of value; and - providing strong and effective marketing support.
Our business is sensitive to a number of factors that influence the levels of consumer spending, including political and economic conditions such as recessionary environments, the levels of disposable consumer income, consumer debt, interest rates and consumer confidence. Declines in consumer spending on apparel and accessories could have an adverse effect on our operating results.
We experience fluctuations in our comparable store sales and margins.
Our continued success depends, in part, upon our ability to continue to further improve sales, as well as both gross margins and operating margins. Our comparable store sales have fluctuated significantly in the past on an annual, quarterly and monthly basis, and we expect that they will continue to fluctuate in the future. A variety of factors affect comparable store sales, including fashion trends, competition, current economic conditions, the timing of release of new merchandise and promotional events, changes in our merchandise mix, the success of marketing programs and weather conditions. These factors may cause our comparable store sales results to differ materially from prior periods and from expectations.
Our ability to deliver healthy comparable store sales results and margins depends in large part on accurately forecasting demand and fashion trends, selecting effective marketing techniques, providing an appropriate mix of merchandise for our customer base, managing inventory effectively and using more effective pricing strategies
Our success is dependent on the performance of our vendors and service providers.
Our business depends on the performance of third parties, including manufacturers and foreign buying agents, telecommunications service providers, the United States Postal Service, United Parcel Service, shipping companies, landlords, paper manufacturers, printers, photographers, creative designers and models and credit card processing companies.
Any interruptions or delays in these services could materially and adversely affect our business and financial condition. Although we believe that, in general, the goods and services we obtain from third parties could be purchased from other sources, identifying and obtaining substitute goods and services could result in delays and increased costs. We do not maintain supply contracts with any of our private label or other merchandise vendors. Rather, we acquire merchandise via purchase orders that terminate upon completion of the order. If any significant merchandise vendor or buying agent were to suddenly discontinue its relationship with us, we could experience temporary delivery delays until a substitute supplier could be found.
Our business is subject to a number of external costs that we are unable to control.
Our business is subject to a number of external costs we are unable to control, including labor costs, insurance costs, printing, paper and postage expenses, shipping charges associated with distributing merchandise to our customers and stores, retail store facility rental and construction costs, and inventory acquisition costs, including product costs, quota and customs charges. Any increase in these or other external costs could adversely affect our financial position, results of operations and cash flows.
Talented personnel are critical to our success.
Our success depends to a significant extent upon our ability to retain key personnel, particularly Hugh W. Mullins, President and Chief Executive Officer, and to continue to attract talented new personnel. The loss of the services of Mr. Mullins or one or more of our current members of senior management, or our failure to attract talented new employees, could have an adverse effect on our business.
A major failure of our information systems could harm our business.
We depend on information systems to operate our website, process transactions, respond to customer inquiries, manage inventory, purchase, sell and ship goods on a timely basis and maintain cost-efficient operations. Any material disruption or slowdown of our systems could cause information to be lost or delayed which could have a negative impact on our business. We may experience operational problems with our information systems as a result of system failures, viruses, computer "hackers" or other causes. We cannot assure that our systems will be adequate to support future growth.
Our financial resources are limited, and we may not be able to attract additional sources of financing.
Other than our secured bank credit facility which supports our investments in inventory and accounts receivable, our principal sources of financing from 2001 through 2003 have been from Inter-Him, N.V., an entity controlled by Ronald de Waal, Howard Lester, one of our directors, and other directors who have invested an aggregate of $15 million in shares of preferred stock and have participated in $4 million of our bank financing. The terms of the preferred stock permit the holders to elect a majority of our directors and the consent of the holders of the preferred stock is required for any significant actions, including additional financing. We are substantially dependent on the support of Ronald de Waal as the owner of Inter-Him and controlling shareholder of the Company for any further financing. Without additional financing, our ability to make additional investments in marketing and store expansions are significantly limited.
Our outstanding preferred stock limits our ability to achieve financial returns for our holders of common stock.
As of January 29, 2005, we have outstanding three series of preferred stock with an aggregate liquidation value of $16.5 million. Holders of preferred stock are entitled to annual dividends in the aggregate amount of approximately $1.5 million before any dividends are paid on common stock, and these dividends reduce the amount of our net income applicable to our shares of common stock. Until we achieve net income in excess of the aggregate dividends payable to holders of preferred stock, we will continue to report net losses per share of common stock.
We do not expect to pay dividends on our common stock.
Due to our weak financial performance and restrictions under our existing credit agreement and preferred stock terms, we do not expect to pay dividends on our common stock for the foreseeable future.
Ronald de Waal, through his ownership of Inter-Him, N.V., which owns a majority of our outstanding preferred stock, controls the Company.
We are effectively controlled by Ronald de Waal by reason of his ownership of Inter-Him, N.V. which owns a majority of our outstanding preferred stock. Holders of the preferred stock have the ability to elect a majority of the board of directors and otherwise control the policies and strategy of the Company. The financial and business objectives of Mr. de Waal and the other holders of preferred stock as it relates to the Company may be different from those that might be beneficial to holders of common stock. Holders of the common stock are dependent on the fiduciary duties of the Board of Directors, a majority of whom are elected by the holders of preferred stock, to protect their interests.
ITEM 2.
ITEM 2. PROPERTIES
Store Leases
At January 29, 2005, the Company owned the Austin outlet store and leased 40 stores. The Company believes rent payable under its store leases is a key factor in determining the sales volume at which a store can be profitably operated. The leases typically provide for an initial term of 10 to 12 years. In most cases, the Company pays a base rent plus a contingent rent based on the store's net sales in excess of a certain threshold, typically four to five percent of net sales in excess of the applicable threshold. Among current store leases, one store lease has percentage rent only. All other store leases provide for a base rent with percentage rent payable above specified minimum net sales. Seven of the leased stores open during all of 2004 operated at sales volumes above the breakpoint (the sales volume below which only base rent is payable). Based on the Company's current level of sales per square foot, the Company believes that some of the risk from any decline in future sales volume in these stores is reduced because a corresponding decline in occupancy expense would occur.
Substantially all of the leases require the Company to pay property taxes, insurance, utilities and common area maintenance charges. The current terms of the Company's leases, including automatic renewal options, expire as follows:
Years Number Leases of Expire Stores 2005 1 2006-2007 7 2008-2010 20 2011 and 12 later
The Company generally has been successful in renewing its store leases as they expire.
During 2004, the Company did not enter into any new store leases. Management believes the terms of its leases are comparable with other similar national retailers in these locations. Base rent (minimum rent under terms of lease) in current leases ranges from $6 per square foot to $65 per square foot annually over the terms of the leases. The following table sets forth the fixed and variable components of the Company's rent expense for the years indicated:
2004 2003 2002
Base rent $6,797, $8,544, $7,793, 000 000 000 Additional rents computed as a 252,000 217,000 288,000 percentage of sales
Total $7,049, $8,761, $8,081, 000 000 000
Corporate Headquarters and Merchandise Buying Office
The Company leases a 46,132 square foot building used primarily as its corporate headquarters and buying offices in Dallas, Texas. The lessor of the Dallas location is a limited partnership whose partners include W. Howard Lester, a director of the Company and a partnership which is comprised of partners Rebecca Powell Casey, an executive officer and director of the Company and certain of her family members. The lease, which was amended in 2003, expires September, 2010 with current monthly rent payments of $26,490, plus insurance, utilities and property taxes until November, 2005 at which time monthly rent will be $38,443, plus insurance, utilities and property taxes until September, 2007 at which time monthly rent will be $40,366 plus insurance, utilities and property taxes until the expiration of the lease. This lease contains two renewal options of five years each. This lease has been approved by all independent directors as being on terms at or below available competitive market renewal rates.
Administrative Offices and Distribution Center
The Company owns a building in Norman, Oklahoma comprised of approximately 18,000 square feet. This space is utilized by the Company for its administrative functions.
The Company leases an 85,000 square foot warehouse distribution center facility located in Norman, Oklahoma. The owner and lessor of the distribution center is the limited partnership of which Rebecca Powell Casey and members of her family are partners. The term of the distribution center lease expires in June 2012, with annual rent increasing on a fixed scale from $365,416 in 2004 up to a maximum of $419,552 during the final year of the lease. This lease has been approved by all independent directors as being on terms at or below available competitive market renewal rates.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
The Company is involved in various claims, administrative agency proceedings and litigation arising out of the normal conduct of its business. Although the ultimate outcome of such litigation cannot be predicted, the management of the Company, after discussions with counsel, believes that resulting liability, if any, will not have a material effect upon the Company's financial position or results of operations.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth quarter of the year covered by this report.
PART II.
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERSAND ISSUER PURCHASES OF EQUITY SECURITIES
At March 15, 2005, there were 663 record holders of the Company's common stock, ("Common Stock"). The Company's Common Stock is listed on the American Stock Exchange under the symbol "HLD". The table below presents the range of the high and low sales prices, for the periods indicated.
Quarterly Common Stock Price Ranges
2004 High Low 1st Quarter 3.20 2.44 2nd Quarter 2.80 2.44 3rd Quarter 2.60 1.35 4th Quarter 1.60 1.15
2003 High Low 1st Quarter $1.20 $0.80 2nd Quarter $1.70 $0.80 3rd Quarter $3.40 $1.03 4th Quarter $5.25 $2.35
Dividend Policy
The Company has never declared or paid cash dividends on its Common Stock and presently intends to retain all earnings for the operation and expansion of its business for the foreseeable future. Any future determination as to the payment of cash dividends will depend on the Company's earnings, capital requirements, financial condition and other factors as the Board of Directors may deem relevant.
The Company has three series of preferred stock outstanding, issued in 2001, 2002 and 2003 in the aggregate amount of $15 million. These shares are entitled to cumulative dividends of 10% on $6 million of preferred stock and 8% on the remaining $9 million, subject to reduction if certain profitability targets are met. See Note 8 to the Consolidated Financial Statements for additional information on the preferred stock.
During 2004, approximately $1,501,000 of preferred stock dividends and preferred stock issuance cost accretion was recorded. Of this amount, approximately $1,441,000 represented preferred stock dividends paid. Approximately $378,000 was paid in additional shares of preferred stock (as provided by the terms of the preferred stocks) and approximately $1,063,000 was paid in cash.
The Company's primary lending agreement does not currently allow for the payment of dividends on common stock. This agreement does, however, allow for the distribution of preferred stock dividends.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following selected consolidated financial information is derived from the audited Consolidated Financial Statements of the Company and should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the Consolidated Financial Statements and the notes thereto, appearing elsewhere herein. See Note 2 to the Consolidated Financial Statements for additional information regarding the restatement of prior year amounts. The approximate impact of this restatement on 2001 was an increase to gross profit of $1,855,000; a decrease in net loss applicable to common stockholders of $389,000; a decrease in net loss per common share of $0.07; an increase in total assets of $10,037,000; a decrease in stockholders' equity of $1,539,000; and a decrease in stockholders' equity per share of $0.25. The approximate impact of this restatement on 2000 was an increase to gross profit of $1,784,000; a decrease in net loss applicable to common stockholders of $330,000; a decrease in net loss per common share of $0.06; an increase in total assets of $11,503,000; a decrease in stockholders' equity of $1,929,000; and a decrease in stockholders' equity per share of $0.32.
