1 FORM 10-Q SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 (Mark One) ( X ) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended October 29, 1995 OR ( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ____________________ to ___________________ . Commission file number 0-21182 ORCHARD SUPPLY HARDWARE STORES CORPORATION ------------------------------------------------------ (Exact name of registrant as specified in its charter) Delaware 95-4214109 ------------------------------- ------------------------------------ (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 6450 Via Del Oro, San Jose, California 95119 - ---------------------------------------- ---------- (Address of principal executive offices) (Zip Code) (408) 281-3500 ---------------------------------------------------- (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ____ At October 29, 1995 there were 6,984,475 shares of the registrant's Common Stock, $0.01 par value, outstanding. Page 1 of 13 2 ORCHARD SUPPLY HARDWARE STORES CORPORATION AND SUBSIDIARY INDEX PART I. FINANCIAL INFORMATION PAGE NO. - ------- --------------------- Item 1. Financial Statements Condensed Consolidated Balance Sheets: October 29, 1995 and January 29, 1995 3 Condensed Consolidated Statements of Income: Three and Nine Month Periods Ended October 29, 1995 and October 30, 1994 4 Condensed Consolidated Statements of Cash Flows: Nine Month Periods Ended October 29, 1995 and October 30, 1994 5 Notes to Condensed Consolidated Financial Statements 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 7 PART II. OTHER INFORMATION - -------- ----------------- Item 6. Exhibits and Reports on Form 8-K 12 Signatures 13 2 3 PART 1 - FINANCIAL INFORMATION ITEM 1 - FINANCIAL STATEMENT ORCHARD SUPPLY HARDWARE STORES CORPORATION AND SUBSIDIARY CONDENSED CONSOLIDATED BALANCE SHEETS (In Thousands) October 29, January 29, 1995 1995 ----------- ----------- (Unaudited) ASSETS CURRENT ASSETS: Cash and cash equivalents $ 15,873 $ 9,240 Investments - 3,000 Accounts receivable, net 17,508 14,417 Inventories 107,233 103,438 Prepaid expenses and other 8,879 8,221 Assets held for disposal 6,384 6,145 -------- -------- Total current assets 155,877 144,461 PROPERTY AND EQUIPMENT, net 132,183 129,840 OTHER ASSETS, net 17,076 18,358 -------- -------- Total assets $305,136 $292,659 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable, accrued and other liabilities $ 76,530 $ 70,919 Notes payable 698 773 Current portion of capital leases and long term debt 2,014 1,720 -------- -------- Total current liabilities 79,242 73,412 OTHER LIABILITIES, net of current portion 408 1,437 CAPITAL LEASES AND LONG-TERM DEBT, net of current portion 133,430 135,232 -------- -------- Total liabilities 213,080 210,081 -------- -------- STOCKHOLDERS' EQUITY: Common stock 70 70 Preferred stock 8 8 Additional paid-in-capital 90,408 90,700 Less notes receivable from sale of common stock (124) (151) Retained earnings (accumulated deficit) 1,694 (8,049) -------- -------- Total equity 92,056 82,578 -------- -------- Total liabilities and stockholders' equity $305,136 $292,659 ======== ======== The accompanying notes are an integral part of these condensed consolidated financial statements. 3 4 ORCHARD SUPPLY HARDWARE STORES CORPORATION AND SUBSIDIARY CONDENSED CONSOLIDATED STATEMENTS OF INCOME (Unaudited) (In Thousands, Except Per Share Data) Nine Months Ended Three Months Ended ------------------------ ------------------------ October 29, October 30, October 29, October 30, 1995 1994 1995 1994 ----------- ----------- ----------- ----------- Sales $402,314 $333,911 $131,497 $111,790 Cost of goods sold 256,831 213,292 83,981 70,747 Gross margin 145,483 120,619 47,516 41,043 Selling, general and administrative expenses 119,371 101,424 40,277 36,665 Pre-opening expenses 2,241 6,973 1,219 595 -------- -------- -------- -------- Operating income 23,871 12,222 6,020 3,783 Interest expense 10,068 9,236 3,149 3,185 -------- -------- -------- -------- Income before provision for income taxes 13,803 2,986 2,871 598 Income tax provision 3,460 - 1,051 - -------- -------- -------- -------- Net income 10,343 2,986 1,820 598 Preferred stock dividends 900 823 300 303 -------- -------- -------- -------- Net income available to common stock $ 9,443 $ 2,163 $ 1,520 $ 295 ======== ======== ======== ======== Income per common share: Primary $ 1.35 $ 0.31 $ 0.22 $ 0.04 ======== ======== ======== ======== Fully diluted $ 1.24 $ 0.31 $ 0.22 $ 0.04 ======== ======== ======== ======== Weighted average number of shares outstanding: Primary 7,020 6,985 7,060 6,990 ======== ======== ======== ======== Fully diluted 8,315 8,265 8,340 8,270 ======== ======== ======== ======== The accompanying notes are an integral part of these condensed consolidated financial statements. 4 5 ORCHARD SUPPLY HARDWARE STORES CORPORATION AND SUBSIDIARY CONDENSED STATEMENTS OF CASH FLOWS (Unaudited) (In Thousands) Nine Months Ended --------------------------- October 29, October 30, 1995 1994 ----------- ----------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income $10,343 $ 2,986 Non-cash adjustments to net income- Depreciation and amortization 8,010 6,110 Loss on asset disposals 507 789 Changes in assets and liabilities- Increase in accounts receivable (3,091) (2,040) Increase in inventories (3,795) (14,861) Increase in prepaid expenses and other (658) (1,438) Increase in other noncurrent assets (161) - Increase in accounts payable, accrued and other liabilities 4,582 11,122 ------- -------- Total Adjustments 5,394 (318) ------- -------- Net cash provided by operating activities 15,737 2,668 ------- -------- CASH FLOWS FROM INVESTING ACTIVITIES: Additions to property and equipment (9,648) (26,563) Redemption (purchase) of investments 3,000 (3,000) ------- -------- Net cash used in investing activities (6,648) (29,563) ------- -------- CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from issuance of preferred stock - 19,400 Common stock issued upon exercise of warrants and options 8 439 Payment of notes receivable from sale of capital stock 27 16 Principal payments on capital leases and long-term debt (1,508) (49,858) Premium on redemption of long-term debt - (2,287) Payment of preferred stock dividend (900) (660) Transaction costs (8) (679) Repayment of notes payable, net (75) (569) ------- -------- Net cash used in financing activities (2,456) (34,198) ------- -------- NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 6,633 (61,093) CASH AND CASH EQUIVALENTS, beginning of period 9,240 75,588 ------- -------- CASH AND CASH EQUIVALENTS, end of period $15,873 $ 14,495 ======= ======== The accompanying notes are an integral part of these condensed consolidated financial statements. 