2004 2003 2002 2001 2000 * (Dollar amounts in (Resta (Resta (Restat (Resta thousands, except per ted) ted) ed) ted) share data)
Statements of Operations Data: Sales $89,3 91,6 89,7 104,6 127,4 57 83 81 24 84 Percentage (decrease) (2.5) 2.1% (14. (17.9) (6.4) increase in total sales % 2)% % %
Gross profit on sales $31,7 30,7 25,4 24,44 35,49 (1) 14 68 43 5 2 Percentage of sales 35.5% 33.6 28.4% 23.4% 27.8 % %
Net income (loss) before $ (12,7 (17,31 (7,86 income taxes 95 (5,67 89) 8) 4) 1) Percentage of sales 0.1% (6.2) (14.2 (16.6) (6.2) % )% % %
Provision (benefit) for $ - 3,20 (3,07 (3,27 income taxes - 6 7) 8) Percentage of sales 0.0% 0.0% 3.6% (2.9) (2.6) % %
Preferred stock dividends and accretion $ 1,306 863 634 - of preferred stock 1,501 issuance costs Percentage of sales 1.7% 1.4% 1.0% 0.6% 0.0%
Net loss applicable to $(1,4 (16,8 (14,87 (4,58 common stockholders 06) (6,97 58) 5) 6) 7) Percentage of sales (1.6) (7.6) (18.8 (14.2) (3.6) % % )% % %
Net loss per common share: $(0.2 (2.77 (2.44) (0.75 Basic and diluted 3) (1.14 ) ) )
Other Operating Data: Stores open at end of 41 42 50 52 52 period Increase (decrease) in comparable store sales (52-53 week basis) 1.9% 11.3% (9.9% (16.3% (11.9 ) ) %)
Balance Sheet Data: Working capital (2) $ 888 309 8,761 10,94 518 7 Total assets $43,0 42,7 51,1 64,62 79,85 65 45 20 6 6 Long-term debt, net of $ 1,358 1,62 1,921 2,758 current maturities 580 1 Stockholders' (deficit) $ (1,45 15,37 30,23 equity (9,59 (8,20 6) 8 9 4) 7) Stockholders' (deficit) $(1.5 (0.24 2.53 4.97 equity per share 4) (1.34 ) )
*Each of the years presented above is a 52 week year except for 2000 which was a 53 week year. (In accordance with retail industry practice, gross profit from 1sales is calculated by subtracting cost of goods sold )(including occupancy and central buying expenses) from sales. (Long-term debt is classified as current to comply with 2accounting pronouncement EITF 95-22. See Note 6 to the )Consolidated Financial Statements for more information. ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Forward-Looking Statements
From time to time, the Company may publish forward-looking statements relating to certain matters including anticipated financial performance, business prospects, the future opening or closing of stores, inventory levels, anticipated capital expenditures, and other matters. All statements other than statements of historical fact contained in this Form 10-K or in any other report of the Company are forward-looking statements. The Private Securities Litigation Reform Act of 1995 provides a safe harbor for forward-looking statements. In order to comply with the terms of that safe harbor, the Company notes that a variety of factors, individually or in the aggregate, could cause the Company's actual results and experience to differ materially from the anticipated results or other expectations expressed in the Company's forward-looking statements including, without limitation, the following: the ability of the Company to generate cash flow from operations in amounts sufficient to meet debt obligations and provide working capital and funds for growth, consumer spending trends and habits; competition in the retail clothing segment; the customary risks of purchasing merchandise abroad, including longer lead times, higher initial purchase commitments and foreign currency fluctuations; the Company's ability to attract and retain qualified personnel; weather conditions in the Company's operating regions; laws and government regulations; general business and economic conditions; availability of capital; the existence or absence of operating initiatives, publicity, advertising and promotional efforts; changes in accounting policies; and the ability of new management to improve the Company's financial condition and performance. In addition, the Company disclaims any intent or obligation to update those forward-looking statements.
Overview
Harold's is a multi-channel specialty retailer of ladies' and men's apparel, including accessories and footwear. Harold's markets its merchandise through retail stores, catalogs and its website at www.harolds.com.
Results of Operations
The following table reflects items in the Company's Statements of Operations as a percentage of sales for the periods indicated:
52 52 52 Weeks Weeks Weeks 2004 2003 2002 (Rest (Rest ated) ated)
Sales 100.0% 100.0% 100.0%
Cost of goods sold (including occupancy and central buying (64.5) (66.4 (71.6 expenses) ) ) Selling, general and (29.7) (29.4 (33.4 administrative expenses ) ) Depreciation and amortization (4.6) (7.6) (6.5) Restructuring charges - (1.8) (1.2) Interest expense (1.1) (1.0) (1.5)
Income (loss) before income 0.1 (6.2) (14.2 taxes )
Provision for income taxes - - 3.6
Net income (loss) 0.1% (6.2)% (17.8) %
The following table reflects the increases and decreases in Company sales for the periods indicated:
52 52 52 Weeks Weeks Weeks 2004 2003 2002
Sales (000's) $89,35 $91,68 $89,78 7 3 1
Total sales (decline) growth (2.5)% 2.1% (14.2)% Increase (decrease) in 1.9 11.3 (9.9) comparable store sales
Store locations: Existing stores, beginning of 42 50 52 period Stores closed (1) (8) (2) New stores opened during - - - period Total stores, end of period 41 42 50
During 2004, total sales decreased 2.5% as compared to an increase of 2.1% in 2003 and a decrease of 14.2% in 2002. No new locations were opened during 2004 or 2003, and one store was closed in 2004 compared to eight closings in 2003. Beginning in April 2004, the Company began to significantly reduce its dependence on promotional activities. Despite this strategic change, comparable store sales increased 1.9% during 2004, compared to an increase of 11.3% in 2003. The Company believes the increases experienced in comparable store sales during 2004 and 2003 were primarily attributable to strong acceptance by customers to the merchandise assortments offered.
During 2003, total sales increased 2.1% as compared to a decrease of 14.2% in 2002. No new locations were opened during 2003 or 2002, and two stores were closed in 2002 and eight in 2003. Comparable store sales increased 11.3% during 2003, compared to a decline of 9.9% in 2002. The Company believes that the increases experienced in comparable store sales during 2003 were primarily attributable to strong acceptance by customers to the merchandise assortments offered. The declines experienced in comparable store sales during 2002 were primarily attributable to sales declines experienced in the full-price retail stores during the fall and holiday periods, a result of inventory levels that were down considerably over the prior year and the difficult retail climate experienced by many retailers during the 2002 holiday period.
Gross margin represents net sales less cost of products and merchandising. Cost of products and merchandising consists primarily of product costs (e.g., product development, sourcing, merchandising, inventory control, inventory acquisition costs and inventory markdowns) and operating costs (e.g., occupancy costs for the Company's retail stores). The Company's gross margin increased to 35.5% in 2004 from 33.6% in 2003. The increase in the Company's gross margin was primarily due to increased rates of selling at full-price requiring fewer needed markdowns. During 2003, the Company's gross margin increased to 33.6% from 28.4% in 2002, or 5.2%. The increase in the Company's 2003 gross margin was primarily due to fewer markdowns being recorded in the full-price stores due to stronger sales.
Selling, general and administrative expenses consist primarily of retail store selling costs, costs to produce, print and distribute direct response catalogs, as well as corporate administrative costs. Selling, general and administrative expenses (including advertising and catalog production costs) increased slightly to 29.7% of sales in 2004 compared to 29.4% of sales in 2003. Selling, general and administrative expenses declined in the aggregate by $366,000 but increased slightly as a percent of sales primarily due to transitional costs associated with the hiring of Mr. Mullins and the retirement of Mr. Hinkley. Selling, general and administrative expenses decreased to 29.4% of sales in 2003 compared to 33.4% of sales in 2002. The decrease in selling, general and administrative expenses as a percentage of sales in 2003 was primarily due to savings experienced from a corporate restructuring commenced in January 2003, savings experienced as a result of closing eight unprofitable store locations during 2003, and increasing comparable store sales trends which provided leverage of fixed costs.
The Company recorded approximately $1,630,000 in restructuring charges during 2003 compared to approximately $1,060,000 in restructuring charges in 2002. The restructuring charges of 2003 primarily relate to lease termination costs paid to close eight unprofitable store locations. For 2002, the restructuring charges recorded in the fourth quarter consisted of severance costs of approximately $330,000 associated with elimination of positions in the corporate office, with the remainder of restructuring charges attributable to the acceleration of amortization of assets in conjunction with planned store closings in the first half of 2003. No restructuring charges were recorded in 2004.
Total 2004 interest expense increased approximately $100,000 from 2003 due to higher average interest rates on the Company's outstanding borrowings and higher average outstanding debt balances. The average balance on total outstanding debt was $20,663,000 in 2004, compared to $19,433,000 in 2003. The increase in average debt balances resulted principally from increased inventory levels. Total 2003 interest expense decreased $442,000 from 2002 due to lower average interest rates on the Company's outstanding borrowings. The average balance on total outstanding debt was $19,433,000 in 2003, compared to $19,729,000 in 2002. Increases to interest expense may occur if the Company's cash flow requires additional borrowed funds and if interest rates continue to rise.
The Company's effective income tax rate was 0% in 2004, 0% in 2003 and 24.2% in 2002. During 2002, the Company increased its valuation allowance to fully provide for all remaining deferred tax assets because the Company's history of operating losses made the realization of these assets uncertain. It is expected that such amounts could be utilized for tax purposes against any future operating income.
Cash Flows
Cash Flows From Operating Activities. During 2004, net cash provided by operating activities was $343,000 as compared to net cash used in 2003 of $1,891,000. The increase in cash flows in 2004 are primarily attributed to a $5.8 million improvement in net income offset by a $5.3 million net increase in inventories.
Cash Flows From Investing Activities. For 2004, net cash used in investing activities was $2,028,000 as compared to $1,614,000 in 2003. The increase is primarily attributed to a $326,000 increase in capital expenditures. Capital expenditures during 2004 and 2003 were invested principally in remodeling of existing stores and equipment expenditures in existing operations.
Cash Flows From Financing Activities. During 2004, the Company made periodic borrowings under its revolving credit facility to finance its inventory purchases, product development and private label programs, store remodeling and equipment purchases for the year (see "Liquidity").
The Company has a line of credit with its bank. This line had average balances of $19,203,000 and $17,679,000 for 2004 and 2003, respectively. During 2004, this line of credit had a high balance of $22,829,000 and a balance of $19,178,000 as of January 29, 2005. The balance at March 15, 2005 was $20,867,000.
The Company has no off-balance sheet arrangements or transactions with unconsolidated, limited purpose entities, nor does it have any undisclosed material transactions or commitments involving related persons or entities.
Liquidity
The Company considers the following as measures of liquidity and capital resources as of the dates indicated (dollars in thousands).
Year end
2004 2003 2002 (Restat (Restat ed) ed)
Working capital (000's) $518 $888 $309 (1) Current ratio (1) 1.02:1 1.03:1 1.01:1 Ratio of working capital .01:1 .02:1 .01:1 to total assets (1) Ratio of long-term debt (including current 2.98:1 2.36:1 2.10:1 maturities) to stockholders' equity (2)
(1) Long-term debt is classified as current to comply with accounting pronouncement EITF 95-22. See Note 6 to the Consolidated Financial Statements for more information. If the debt under the Company's line of credit was classified as long-term, working capital would be $19,696, $17,508 and $16,401 in 2004, 2003 and 2002, respectively; current ratio would be 3.01:1, 2.81:1 and 2.19:1 in 2004, 2003 and 2002, respectively and working capital to total assets would be .46:1, .41:1 and .32:1 in 2004, 2003 and 2002, respectively. (2) Preferred stock is treated as equity for this calculation.
Cash flow from operations and proceeds from credit facilities represent the Company's sources of liquidity, supplemented in 2004 and prior periods by investments and extensions of credit from its preferred shareholders. Management anticipates these sources of liquidity to be adequate for the foreseeable future but does not anticipate needing funding from preferred shareholders in 2005. The Company's capital expenditures budget for 2005 is approximately $2,000,000 to be used for the purchase of fixtures and equipment as well as store remodeling expenses.
See Note 6 to the Consolidated Financial Statements for information about restrictions and covenants under the Company's revolving line of credit.
Seasonality
The Company's business is subject to seasonal influences, with the major portion of sales realized during the fall season (third and fourth quarters) of each year, which includes the fall and holiday selling seasons. In light of this pattern, selling, general and administrative expenses are typically higher as a percentage of sales during the spring seasons (first and second quarters) of each year.
Inflation
Inflation affects the costs incurred by the Company in its purchase of merchandise and in certain components of its selling, general and administrative expenses. The Company attempts to offset the effects of inflation through price increases and control of expenses, although the Company's ability to increase prices is limited by competitive factors in its markets. Inflation has had no meaningful effect on sales or net earnings of the Company.
Critical Accounting Policies
The Consolidated Financial Statements and Notes to Consolidated Financial Statements contain information that is pertinent to Management's Discussion and Analysis. In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Changes to these assumptions and estimates could have a material effect on the Company's consolidated financial statements. However, the Company believes it has taken reasonable but conservative positions, where assumptions and estimates are used, in order to minimize the negative financial impact to the Company that could result if actual results vary from the assumptions and estimates. In management's opinion, the areas of the Company where the most significant judgment is exercised is in the allowance for doubtful accounts related to the Company's proprietary credit card program, the valuation of inventory, asset impairment estimates and revenue recognition. The selection, application and disclosure of the following critical accounting estimates have been discussed with the Company's audit committee.
In 2004, approximately 32% of the Company's net retail sales were made under its proprietary credit card program, which resulted in customer accounts receivable balances of approximately $7,343,000 at January 29, 2005. The Company has significant experience in managing its credit card program. Each month, the Company reviews all of its credit card accounts and writes off those deemed uncollectible. The allowance for uncollectible accounts is maintained and periodically reviewed. The allowance is primarily based on account write-off trends and aging information. The Company does not expect actual results to vary significantly from its estimate.
The Company uses the retail inventory method. Under this method, the Company records markdowns to value merchandise inventories at net realizable value. The Company closely monitors actual and forecasted sales trends, current inventory levels, and aging information by merchandise categories. If forecasted sales are not achieved, additional markdowns may be needed in future periods to clear excess or slow-moving merchandise, which may result in lower gross margins.
When a store experiences unfavorable operating performance, the Company evaluates whether an impairment charge should be recorded. A store's assets are evaluated for impairment by comparing the store's estimated undiscounted cash flows to the assets' carrying value. If the cash flows are not sufficient to recover the carrying value, the assets are written down to fair value. Impairment losses associated with these reviews have not been significant. However, if comparative store sales decline, future impairment losses could be significant.
Sales from store locations represented 99% of the Company's total sales for 2004. These sales are recognized at the time of the customer's purchase. Sales are net of returns and exclude sales tax. The Company's direct catalog and internet sales represented about one percent of the total sales during 2004. These sales are recognized at the time the order is shipped to the customer. Gift card sales are recognized as revenue when the gift card is redeemed, not when it is sold.
Impact of New Accounting Pronouncements
On December 16, 2004, the FASB issued FASB Statement No. 123 (revised 2004) ("SFAS 123(R)"), "Share-Based Payment", which must be adopted by the Company no later than January 29, 2006. SFAS 123(R) requires an entity to recognize compensation expense in an amount equal to the fair value of share-based payments granted to employees. The Company will adopt SFAS 123(R) in the required period and apply the standard using the modified prospective method, which requires compensation expense to be recorded for new and modified awards. For any unvested portion of previously issued and outstanding awards, compensation expense is required to be recorded based on the previously disclosed SFAS 123 methodology, and amounts. Prior periods presented are not required to be restated. The Company is still assessing the impact on its results of operations and financial position upon the adoption of SFAS 123(R).
Commitments
The following table reflects certain of the Company's commitments as of January 29, 2005.
Payments due by Period (In Thousands) Less More than than Contractual Total 1 year 1-3 3-5 5 years Obligations years years Long-term debt $20,53 $19,95 ( $ $ $ 8 8 1 188 222 170 ) Store leases (2) 31,426 6,111 11,794 8,124 5,397 Operating leases 6,176 1,028 1,990 1,851 1,307 (other than stores) Purchase 425 178 147 50 50 obligations Estimated interest 8,709 1,274 2,530 2,479 2,426 payments
Total $67,27 $28,54 $16,64 $12,72 $9,350 4 9 9 6
(1) The expiration of the Company's loan agreement, which represents the overwhelming majority of this amount, is February 5, 2007. It is unlikely such debt will be repaid within one year. See Note 6 to the Consolidated Financial Statements for further information. (2) Store leases are based on minimum rents exclusive of percentage rent based on sales which could increase rental expense.
The foregoing table does not include contractual commitments pursuant to executory contracts for products and services such as telephone, data, computer maintenance and other regular payments pursuant to contracts that are expected to remain in existence for several years but as to which the Company's obligations are contingent upon the Company's continued receipt of the contracted products and services.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
The primary objective of the following information is to provide forward-looking quantitative and qualitative information about the Company's potential exposure to market risks. The term "market risk" for the Company refers to the risk of loss arising from adverse changes in interest rates and various foreign currencies. The disclosures are not meant to be precise indicators of expected future losses, but rather indicators of reasonably possible losses. This forward-looking information provides indicators of how the Company views and manages its ongoing market risk exposures.
Interest Rate
At January 29, 2005, the Company had debt outstanding of approximately $20.5 million. Of this amount, $1.3 million bears interest at a weighted average fixed rate of 6.32%. The remaining $19.2 million bears interest at a variable rate, which averaged approximately 4.70% during 2004. A 10% increase in short-term interest rates on the variable rate debt outstanding at January 29, 2005 would approximate 46 basis points. Such an increase in interest rates would increase the Company's interest expense by approximately $88,000 assuming borrowed amounts remain outstanding.
The above sensitivity analysis for interest rate risk excludes accounts receivable, accounts payable and accrued liabilities because of the short-term maturity of such instruments. The analysis does not consider the effect this movement may have on other variables including changes in sales volumes that could be indirectly attributed to changes in interest rates. The actions management would take in response to such a change is also not considered. If it were possible to quantify this impact, the results could well be different than the sensitivity effects shown above.
The table below provides information about the Company's debt obligations that are sensitive to changes in interest rates:
Expected Maturity (In thousands)
2005 2006 2007 2008 2009 Thereaf Total ter
Long-term debt: Variable Rate $19,17 $ $ $ $ $ $19,17 7 - - - - - 7 Weighted Average 4.70% - - - - - Interest Rate
Fixed Rate $ $ $ $ $ $ $ 780 90 98 107 116 170 1,361 Weighted Average 6.32% 6.32% 6.32% 6.32% 6.32% 6.32% Interest Rate
Foreign Currency
Substantially all of the Company's purchases are priced in U.S. dollars. However, some European purchases are denominated in local currency and, therefore, are subject to the fluctuation in currency exchange rates. From time to time the Company utilizes forward exchange contracts to secure firm pricing related to purchase commitments to be denominated in foreign currencies. The contracts are of varying short-term durations and amounts include a window delivery feature, which provides the Company with an option to enter into a swap agreement in the event that all of the currency is not utilized at the end of the contract's delivery term. The Company's objective in managing its exposure to foreign currency exchange rate fluctuations is to reduce the impact of adverse fluctuations in earnings and cash flows associated with foreign currency exchange rate changes. The principal currency hedged is the Italian lira. The Company regularly monitors its foreign exchange exposures to ensure the overall effectiveness of its foreign currency hedge positions. However, there can be no assurance the Company's foreign currency hedging activities will substantially offset the impact of fluctuations in currency exchange rates on its results of operations and financial position.
The Company had no foreign exchange instruments outstanding at January 29, 2005; therefore, a sensitivity analysis would result in no impact to earnings. Anticipated transactions, firm commitments, and accounts payable denominated in foreign currencies would be excluded from the sensitivity analysis. Additionally, as the Company utilizes foreign currency instruments for hedging anticipated and firmly committed transactions, a loss in fair value for those instruments is generally offset by increases in the value of the underlying exposure. Foreign currency fluctuations did not have a material impact on the Company during 2004, 2003 or 2002.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See the Consolidated Financial Statements included immediately following the Exhibit Index to this Report.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND CONSOLIDATED FINANCIAL DISCLOSURE
None.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
The Company's Principal Executive Officer and Principal Financial Officer have reviewed and evaluated the effectiveness of the Company's disclosure controls and procedures (as defined in Exchange Act Rule 240.13a-14(c)) as of the end of the period covered by this report. Based on that evaluation, the Principal Executive Officer and the Principal Financial Officer have concluded that the Company's current disclosure controls and procedures are effective to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission's rules and forms.
PART III.
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required under Item 10 will be contained in the definitive Proxy Statement of the Company for its 2005 Annual Meeting of Stockholders (the "Proxy Statement") and is incorporated herein by reference. The Proxy Statement will be filed pursuant to Regulation 14A with the Securities and Exchange Commission not later than 120 days after January 29, 2005.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information required under Item 11 will be contained in the Proxy Statement and is incorporated herein by reference.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The information required under Item 12 will be contained in the Proxy Statement and is incorporated herein by reference.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required under Item 13 will be contained in the Proxy Statement and is incorporated herein by reference.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required under Item 14 will be contained in the Proxy Statement and is incorporated herein by reference.
PART IV.
ITEM 15.
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) (1) and (2) The following consolidated financial statements and schedule are attached as a separate section of this report entitled "Consolidated Financial Statements and Schedule":
MANAGEMENT'S RESPONSIBILITY FOR FINANCIAL REPORTING
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
CONSOLIDATED FINANCIAL STATEMENTS: Consolidated Balance Sheets as of January 29, 2005 and January 31, 2004 Consolidated Statements of Operations for the Years Ended January 29, 2005, January 31, 2004 and February 1, 2003 Consolidated Statements of Stockholders' Deficit for the Years Ended January 29, 2005, January 31, 2004 and February 1, Consolidated Statements of Cash Flows for the Years Ended January 29, 2005, January 31, 2004 and February 1, 2003 Notes to Consolidated Financial Statements
SCHEDULE: Schedule II - Harold's Stores, Inc. and subsidiaries valuation account
All other schedules have been omitted because they are not applicable, not required, or the information is included elsewhere in the financial statements or notes thereto.
(b) Exhibits: See accompanying Index to Exhibits. The Company will furnish to any stockholder, upon written request, any exhibit listed in the accompanying Index to Exhibits upon payment by such stockholder of the Company's reasonable expenses in furnishing any such exhibit. SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
HAROLD'S STORES, INC.
Date: April 29, /s/ Hugh W. Mullins Hugh W. Mullins Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934 this report has been signed below by the following persons on behalf of the Registrant and in the capacities shown, and on the dates indicated.
Signature Title Date
President, Chief April 29, /s/ Hugh W. Executive Officer 2005 Mullins and Director Hugh W. Mullins (Principal Executive Officer)
/s/ William E. Non-Executive Chairman April Haslam of the Board 29, 2005 William E. Haslam and Director
/s/ Rebecca P. Executive Vice April Casey President 29, 2005 Rebecca P. Casey and Director
/s/ Jodi L. Taylor Chief Financial April Officer and Secretary 29, 2005 Jodi L. Taylor (Principal Financial and Accounting Officer)
/s/ Clark J. Director April Hinkley 29, 2005 Clark J. Hinkley
/s/ James D. Director April Abrams 29, 2005 James D. Abrams
/s/ Robert L. Director April Anderson 29, 2005 Robert L. Anderson
/s/ Margaret A. Director April Gilliam 29, 2005 Margaret A. Gilliam
/s/ W. Howard Director April Lester 29, 2005 W. Howard Lester
/s/ Leonard M. Director April Snyder 29, 2005 Leonard M. Snyder INDEX TO EXHIBITS
No. Description
3.1 Certificate of Incorporation of the Company, as amended (Incorporated by reference to Exhibit 3.1 to Form 10-K for the year ended February 3, 2001).
3.2 By-laws of the Company (Incorporated by reference to Exhibit 3.2 to Form 8-B Registration Statement, Registration No. 1-10892).
4.1 Specimen Certificate for Common Stock (Incorporated by reference to Exhibit 4.1 to Form S-1 Registration Statement, Registration No. 33-15753).
4.2 Certificate of Elimination of Designations of the Series 2001-A Preferred Stock (Incorporated by reference to Exhibit 4.1 to Form 8-K dated August 2, 2002).
4.3 Certificate of Designations of the Amended Series 2001-A Preferred Stock (Incorporated by reference to Exhibit 4.2 to Form 8-K dated August 2, 2002).
4.4 Certificate of Designations of the Series 2002-A Preferred Stock (Incorporated by reference to Exhibit 4.3 to Form 8-K dated August 2, 2002).
4.5 Amendment to the Certificate of Designation of the Amended Series 2001-A Preferred Stock ($0.01 Par Value) of Harold's Stores, Inc., dated February 4, 2003 (Incorporated by reference to Exhibit 4.1 to Form 8-K dated February 4, 2003).
4.6 Certificate of Designations of the Series 2003-A Preferred Stock (Incorporated by reference to Exhibit 4.2 to Form 8-K dated February 4, 2003).
10. Lease Agreement effective May 1, 1996 between Company and 1 Carousel Properties, Inc. (Campus Corner Store, Norman, Oklahoma) (Incorporated by reference to Exhibit 10.7 to Form S-2 Registration Statement, Registration No. 333- 04117) and amendment to Lease Agreement dated April 4, 2002. (Incorporated by reference to Exhibit 10.1 to Form 10-Q for the quarter ended May 4, 2002).
10. Amended and Restated Lease Agreement dated as of June 3, 2 1996 between Company and 329 Partners II Limited Partnership (East Lindsey Warehouse Facility, Norman, Oklahoma) (Incorporated by reference to Exhibit 10.13 to Amendment No. 1 to Form S-2 Registration Statement, Registration No. 333-04117).
10. Amended and Restated Lease Agreement dated as of June 20, 3 2001 between Company and 329 Partners II Limited Partnership (Outlet Store, Norman, Oklahoma) (Incorporated by reference to Exhibit 10.6 to Form 10-K for the year ended February 2, 2002).
10. 2002 Performance and Equity Incentive Plan of Company. 4* (Incorporated by reference to Definitive Proxy Statement dated May 17, 2002, for annual meeting of shareholders held on June 20, 2002.
10. Employment Agreement dated February 9, 2004 between 5* Company and Hubert W. Mullins (Incorporated by reference to Exhibit 10.5 to Form 10-K for the year ended January 31, 2004).
10. Employment Agreement dated February 9, 2004 between 6* Company and Clark Hinkley (Incorporated by reference to Exhibit 10.6 to Form 10-K for the year ended January 31, 2004).
10. Stock Option Agreement dated February 23, 2001 between 7* Company and Clark Hinkley (Incorporated by reference to Exhibit 10.12 to Form 10-K for the year ended February 3, 2001).
10. First Amendment to Stock Option Agreement dated February 8* 9, 2004 between Company and Clark Hinkley (Incorporated by reference to Exhibit 10.8 to Form 10-K for the year ended January 31, 2004).
10. Employment and Deferred Compensation Agreement dated 9* February 1, 1998 between Company and Harold G. Powell (Incorporated by reference to Exhibit 10.25 to Form 10-Q for quarter ended May 2, 1998).
10. First Amendment dated February 28, 2001 to Employment and 10* Deferred Compensation Agreement between Company and Harold G. Powell (Incorporated by reference to Exhibit 10.17 to Form 10-K for the year ended February 3, 2001).
10. Series 2001-A Preferred Stock Purchase Agreement dated 11 February 23, 2001 between Company and Inter-Him N.V. (Incorporated by reference to Exhibit 10.1 to Form 8-K dated February 28, 2001).
10. Investor Rights Agreement dated February 28, 2001 between 12 Company and Inter-Him N.V. (Incorporated by reference to Exhibit 10.2 to Form 8-K dated February 28, 2001).
10. Voting Agreement dated February 28, 2001 among Company, 13 Inter-Him N.V. and the other stockholders named therein (Incorporated by reference to Exhibit 10.3 to Form 8-K dated February 28, 2001).
10. Right of First Refusal Agreement dated February 28, 2001 14 among Company, Inter-Him N.V. and the other stockholders named therein (Incorporated by reference to Exhibit 10.4 to Form 8-K dated February 28, 2001).
10. First Amended and Restated Stockholders Agreement dated 15 June 15, 1998 among certain stockholders of Company (Incorporated by reference to Exhibit 10.2 to Form 10-Q for quarter ended August 1, 1998).
10. First Amendment dated February 28, 2001 to First Amended 16 and Restated Stockholders Agreement among certain stockholders of Company (Incorporated by reference to Exhibit 10.6 to Form 8-K dated February 28, 2001).
10. Series 2002-A Preferred Stock Purchase Agreement dated as 17 of June 26, 2002, by and among Harold's Stores, Inc., Inter-Him, N.V., W. Howard Lester, William E. Haslam, Clark J. Hinkley and Margaret A. Gilliam (Incorporated by reference to Exhibit 10.1 to Form 8-K dated August 2, 2002).
10. First Amendment to Investor Rights Agreement dated as of 18 August 2, 2002, by and among Harold's Stores, Inc., Inter- Him, N.V., W. Howard Lester, William E. Haslam, Clark J. Hinkley and Margaret A. Gilliam (Incorporated by reference to Exhibit 10.2 to Form 8-K dated August 2, 2002).
10. First Amendment to Right of First Refusal Agreement dated 19 as of August 2, 2002, by and among Harold's Stores, Inc., Inter-Him, N.V., W. Howard Lester, Harold G. Powell, Anna M. Powell, Rebecca Powell Casey, H. Rainey Powell, Lisa Powell Hunt, Clay M. Hunt and Arvest Trust Company, N.A. (Incorporated by reference to Exhibit 10.3 to Form 8-K dated August 2, 2002).
10. First Amendment to Voting Agreement dated as of August 2, 20 2002, by and among Harold's Stores, Inc., Inter-Him, N.V., W. Howard Lester, William E. Haslam, Clark J. Hinkley, Margaret A. Gilliam, Harold G. Powell, Anna M. Powell, Rebecca Powell Casey, H. Rainey Powell, Lisa Powell Hunt, Clay M. Hunt and Arvest Trust Company, N.A. (Incorporated by reference to Exhibit 10.4 to Form 8-K dated August 2, 2002).
10. Series 2003-A Preferred Stock Purchase Agreement dated as 21 of February 5, 2003, by and among Harold's Stores, Inc., Inter-Him N.V. and W. Howard Lester (Incorporated by reference to Exhibit 10.1 to Form 8-K dated February 4, 2003).
10. Second Amendment to Investor Rights Agreement dated as of 22 February 5, 2003, by and among Harold's Stores, Inc., Inter-Him N.V. and W. Howard Lester (Incorporated by reference to Exhibit 10.2 to Form 8-K dated February 4, 2003).
10. Loan and Security Agreement dated as of February 5, 2003, 23 by and among Wells Fargo Retail Finance, LLC, Harold's Stores, Inc., Harold's Financial Corporation, Harold's Direct, Inc., Harold's Stores of Texas, L.P., Harold's Stores of Georgia, L.P., and Harold's of Jackson, Inc. (Incorporated by reference to Exhibit 10.3 to Form 8-K dated February 4, 2003).
10. Series 2003-A Preferred Stock Investment Agreement dated 24 as of February 4, 2003, by and between Harold's Stores, Inc. and 329 Partners-II Limited Partnership (Incorporated by reference to Exhibit 10.6 to Form 8-K dated February 4, 2003).
10. Form of Indemnification Agreement between Company and 25 members of its Board of Directors (Incorporated by reference to Exhibit 10.36 to Form 10-K for the year ended February 1, 2003).
10. Form of Waiver of Claims and Covenant Not to Sue 26 Directors between principal shareholders of the Company and members of the Company's Board of Directors (Incorporated by reference to Exhibit 10.37 to Form 10-K for the year ended February 1, 2003).
10. Participation Agreement dated as of July 10, 2003, by and 27 between Wells Fargo Retail Finance II, LLC and RonHow, LLC (Incorporated by reference to Exhibit 10.3 to Form 8- K dated July 10, 2003).
10. Amended and Restated Participation Agreement dated as of 28 April 29, 2004, by and between Wells Fargo Retail Finance II, LLC and RonHow, LLC (Incorporated by reference to Exhibit 10.28 to Form 10-K for the year ended January 31, 2004).
10. Assignment and Assumption of Lease Agreement and Third 29 Amendment to Lease Agreement dated October 1, 2003 by and between Company and 329 Partners-II Limited Partnership (Dallas Buying Office, Dallas, Texas) (Incorporated by reference to Exhibit 10.1 to Form 10-Q dated November 1, 2003).
10. Option Agreement between Company and RONHOW LLC dated 30 April 30, 2004 (Incorporated by reference to Exhibit 10.30 to Form 10-K for the year ended January 31, 2004).
10. First Amendment to Loan and Security Agreement dated as 31 of February 5, 2003, by and among Wells Fargo Retail Finance, LLC, Harold's Stores, Inc., Harold's Financial Corporation, Harold's Direct, Inc., Harold's Stores of Texas, L.P., Harold's Stores of Georgia, L.P., and Harold's of Jackson, Inc. (Incorporated by reference to Exhibit 10.31 to Form 10-K for the year ended January 31, 2004).
10. Second Amendment to Loan and Security Agreement dated as 32 of April 29, 2004, by and among Wells Fargo Retail Finance, LLC, Harold's Stores, Inc., Harold's Financial Corporation, Harold's Direct, Inc., Harold's Stores of Texas, L.P., Harold's Stores of Georgia, L.P., and Harold's of Jackson, Inc. (Incorporated by reference to Exhibit 10.32 to Form 10-K for the year ended January 31, 2004).
22. Subsidiaries of Company (Incorporated by Reference to 1 Exhibit 22.1 to Form 8-B Registration Statement, Registration No. 1-10892).
23. Consent of Ernst & Young LLP.
31. Certification of Chief Executive Officer Pursuant to 1 Rule 13a-14(a) under the Securities Exchange Act of 1934.
31. Certification of Chief Financial Officer Pursuant to 2 Rule 13a-14(a) under the Securities Exchange Act of 1934.
32. Certification of Chief Executive Officer Pursuant to 18 1 U.S.C. Section 1350.
32. Certification of Chief Financial Officer Pursuant to 18 2 U.S.C. Section 1350 ___________________________ * Constitutes a management contract or compensatory plan or arrangement required to be filed as an exhibit to this report. Harold's Stores, Inc. and Subsidiaries Consolidated Financial Statements and Schedule January 29, 2005, January 31, 2004 and February 1, 2003 (With Independent Registered Public Accounting Firm's Report Thereon) MANAGEMENT'S RESPONSIBILITY FOR FINANCIAL REPORTING
The management of Harold's Stores, Inc. has the responsibility for preparing the accompanying consolidated financial statements and for their integrity and objectivity. The statements were prepared in accordance with accounting principles generally accepted in the United States and include amounts that are based on management's best estimates and judgment where necessary. Management believes that all representations made to our external auditors during their examination of the financial statements were valid and appropriate.
To meet its responsibility, management has established and maintains a comprehensive system of internal control that provides reasonable assurance as to the integrity and reliability of the consolidated financial statements, that assets are safeguarded, and that transactions are properly executed and reported. This system can provide only reasonable, not absolute, assurance that errors and irregularities can be prevented or detected. The concept of reasonable assurance is based on the recognition that the cost of a system of internal control is subject to close scrutiny by management and is revised as considered necessary.
The Board of Directors of Harold's Stores, Inc. has engaged Ernst & Young LLP, an independent registered public accounting firm, to conduct an audit of the 2004 consolidated financial statements. Their report is included on the following page.
/s/ Hugh W. Mullins Hugh W. Mullins President/Chief Executive Officer
/s/ Jodi L. Taylor Jodi L. Taylor Chief Financial Officer
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders Harold's Stores, Inc.
We have audited the accompanying consolidated balance sheets of Harold's Stores, Inc. and subsidiaries as of January 29, 2005 and January 31, 2004, and the related consolidated statements of operations, stockholders' deficit, and cash flows for each of the three years in the period ended January 29, 2005. Our audits also included the financial statement schedule for the 52 weeks ended January 29, 2005, January 31, 2004, and February 1, 2003 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 the standards of the Public Company Accounting Oversight Board (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. We were not engaged to perform an audit of the Company's internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Harold's Stores, Inc. and subsidiaries as of January 29, 2005 and January 31, 2004, and the consolidated results of their operations and their cash flows for each of the three years in the period ended January 29, 2005, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule for the 52 weeks ended January 29, 2005, January 31, 2004, and February 1, 2003, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects, the information set forth therein.
As discussed in Note 2 of the consolidated financial statements, the consolidated financial statements as of January 31, 2004 and for each of the two years in the period then ended have been restated.
/s/ Ernst and Young LLP Ernst and Young LLP
Oklahoma City, Oklahoma April 20, 2005
HAROLD'S STORES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (In Thousands)
Januar Januar y 29, y 31, 2005 2004 ASSETS: (Restat ed)
Current assets: Cash and cash equivalents $ $ 674 1,118 Trade accounts receivable, less allowance for doubtful accounts of $200 as of January 29, 2005 and as 7,343 7,120 of January 31, 2004 Note and other receivables 125 109 Merchandise inventories 20,12 17,71 3 3 Prepaid expenses 1,254 1,130
Total current assets 29,51 27,19 9 0
Property and equipment, at cost 44,21 43,48 1 4 Less accumulated depreciation and (30,66 (27,92 amortization 5) 9)
Net property and equipment 13,54 15,55 6 5
Total assets $ $ 43,06 42,74 5 5
The accompanying notes are an integral part of the consolidated balance sheets.
HAROLD'S STORES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (In Thousands, Except Share Data)
Januar Januar y 29, y 31, 2005 2004 LIABILITIES AND STOCKHOLDERS' (Restat DEFICIT: ed)
Current liabilities: Accounts payable $ $ 7,116 7,526 Redeemable gift certificates 1,130 926 Accrued payroll expenses and 613 890 bonuses Accrued rent expense 184 102 Current maturities of long-term 19,958 16,858 debt
Total current liabilities 29,001 26,302
Accrued rent expense, net of current 6,587 7,381 Long-term debt, net of current 580 1,358 maturities
Commitments and contingent liabilities (Notes 9, 11 and 13)
Convertible preferred stock of $.01 par value Amended Series 2001-A, authorized 600,000 shares, issued and outstanding 336,231 as of January 6,725 6,627 29, 2005 and 331,631 as of January 31, 2004
Series 2002-A, authorized 300,000 shares, issued and outstanding 217,732 as of January 29, 2005 and 4,340 4,133 208,803 as of January 31, 2004
Series 2003-A, authorized 100,000 shares, issued and outstanding 54,514 as of January 29, 2005 and 5,426 5,151 52,024 as of January 31, 2004
Amended 2001-A and 2002-A entitled to $20.00 per share, and 2003-A entitled to $100.00 per share, in each case plus accrued but unpaid dividends in liquidation
Stockholders' deficit:
Common stock of $.01 par value Authorized 25,000,000 shares; issued and outstanding 6,222,308 as of January 29, 62 62 2005 and 6,209,147 as of January 31, 2004 Additional paid-in capital 34,468 34,449 Accumulated deficit (44,122 (42,716 ) ) (9,592) (8,205) Less: Treasury stock of 205 shares as of January 29, 2005 and as of (2) (2) January 31, 2004 recorded at cost
Total stockholders' deficit (9,594) (8,207)
Total liabilities and stockholders' $43,06 $42,74 deficit 5 5
The accompanying notes are an integral part of the consolidated balance sheets.
HAROLD'S STORES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (In Thousands, Except Share Data)
52 52 52 Weeks Weeks Weeks Ended Ended Ended January January February 29, 31, 1, 2003 2005 2004 (Restat (Restat ed) ed)
Sales $89,357 $91,683 $89,781
Costs and expenses: Cost of goods sold (including occupancy and central buying expenses, exclusive of items 57,643 60,915 64,338 shown separately below)
Selling, general and 26,564 26,930 30,053 administrative expenses
Depreciation and amortization 4,076 7,000 5,798
Restructuring charges - 1,630 1,060
Interest expense 979 879 1,321
89,262 97,354 102,570
Income (loss) before income 95 (5,671) (12,789 taxes )
Provision for income taxes - - 3,206
Net income (loss) $ $(5,671 $(15,99 95 ) 5)
NET LOSS APPLICABLE TO COMMON STOCKHOLDERS:
Net income (loss) $ $(5,671 $(15,99 95 ) 5)
Less: Preferred stock dividends and accretion of 1,501 1,306 863 preferred stock issuance costs
Net loss applicable to common $(1,406 $(6,977 $(16,85 stockholders ) ) 8)
Net loss per common share: Basic $ $ $ (0.23) (1.14) (2.77) Diluted $ $ $ (0.23) (1.14) (2.77)
Weighted average number of 6,217,6 6,114,2 6,096,5 common shares 29 02 00
Weighted average number of common shares assuming 6,217,6 6,114,2 6,096,5 dilution 29 02 00
The accompanying notes are an integral part of these consolidated financial statements.
HAROLD'S STORES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIT (Dollars in Thousands)
52 52 52 Weeks Weeks Weeks Ended Ended Ended January January Februar 29, 31, y 1, 2005 2004 2003 Common stock: (Restat (Restat ed) ed)
Balance (net of treasury shares), $ $ $ beginning of year 60 59 59
Stock bonuses issued, 16 shares in 2004, no shares in 2003, 1,165 0 - 0 shares in 2002
Stock options exercised, 13,350 shares in 2004, 109,439 shares in 0 1 0 2003, 4,000 shares in 2002
Shares issued to members of the board of directors, none in 2004, - - 0 none in 2003, 5,210 shares in
Balance (net of treasury shares), $ $ $ end of year 60 60 59
Additional paid-in capital:
Balance, beginning of year $ $ $ 34,449 34,224 34,200
Stock bonuses - - 4
Stock options exercised 19 225 8
Shares issued to members of the - - 12 board of directors
Balance, end of year $ $ $ 34,468 34,449 34,224
Accumulated deficit:
Balance, beginning of year $ $ $ (42,716 (35,739 (18,881 ) ) )
Net income (loss) 95 (5,671) (15,995 )
Preferred stock dividends and (1,501) (1,306) (863) accretion
Balance, end of year $ $ $ (44,122 (42,716 (35,739 ) ) )
The accompanying notes are an integral part of these consolidated financial statements.
HAROLD'S STORES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Dollars in Thousands)
52 52 52 Weeks Weeks Weeks Ended Ended Ended January January February 29, 31, 1, 2003 2005 2004 (Restat (Restat ed) ed) Cash flows from operating activities: Net income (loss) $ $ $(15,99 95 (5,671) 5) Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Depreciation and amortization 4,076 7,000 6,528 Deferred income tax provision - - 3,206 (Gain) loss on sale of assets (67) (12) 107 Shares issued to members of the - - 12 board of directors Changes in assets and liabilities: Increase in trade and other (174) (658) (111) receivables (Increase) decrease in (2,410) 2,917 921 merchandise inventories (Increase) decrease in prepaid (124) 830 (41) expenses Decrease in income taxes - - 4,237 receivable (Decrease) increase in accounts (268) (3,047) 2,808 payable Increase (decrease) in accrued (785) (3,250) (2,390) expenses Net cash provided by (used in) 343 (1,891) (718) operating activities
Cash flows from investing activities: Acquisition of property and (2,030) (1,704) (1,863) equipment Proceeds from disposal of 67 77 117 property and equipment Issuance of notes receivable (102) - - Payments received for note 37 13 10 receivable Net cash used in investing (2,028) (1,614) (1,736) activities
Cash flows from financing activities: Payments of long-term debt (272) (1,291) (2,014) Advances on revolving line of 100,53 102,15 107,28 credit 2 5 8 Payments on revolving line of (97,975 (101,62 (106,72 credit ) 7) 7) Proceeds from the issuance of 18 226 11 common stock Proceeds from the issuance of - 4,939 3,913 preferred stock Preferred stock dividends (1,062) (809) (413) Net cash provided by financing 1,241 3,593 2,058 activities
Net (decrease) increase in cash (444) 88 (396) and cash equivalents Cash and cash equivalents at 1,118 1,030 1,426 beginning of year Cash and cash equivalents at end $ $ $ of year 674 1,118 1,030
Supplemental disclosure of cash flow information: Cash paid during the year for: Income taxes $ $ $ 44 40 37
Interest $ $ $ 1,096 778 1,358
Non-cash investing and financing activities: Issuance of note receivable for $ $ $ sale of equipment - - 80 Issuance of common stock to members of the board of $ $ $ directors - - 12 Preferred stock dividends accrued $ $ $ 378 426 367
The accompanying notes are an integral part of these consolidated financial statements. HAROLD'S STORES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Summary of Significant Accounting Policies
Nature of Entity
Harold's Stores, Inc., an Oklahoma corporation (the Company), operates a 41-store chain of "updated traditional", classic styled ladies and men's specialty apparel stores. The Company offers its merchandise in stores primarily across the South and Southwest. The Company creates the majority of its product assortment through its private label program. The product development and private label programs provide an exclusive selection of upscale merchandise to the consumer.
Basis of Presentation
The consolidated financial statements include the accounts of the Company and its subsidiaries, all of which are wholly owned. All significant intercompany accounts and transactions have been eliminated.
Reclassification
Certain comparative prior year amounts in the consolidated financial statements have been reclassified to conform to the current year presentation.
Definition of Fiscal Year
The Company has a 52-53 week year that ends on the Saturday closest to January 31. Years 2004, 2003 and 2002 ended on January 29, 2005, January 31, 2004, February 1, 2003, respectively. The years 2004, 2003 and 2002 each comprised 52- week years.
Accounting Pronouncements
On December 16, 2004, the FASB issued FASB Statement No. 123 (revised 2004) ("SFAS 123(R)"), "Share-Based Payment", which must be adopted by the Company no later than January 29, 2006. SFAS 123(R) requires an entity to recognize compensation expense in an amount equal to the fair value of share-based payments granted to employees. The Company will adopt SFAS 123(R) in the required period and apply the standard using the modified prospective method, which requires compensation expense to be recorded for new and modified awards. For any unvested portion of previously issued and outstanding awards, compensation expense is required to be recorded based on the previously disclosed SFAS 123 methodology, and amounts. Prior periods presented are not required to be restated. The Company is still assessing the impact on its results of operations and financial position upon the adoption of SFAS 123(R).
Cash and Cash Equivalents
Cash and cash equivalents include overnight investments and credit card receivables collected within three business days.
Concentration of Credit Risk
Financial instruments that potentially subject the Company to credit risk consist principally of trade accounts receivable and cash equivalents. The company extends credit to its customers in the normal course of business. The Company performs ongoing credit evaluations and generally does not require collateral. The Company maintains reserves for potential credit losses based upon its loss history and its aging analysis. Accounts receivable are comprised of a diversified customer base that results in a lack of concentration of credit risk.
Accounts Receivable and Finance Charges
Trade accounts receivable primarily represents the Company's credit card receivables from customers. These customers are primarily residents of Oklahoma and Texas. Finance charges on these revolving receivables are imposed at various annual rates in accordance with the state laws in which the Company operates, and are recognized in income when applied to the customers' statements. Minimum monthly payments are required and are generally equal to ten percent of the outstanding balance. The average liquidation rate at January 29, 2005 was approximately 2.65 months. Finance charge revenue is netted against selling, general and administrative expenses and was approximately $1,142,000, $1,140,000, and $1,152,000, in 2004, 2003, and 2002, respectively.
Allowances for doubtful accounts are established based upon historical losses and increased as necessary to cover specific items. Receivables determined to be uncollectible are written off as a charge to the allowance. Recoveries of previously written off amounts are added back to the allowance. Charge-offs related to these accounts were approximately $253,000, $221,000 and $275,000 during 2004, 2003 and 2002, respectively.
Merchandise Inventories
Merchandise inventories are valued at the lower of cost or market using the retail method of accounting. Manufacturing inventories of raw materials, work-in-process and in-transit items are valued at the lower of cost (first-in, first-out method) or market, and approximate $3,570,000 and $2,604,000 at January 29, 2005 and January 31, 2004, respectively.
Stock Options
The Company follows the intrinsic value method of accounting for common stock options granted to employees, in accordance with the provisions of Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees", and related interpretations.
Had the Company elected to recognize compensation expense based on the fair value of the stock options granted as of their grant date, the Company's 2004, 2003 and 2002 pro forma net loss and pro forma net loss per share would have differed from the amounts actually reported as shown in the table below. The pro forma amounts shown reflect only options granted in 1995 through 2004. Therefore, the full impact of calculating compensation cost for stock options based on their fair value is not reflected in the pro forma net loss amounts presented because compensation cost is reflected over the options' vesting period of up to 10 years and compensation cost for options granted prior to January 29, 1995 is not considered.
Year Ended January January Februar 29, 31, y 1, 2005 2004 2003 (Resta (Resta ted) ted) (In thousands, except per share data)
Net loss applicable to common $(1,40 $(6,9 $(16, stockholders, as reported 6) 77) 858)
Add: Stock-based employee compensation expense included - - - in reported net loss
Deduct: Stock-based employee compensation expense determined 375 460 496 under fair value method for all awards
Pro forma net loss applicable $(1,78 $(7,4 $(17, to common stockholders 1) 37) 354)
Net loss per common share: Basic, as reported $(0.23 $(1.1 $(2.7 ) 4) 7) Basic, pro forma $(0.29 $(1.2 $(2.8 ) 2) 5)
Diluted, as reported $(0.23 $(1.1 $(2.7 ) 4) 7) Diluted, pro forma $(0.29 $(1.2 $(2.8 ) 2) 5)
Revenue Recognition
Sales from store locations represented 99% of the Company's total sales for 2004. These sales are recognized at the time of the customer's purchase. Sales are net of returns and exclude sales tax. The Company's direct catalog and internet sales represented about one percent of the total sales during 2004. These sales are recognized at the time the order is shipped to the customer. Gift card sales are recognized as revenue when the gift card is redeemed, not when it is sold.
Advertising
During 2004, 2003 and 2002, the Company incurred approximately $4,313,000, $4,190,000, and $4,220,000, respectively, in advertising expenses. Advertising expenditures related to small publications mailed to the Company's database of active customers are expensed at the time of mailing to the customer.
Depreciation, Amortization and Maintenance and Repairs
Depreciation is computed using the straight-line method over the estimated useful lives of the related assets. Leasehold improvements are amortized over the shorter of the life of the respective leases or the expected life of the improvements. The following are the estimated useful lives used to compute depreciation and amortization:
Buildings 30 years Leasehold improvements 5-10 years Furniture and equipment 4-7 years Software and related costs 3 years
Maintenance and repairs are charged directly to expense as incurred, while betterments and renewals are generally capitalized in the property accounts. When an item is retired or otherwise disposed of, the cost and applicable accumulated depreciation are removed from the respective accounts and the resulting gain or loss is recognized. During 2004, 2003 and 2002, the Company recorded approximately $4,076,000, $7,000,000, and $5,798,000, respectively, of depreciation and amortization expense.
Computer Software Costs
For 2004, 2003 and 2002, software related costs of approximately $70,000, $55,000 and $57,000, respectively, were capitalized. These costs are amortized over the life of the related software.
Income Taxes
Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. During 2002, the Company increased its valuation allowance to fully provide for all remaining deferred tax assets because the Company's recent history of operating losses made the realization of these assets uncertain. As of January 29, 2005, the Company's valuation allowance was equal to 100% of its deferred tax assets. See Note 7 for additional discussion.
Net loss Per Common Share
Basic net loss per common share is computed by dividing net loss applicable to common stock by the weighted average number of common shares outstanding for the period. Diluted earnings per share reflect the potential dilution that could occur if the Company's outstanding stock options were exercised (calculated using the treasury stock method).
The following table reconciles the net loss applicable to common shares and weighted average common shares outstanding used in the calculation of basic and diluted earnings per common share for the periods indicated:
2004 2003 2002 (Resta (Resta ted) ted) (In thousands, except per share data)
Net loss applicable to common $(1,40 $(6,97 $(16,8 stockholders, basic and diluted 6) 7) 58)
Weighted average number of common 6,218 6,114 6,097 shares outstanding - basic Dilutive effect of potential common shares issuable upon - - - exercise of employee stock options Weighted average number of common 6,218 6,114 6,097 shares outstanding - diluted
Net loss per share: Basic $(0.23 $(1.14 $(2.77 ) ) ) Diluted $(0.23 $(1.14 $(2.77 ) ) )
Options to purchase 1,606,313, 1,680,084 and 2,175,755 shares of common stock were outstanding during 2004, 2003 and 2002, respectively, but were not included in the computation of earnings per share because the options' exercise price was greater than the average market price of common shares and their inclusion would result in anti-dilution. The options expire through the year 2014.
Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Impairment of Long-Lived Assets
Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets.
2. Restatement of Financial Statements
In light of a recent SEC clarification on lease accounting, we re-evaluated our lease accounting practices and have corrected the way we account for our leases, specifically the accounting for operating leases with scheduled rent increases and tenant allowances.
Under the requirements of FASB Technical Bulletin 85-3, "Accounting for Operating Leases with Scheduled Rent Increases," rent expense should be amortized on a straight-line basis over the term of the lease. In prior periods, we had determined that the term of the lease begins on the commencement date of the lease, which generally coincides with the store opening date, instead of at the time we take physical possession of the property to start construction on leasehold improvements. This had the effect of excluding the construction period of the stores from the calculation of the period over which rent is expensed. We have restated our previously reported Consolidated Financial Statements to correct our accounting for scheduled rent increases.
In addition, under FASB Technical Bulletin 88-1, "Issues Relating to Accounting for Leases," lease incentives such as tenant allowances received from the landlord to cover construction costs incurred by us should be reflected as a deferred liability, amortized over the term of the lease and reflected as a reduction to rent expense. We had previously classified tenant allowances as a reduction to store build out costs (leasehold improvements). As a result, we reflected the amortization as a reduction to depreciation expense instead of as a reduction to rent expense. We have restated our previously reported Consolidated Financial Statements to properly account for tenant allowances.
The restatement primarily resulted in a decrease to retained earnings of $1,540,000 as of February 2, 2002 and an increase in net earnings of $58,000, $503,000, and $484,000 in 2004, 2003 and 2002, respectively. The majority of the adjustments relate to periods prior to 2002.
As a result of these restatements, the Company's financial results have been adjusted as follows (in thousands, except per share data):
As As Previous Restated ly Reported January January 31, Adjustme 31, 2004 nts 2004 Property and equipment 30,037 13,447 43,484 Accumulated amortization (20,064) (7,865) (27,929) Accrued rent expense, 1,247 6,134 7,381 net of current Accumulated deficit (42,164) (552) (42,716) Total stockholders' (7,655) (552) (8,207) deficit
As As Previous Restated ly Reported January January 31, Adjustme 31, 2004 nts 2004 Sales $91,683 - $91,683 Costs and expenses: Cost of goods sold 64,363 (3,448) 60,915 Selling, general and administrative expenses 26,930 - 26,930 Depreciation and 4,055 2,945 7,000 amortization Restructuring charges 1,630 - 1,630 Interest expense 879 - 879 97,857 (503) 97,354 Loss before income taxes $(6,174) 503 $(5,671) Provision for income - - - taxes Net loss $(6,174) 503 $(5,671) NET LOSS APPLICABLE TO COMMON STOCKHOLDERS: Net loss $(6,174) 503 $(5,671) Less: Preferred stock dividends and accretion 1,306 - 1,306 of preferred stock issuance costs Net loss applicable to common stockholders $(7,480) 503 $(6,977) Net loss per common share: Basic and diluted $ 0.08 $ (1.22) (1.14)
As As Previous Restated ly Reported February February 1, Adjustme 1, 2003 nts 2003 Sales $89,781 - $89,781 Costs and expenses: Cost of goods sold 66,707 (2,369) 64,338 Selling, general and administrative expenses 30,053 - 30,053 Depreciation and 3,913 1,885 5,798 amortization Restructuring charges 1,060 - 1,060 Interest expense 1,321 - 1,321 103,054 (484) 102,570 Loss before income taxes $(13,273 484 $(12,789 ) ) Provision for income 3,206 - 3,206 taxes Net loss $(16,479 484 $(15,995 ) ) NET LOSS APPLICABLE TO COMMON STOCKHOLDERS: Net loss $(16,479 484 $(15,995 ) ) Less: Preferred stock dividends and accretion 863 - 863 of preferred stock issuance costs Net loss applicable to common stockholders $(17,342 484 $(16,858 ) ) Net loss per common share: Basic and diluted $ 0.07 $ (2.84) (2.77)
3. Fair Value of Financial Instruments
Balance Sheet: Cash and cash equivalents, accounts receivable, accounts payable and accrued expenses approximate fair value because of the short maturity of these financial instruments. Substantially all of the debt is at variable interest rates, therefore, fair value approximates carrying value.
Off balance sheet: There were no outstanding notional principal amounts of forward exchange contract commitments at January 29, 2005 or at January 31, 2004.
4. Note Receivable
On April 2, 2002, the Company sold its only restaurant accepting a promissory note in return in the principal amount of $80,000. Interest income is netted against selling, general and administrative expenses and was $4,000 during 2004 and $4,000 during 2003. The balance of this note at January 29, 2005 and January 31, 2004 was approximately $41,000 and $57,000, respectively.
5. Property and Equipment
Property and equipment at January 29, 2005 and January 31, 2004 consisted of the following:
2004 2003 (Resta ted) (in thousands)
Land 631 631 Buildings 3,039 3,039 Leasehold improvements 25,624 25,922 Furniture and 14,917 13,89 equipment 2 44,211 43,484
6. Long-term Debt
Long-term debt at January 29, 2005 and January 31, 2004 consisted of the following:
2004 2003 (in thousands)
Borrowings under line of credit with a maximum availability of $22,000,000, bearing interest at a weighted-average variable rate (4.70% at January 29, 2005) payable $ $ monthly, due February, 2007. This 19,17 16,62 line of credit is secured by 8 0 substantially all assets of the Company.
Note payable to financial institution, secured by building and land, bearing interest at a fixed rate (8.34%), due in monthly 663 740 installments of principal and interest of approximately $11,000, with final payment due June, 2011.
Note payable to financial institution, secured by certain equipment, bearing interest at a fixed rate (8.1%), due in monthly - 105 installments of principal and interest of approximately $12,000, with final payment due November, 2004.
Note payable to financial institution, secured by building and land, bearing interest at a fixed rate (4.25%) due in monthly 670 751 installments of principal and interest of approximately $9,000, with final payment due December, 2005.
Capital lease obligation, secured by computer equipment, bearing interest at a fixed rate (8.00%) due in quarterly installments of principal 27 - and interest of approximately $9,000, with final payment due September, 2005.
Total debt 20,53 18,2 8 16
Less current maturities of long- 19,95 16,85 term debt 8 8
Long-term debt, net of current $ $ maturities 580 1,358
The Company's original three-year credit facility with Wells Fargo Retail Finance II, LLC, ("WFRF") was entered into on February 5, 2003 and provided the Company with a maximum available credit limit of $22 million. This agreement was scheduled to expire in February 2006. As discussed below, on April 29, 2004, the maximum available credit line was increased to the lesser of $25 million or $22 million plus outstanding participant advances, and the expiration date was extended to February 5, 2007. The credit facility is secured by substantially all assets of the Company and its subsidiaries and is subject to a borrowing base calculation based primarily on inventory and accounts receivable. The facility has two financial covenants, a minimum excess availability covenant of $1.35 million and a maximum capital expenditure covenant, established at $2.75 million for 2004. Interest rates under the facility are at prime plus 0.5% or LIBOR plus 2.50%, with the ability to reduce the rate if the Company achieves certain financial criteria. The balance outstanding on the Company's line of credit at January 29, 2005 was $19,178,000 which includes the $4 million outstanding under the bridge facility discussed below. At January 29, 2005 the Company's availability under the WFRF line of credit was approximately $3.0 million above the minimum availability requirement of $1.35 million and the average interest rate on the credit line was 4.70%.
Subsequent to securing the initial credit facility, the Company negotiated an increase of $2 million in its total borrowing availability under its existing credit facility with WFRF. The Company obtained this increase in order to provide for additional working capital. The full $2 million was available for borrowing on July 15, 2003 and has been extended to the Company by Wells Fargo based upon a loan participation agreement between Wells Fargo and RonHow, LLC, an entity established in July 2003 which is owned and controlled directly or indirectly by Ronald de Waal and W. Howard Lester. Mr. de Waal and Mr. Lester are both major beneficial owners of the Company's common stock, and Mr. Lester is also a director of the Company.
In order to achieve additional liquidity, on April 29, 2004, the Company completed an amendment to the credit facility with WFRF which increased the Company's borrowing availability under the facility. The amendment increased the Company's maximum inventory advance rate cap from 75% to 80% during non-peak times and from 80% to 85% during peak times. Peak times were amended to include the eight weeks prior to Easter and the eight weeks prior to October 1. The increase in advance rates is expected to increase the availability under the facility by as much as $3 million depending on the level of inventories. Additionally, the amendment extended the term of the credit facility by one year, with a new expiration of February 5, 2007. The amendment also increased the maximum revolver amount from $22 million to the lesser of $25 million or $22 million plus outstanding participant advances. Finally, the amendment provided for an additional increase of $2 million in the Company's borrowing availability under the facility based upon an increase in the existing loan participation agreement between WFRF and RonHow, LLC. WFRF will continue to serve as the lending agent for the Company under the credit facility, and the principal covenants and conditions imposed upon the Company pursuant to the WFFR credit facility agreement have not materially changed. RonHow, LLC's right to repayment of any advances under the credit facility that are attributable to its total $4 million participation is generally subordinate to the repayment rights of the other credit facility lenders. However, the Company may repay these advances provided it meets certain conditions, including the maintenance of an average daily excess availability under the credit facility of at least $2.5 million for the 30 days prior to and 30 days projected immediately following the repayment. The average excess availability requirement is higher than the excess availability otherwise required of the Company under the credit facility. If the Company does not repay the new $2 million loan participation of RonHow during the 18 months subsequent to April 29, 2004, RonHow will have an option at that time to convert any of the incremental $2 million not repaid into shares of authorized but unissued 2003-A Preferred Stock, which will be convertible into shares of common stock at a price of $2.524 per share, which was the 20-day average closing price of the Company's common stock for the period ending immediately before closing of the loan amendment. Additionally, if the Company has not repaid the initial $2 million of loan participation by February 2006, the Company will pay an additional 4% fee per annum on the outstanding participation amount up to $2 million. This transaction was approved by the independent directors.
The Company was in compliance with its debt covenants for the year ended January 29, 2005. Although the Company's line of credit with WFRF does not expire until February 2007, the Company has classified its borrowings under its line of credit as current in its consolidated balance sheets due to the terms of its agreement with the lender. Under the bank agreement, there is an acceleration clause which potentially allows the bank to demand immediate payment of all outstanding borrowings upon the occurrence of a material adverse change in the Company's operations or financial position. Determination of what constitutes a material adverse change is at the discretion of the bank, however, it is subject to reasonableness standards. In addition, the Company is required to maintain a lock-box agreement with the bank whereby all cash received is applied against current borrowings. As a result of these items, the Company is required to classify its line of credit borrowings as current as proscribed by 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."
The annual maturities of the above long-term debt as of January 29, 2005 are as follows (in thousands):
Year 2005 $19,9 2006 90 2007 98 2008 106 2009 116 2010 and 170 subsequent Total $20,5
7. Income Taxes
Income tax provision for the years ended January 29, 2005, January 31, 2004 and February 1, 2003, consisted of the following:
2004 2003 2002 (in thousands)
Current provision - - - (benefit) Deferred provision - - 3,206 (benefit)
Total - - 3,206
Income tax expense differs from the statutory tax rate as follows:
2004 2003 2002
Statutory tax rate 34.0% (34.0) (34.0) % % Changes in income taxes caused by: State income taxes 6.0 (6.0) (6.0) Non-deductible - - - goodwill Net operating loss valuation allowance (40.0) 40.0 64.2 and other Effective tax rate 0.0% 0.0% 24.2%
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets at January 29, 2005 and January 31, 2004 are presented below:
2004 2003 (in thousands) Deferred tax assets - current: Allowance for 80 80 doubtful accounts Merchandise 497 1,241 inventories Accrued expenses 607 565 1,184 1,886 Less: Valuation (1,184 (1,886 allowance ) ) - -
Deferred tax assets - noncurrent: Property and 3,160 2,969 equipment Net operating loss 9,184 7,931 12,344 10,900 Less: Valuation (12,34 (10,90 allowance 4) 0) - -
The Company's federal net operating losses of approximately $21.6 million will begin to expire in 2021. The Company also has state net operating losses of approximately $30.7 million which begin to expire in 2005. During 2002, the Company increased its valuation allowance to fully provide for all remaining deferred tax assets because the Company's recent history of operating losses made the realization of these assets uncertain. The Company's valuation allowance as of January 29, 2005 is equal to 100% of its deferred tax assets.
The ability of the Company to utilize net operating loss carryforwards to reduce future federal taxable income and federal income tax of the Company is subject to various limitations under the Internal Revenue Code of 1986 ("the Code"), as amended. The utilization of such carryforwards may be limited upon the occurrence of certain ownership changes, including the issuance or exercise of rights to acquire stock, the purchase or sale of stock by 5% stockholders, as defined in the Treasury regulations, and the offering of stock by the Company during any three-year period resulting in an aggregate change of more than 50% in the beneficial ownership of the Company.
In the event of an ownership change (as defined for income tax purposes), Section 382 of the Code imposes an annual limitation on the amount of a corporation's taxable income that can be offset by these carryforwards. The limitation is generally equal to the product of (i) the fair market value of the equity of the Company multiplied by (ii) a percentage approximately equivalent to the yield on long-term tax exempt bonds during the month in which an ownership change occurs. The Company's management, in consultation with its tax advisors, has been assessing the impact its preferred stock issuances had on the change in the beneficial ownership of the Company, and whether or not such a change would impact the Company's ability to utilize its net operating loss carryforwards ("NOLs"). After thorough review, it was determined in the third quarter of 2004 that a change in ownership had occurred on October 1, 2002, and that this change resulted in a limitation on the Company's ability to utilize its NOLs under Section 382 of the Code. As a result of the limitation, the Company may only utilize $1.0 million per year of its total October 1, 2002 pre-change NOL of $12.5 million. Any portion of the $1.0 million annual limitation not utilized in a particular year may be carried over to the next year and added to that year's limitation. Based on the Company's 2004 projected taxable loss, the cumulative excess annual limitation carryover to 2005 is approximately $2.4 million.
8. Stock and Stock Options
The Company has authorized 1,000,000 shares of preferred stock, par value $.01 per share. This preferred stock may be issued in one or more series and the terms and rights of such stock will be determined by the Board of Directors. As of January 31, 2004, The Board had authorized three series of preferred stock, the Amended Series 2001-A Preferred Stock, consisting of 600,000 shares, and the 2002-A Preferred Stock consisting of 300,000 shares, and the 2003-A Preferred Stock consisting of 100,000 shares.
On February 28, 2001, the Company executed a definitive agreement to allow an investor to purchase from the Company 300,000 shares of convertible preferred stock for a total purchase price of $6 million. Under this preferred stock agreement, each of the 300,000 initially issued shares of preferred stock is convertible into 15.6863 shares of common stock of the Company. The preferred shares have voting rights equal to the number of common shares into which they may be converted. Until converted, the preferred stock is entitled to receive quarterly dividends that cumulate annually at a rate of 10% per annum, which are reduced to 8% per annum if the Company's operating income for any fiscal year ending after February 28, 2001 exceeds $4,735,000. Dividends are payable 50% in cash and 50% in additional shares of preferred stock until February 28, 2003 and thereafter in additional shares of preferred stock or cash as the holder of the preferred stock may elect. Shares of preferred stock issued in respect of dividends are convertible into common stock based upon an average market price of the common stock as of the respective dividend dates. Following the third anniversary of the original issuance date, the preferred shares are redeemable at the option of the Company at a price equal to the initial purchase price plus cumulated and accrued but unpaid dividends. The preferred shares are not included in the stockholders' equity section of the balance sheet because the preferred shareholders have special voting rights that empower them to elect a majority of the board of directors and maintain effective control over the Company.
On August 2, 2002, the Company executed a definitive agreement to allow a group of investors to purchase from the Company 200,000 shares of Series 2002-A convertible preferred stock for a total purchase price of $4 million. Under this preferred stock agreement, each of the 200,000 issued shares of preferred stock is convertible into common stock of the Company at a fixed rate of $2.72 per share. The preferred shares have voting rights equal to the number of common shares into which they may be converted. Until converted, the preferred stock is entitled to receive quarterly dividends that cumulate annually at a rate of 8% per annum, which is reduced to 6% per annum if certain profitability targets are met by the Company. Dividends are payable 50% in cash and 50% in additional shares of preferred stock until July 1, 2003 and thereafter in additional shares of preferred stock or cash as the holder of the preferred stock may elect. Following the third anniversary of the original issuance date, the Series 2002-A Preferred Stock is redeemable at the option of the Company at a price equal to the initial purchase price plus cumulated and accrued but unpaid dividends. The preferred shares are not included in the stockholders' equity section of the balance sheet because the preferred shareholders have special voting rights that empower them to elect a majority of the board of directors and maintain effective control over the Company.
On February 5, 2003, the Company closed on a $5 million private equity investment by Inter-Him, N.V., of which Ronald de Waal is a Managing Director, and W. Howard Lester, a director of the Company (the "Investors"). The Investors purchased an aggregate of 50,000 shares of a new series of preferred stock, designated Series 2003-A Preferred Stock, at a purchase price of $100.00 per share. The Series 2003-A Preferred Stock is convertible into common stock at a fixed rate of $1.15 per share, and otherwise provides rights and preferences substantially similar to the Company's existing 2002-A Preferred Stock. As a result of the sale of the 2003-A Preferred Stock, the percentage ownership of common stock on an as-converted basis (assuming conversion of all of the Company's outstanding preferred stock) by Inter-Him and Mr. de Waal is 52.6%. The preferred shares are not included in the stockholders' equity section of the balance sheet because the preferred shareholders have special voting rights that empower them to elect a majority of the board of directors and maintain effective control over the Company.
The Company has reserved 3,000,000 shares of its common stock for issuance to key employees under its current stock option and equity incentive plan, which was adopted in 2002 and replaced a prior plan initially adopted in 1993. The current plan has a term of ten years. The Compensation Committee of the Board of Directors may grant incentive or non-qualified stock options, restricted stock, stock appreciation rights and other stock-based and cash awards under the provisions of the plan. The exercise price of incentive stock options is the fair market value of the stock at the date of the grant, plus ten percent if the employee possesses more than ten percent of the total combined voting power of all classes of the Company's stock. Options granted may have a term of up to ten years, except that incentive stock options granted to stockholders who have more than ten percent of the Company's voting stock at the time of the grant may have a term of up to five years. No options were granted to stockholders who have more than 10% of the Company's voting stock during 2003, 2002 or 2001 under the incentive plan. Twenty percent of each option grant, except for grants to non- employee board members, vests one year after the date of issuance with the remaining options vesting at 20% per year for four years. Non-employee board members are required to wait six months from the date of grant before exercising any options from that grant, at which time the options are fully vested. Any unexercised portion of the options will automatically and without notice terminate upon the applicable anniversary of the issuance date or termination of employment. A summary of the status of the Company's stock option plan, and activity for the periods indicated, is presented as follows:
Options Options Outstanding Exercisable Weight Weight ed ed Avg. Avg. Shares Exerci Shares Exerci se se Price Price
Balance of options 1,962, 3.88 810,77 $5.69 outstanding at February 2, 082 9
Granted 461,00 2.25 Terminated (245,4 2.50 57) Exercised (4,000 2.00 )
Balance of options 2,173, 3.70 1,159, $4.83 outstanding at February 1, 625 482
Granted 312,80 1.13 Terminated (156,2 3.42 02) Exercised (109,4 2.07 39)
Balance of options 2,220, $3.43 1,282, $4.45 outstanding at January 31, 784 736
Granted 359,55 3.02 Terminated (436,1 4.82 43) Exercised (13,35 1.46 0)
Balance of options 2,130, $3.09 1,383, $3.46 outstanding at January 29, 841 431
As of the year ended January 29, 2005, the range of exercise prices and weighted average remaining contractual life of outstanding options was $0.95 - $16.71, and 5.9 years, respectively. The following table summarizes information about the Company's stock options, which were outstanding, and those, which were exercisable as of January 29, 2005:
Options Outstanding Options Exercisable Range Weighted Weighted Weighted of Number Average Average Number Average Exercise Outstand Remainin Exercise Exercisa Exercisab Prices ing g Life Price ble le Price
0.95- 396,28 7.9 $1.34 208,82 $1.44 1.20 0 0 1.20- 1,446, 5.9 $2.58 886,48 $2.45 4.06 436 6 4.06- 203,62 3.8 $6.24 203,62 $6.24 7.66 6 6 7.66- 84,499 1.7 $12.38 84,499 $12.38 16.71 2,130, 1,383, 841 431
The weighted average fair values of options granted under the non-qualified plan during 2004, 2003 and 2002 were $2.25, $0.80, and $1.63, respectively.
The fair value of each non-qualified and incentive option granted was estimated using the Black-Scholes Option Pricing Model with the following assumptions for 2004, 2003 and 2002: risk-free interest rate of 4.15% for 2004, 4.28% for 2003, and 4.84% for 2002; expected dividend yield of 0% for all periods; expected lives of approximately seven years for 2004, 2003 and 2002; and volatility of the price of the underlying common stock of 79.0% for 2004, 75.1% for 2003, and 73.6% for 2002.
9. Retirement and Benefit Plans
The Company has a profit sharing retirement plan with a 401(k) provision that allows participants to annually contribute up to $13,000 of their compensation before income taxes plus an additional catch up contribution of $3,000 before income taxes if the participant is at least 50 years old. Eligible participants are employees at least 21 years of age with one year of service. The Company's Board of Directors will designate annually the amount of the profit sharing contribution as well as the percentage of participants' compensation that it will match as 401(k) contributions. For the years ended January 29, 2005, January 31, 2004, and February 1, 2003, the Company contributed approximately $250,000, $249,000, and $243,000, respectively, to the 401(k) plan.
10. Related Party Transactions
The Company leases its Norman, Oklahoma retail and outlet stores and a distribution center facility from a limited partnership whose partners include Rebecca Powell Casey, an executive officer and a director of the Company, and certain of her family members. The store lease terms in 2004, 2003 and 2002, provided for annual base rental payments and percentage rent equal to four percent of sales plus insurance, utilities, and property taxes. During the years ended January 29, 2005, January 31, 2004, and February 1, 2003, the total of such rent for the stores was approximately $246,000, $214,000, and $230,000, respectively. The term of the retail space lease is twelve years commencing June 4, 1996. The term of the distribution center lease is sixteen years commencing July 1, 1996, with increasing annual rental payments on a fixed scale which has a maximum annual rental up to $419,951 during the final year of the lease. The lease also provides for payments to the partnership for insurance, utilities and property taxes. The Company leases its corporate headquarters location from a limited partnership whose partners include W. Howard Lester, a director of the Company and the above referenced partnership. The lease, which was amended in 2003, expires September, 2010 with monthly rent payments of $26,490, plus insurance, utilities and property taxes until November, 2005 at which time monthly rent will be $38,443, plus insurance, utilities and property taxes until September, 2007 at which time monthly rent will be $40,366 plus insurance, utilities and property taxes until the expiration of the lease. This lease contains two renewal options of five years each. These leases have been approved by all independent directors as being on terms at or below available competitive market renewal rates.
See Note 8 for information concerning the purchase of preferred stock by one of the Company's executive officers and certain members of the Company's Board of Directors.
11. Facility Leases
The Company conducts a majority of its retail operations from leased store premises under leases that will expire within the next ten years. In addition to minimum rental payments, certain leases provide for payment of taxes, maintenance, and percentage rentals based upon sales in excess of stipulated amounts.
Minimum rental commitments (excluding renewal options) for store, distribution premises, office space and equipment under noncancelable operating leases having a term of more than one year as of January 29, 2005 were as follows (in thousands):
Year: 2005 $ 7,139 2006 7,037 2007 6,748 2008 5,829 2009 4,145 2010 and 6,704 subsequent Total $37,6
Total rental expense for the years ended January 29, 2005, January 31, 2004 and February 1, 2003, was as follows (in thousands):
2004 2003 2002
Base rent $6,79 $8,54 $7,79 7 4 3 Additional rents computed 252 217 288 As percentage of sales Total $7,04 $8,76 $8,08 9 1 1
12. Business Concentrations
More than 95% of the ladies' apparel sales were attributable to the Company's product development and private label programs during 2004, 2003 and 2002. The breakdown of total sales between ladies' and men's apparel was approximately 81% and 19% for 2004, 78% and 22% for 2003, and 76% and 24% for 2002.
13. Commitments and Contingent Liabilities
The Company may issue letters of credit which are used principally in overseas buying, cooperative buying programs, and for other contract purchases. At January 29, 2005, the Company had no outstanding letters of credit to secure orders of merchandise from various domestic and international vendors.
The Company did not enter into any forward exchange contracts during the year ended January 29, 2005. Normally, forward exchange contracts require the Company to exchange U.S. dollars for foreign currencies at maturity, at rates agreed to at inception of the contracts. The contracts are usually of varying short-term duration and include a window delivery feature that provides the Company with an option to enter into a swap agreement in the event that all of the currency is not utilized at the end of the contract's delivery term. A swap allows the Company to sell the unused currency, at the contract's maturity, to the counterparty at the current market rate and then buy back the same amount for the time period to which the Company wants to extend. The counterparty to the derivative transactions is a major financial institution. The credit risk is generally limited to the unrealized gains or losses in such contracts should this counterparty fail to perform as contracted. The Company considers the risk of counterparty default to be minimal.
The Company is involved in various claims, administrative agency proceedings and litigation arising out of the normal conduct of its business. Although the ultimate outcome of such litigation cannot be predicted, the management of the Company, after discussions with counsel, believes that resulting liability, if any, will not have a material effect upon the Company's financial position or results of operations.
14. Business Segments
The Company manages its operations on an individual store basis. Financial information is maintained for each store and provided to the Company's management for review and as a basis for decision making. The Company fully allocates all expenses down to a pre-tax level and monitors each store's performance accordingly. Given the economic characteristics of the store formats, the similar nature of the products sold, the type of customer and method of distribution, the operations of the Company are aggregated into one reportable segment. The Company has no operations that would qualify as a separate operating segment under Statement of Financial Accounting Standards (SFAS) No. 131 "Disclosure About Segments of an Enterprise and Related Information."
SUPPLEMENTARY DATA
Summarized unaudited quarterly financial results are as follows (in thousands, except per share data):
First Second Third Fourth 52 Weeks Ended January 29, 2005 Sales $24,1 $19,2 $23,1 $22,7 69 90 10 88 Gross profit on sales as 9,032 6,156 8,382 N/A previously reported Gross profit on sales 9,297 6,421 8,647 7,349 (as restated, see Note 2) Net income (loss) applicable to common 237 (1,434 272 N/A stockholders as ) previously reported Net income (loss) applicable to common 251 (1,420 286 (525) stockholders (as ) restated, see Note 2) Net income (loss) per common share: Basic as previously $0.04 ($0.23 $0.05 N/A reported ) Basic (as restated, $0.04 ($0.23 $0.05 ($0.09 see Note 2) ) ) Diluted as previously $0.04 ($0.23 $0.04 N/A reported ) Diluted (as restated, $0.04 ($0.23 $0.04 ($0.08 see Note 2) ) )
52 Weeks Ended January 31, 2004 Sales $24,6 $19,5 $23,8 $23,5 95 61 63 64 Gross profit on sales as 7,174 5,824 9,087 5,235 previously reported Gross profit on sales 8,036 6,686 9,949 6,097 (as restated, see Note 2) Net (loss) income applicable to common (2,515 (2,535 629 (3,059 stockholders (A) as ) ) ) previously reported Net (loss) income applicable to common (2,389 (2,409 755 (2,934 stockholders (A) (as ) ) ) restated, see Note 2) Net (loss) income per common share: Basic as previously ($0.41 ($0.42 $0.10 ($0.49 reported ) ) ) Basic (as restated, ($0.39 ($0.40 $0.12 ($0.47 see Note 2) ) ) ) Diluted as previously ($0.41 ($0.42 $0.06 ($0.49 reported ) ) ) Diluted (as restated, ($0.39 ($0.40 $0.06 ($0.47 see Note 2) ) ) )
(A) In the first and second quarters of 2003, the Company recorded restructuring charges of approximately $1.63 million. The restructuring charges consisted primarily of lease termination costs of approximately $1.24 million. The remainder of the restructuring charges consisted primarily of legal and consulting fees related to planned store closings in the first half of 2003.
Schedule II
HAROLD'S STORES, INC. AND SUBSIDIARIES VALUATION ACCOUNT (In Thousands)
Additi Balanc Additi ons- Deduct Balanc e at ons- Recove ions- e at Description Beginn Charge ries Write- End of ing of d to of off of Period Period Expens Accoun Accoun e ts ts Writte n off
52 Weeks ended January 29, 2005: Allowance for $200 218 35 253 $200 doubtful accounts
52 Weeks ended January 31, 2004: Allowance for $200 192 29 221 $200 doubtful accounts
52 Weeks ended February 1, 2003: Allowance for $200 217 58 275 $200 doubtful accounts