5 6 ORCHARD SUPPLY HARDWARE STORES CORPORATION AND SUBSIDIARY NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 1. BASIS OF PRESENTATION The condensed consolidated financial statements included herein have been prepared by the Company, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (SEC). Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. However, the Company believes that the disclosures are adequate to make the information presented not misleading. These condensed consolidated financial statements should be read in conjunction with the financial statements and the notes thereto for the year ended January 29, 1995 included in the Company's Form 10-K. The unaudited condensed consolidated financial statements included herein reflect all adjustments (which include only normal, recurring adjustments) that are, in the opinion of management, necessary to state fairly the results for the periods presented. The results for such periods are not necessarily indicative of the results to be expected for the full fiscal year. 2. EARNINGS PER SHARE Net income per common and equivalent share is computed by dividing net income available to common stock (net income less preferred stock dividend requirements) by the weighted average number of common and equivalent shares. Common and common equivalent shares include common stock issuable upon exercise of stock options and warrants (using the treasury stock method) less shares assumed repurchased with the proceeds from the management notes. Common equivalents included in the weighted average number of shares assume the conversion of options outstanding under the Nonqualified Stock Option Plan, the Non-Employee Directors Plan, the 1993 Stock Option Plan and the warrants, unless antidilutive. Certain options granted to the President are excluded from the calculation due to their contingent nature. For purposes of the calculation of earnings per share on a fully-diluted basis, outstanding shares of convertible preferred stock are assumed to be converted if dilutive. 3. INCOME TAX PROVISION The effective tax rate for the quarter ended October 29, 1995 reflects the estimated tax rate for the year ended January 28, 1996 based upon projected income and other factors. This rate differs from the combined federal and state of California statutory rates primarily due to expected reductions in the previously established valuation allowance related to deferred tax assets, primarily net operating loss carryforwards. 6 7 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. GENERAL Since the Company's initial public offering in April 1993, new store expansion has increased. In fiscal 1994 the Company opened 14 stores, nine through the acquisition of former Builders Emporium store sites, on a base of 43 stores. Five stores will open in fiscal 1995 and five to ten store openings per year are planned thereafter. As the Company implements its new store opening program, operating expenses as a percent of sales for the new stores will initially be higher, adversely affecting overall operating margins until these new stores achieve sales maturity. In addition, the Company expects that it will generally experience higher marketing, distribution and occupancy costs in its new stores in the metropolitan Los Angeles market where a significant amount of its future expansion will be directed. The Company believes, however, that these higher expenses will be offset by higher sales at these stores than are typical of mature Orchard stores in Northern and Central California. The Company expects that the impact of these factors will be to reduce operating margins so long as the Company continues to open a large number of stores relative to its existing store base. The Company's results of operations exhibit some measure of seasonality. During the three fiscal years ended January 29, 1995, approximately 28.0% of the Company's annual sales and approximately 37.0% to 40.0% of its annual operating income before pre-opening expenses were generated in the second fiscal quarter. This is due primarily to increased sales of garden, nursery and related products during the first and second quarters, which is the beginning of the spring/summer gardening season. Weather conditions have the most impact on sales of these outdoor related products during this period. Conversely, during the three years ended January 29, 1995, approximately 24.0% of the Company's annual sales and approximately 13.0% to 19.0% of its annual operating income before pre-opening expenses were generated in the fourth fiscal quarter, due primarily to decreased sales of garden, nursery and related products during this quarter. 7 8 RESULTS OF OPERATIONS The following table sets forth selected results of operations as percentages of sales for the periods indicated: Three Months Ended Nine Months Ended ----------------------------- ---------------------------- October 29, October 30, October 29, October 30, 1995 1994 1995 1994 ----------- ----------- ----------- ----------- Sales 100.0% 100.0% 100.0% 100.0% Gross margin 36.1 36.7 36.2 36.1 Selling general and administrative expenses 30.6 32.8 29.7 30.4 Pre-opening expense 0.9 0.5 0.6 2.1 ----- ----- ----- ----- Operating income 4.6 3.4 5.9 3.7 Interest expense, net 2.4 2.8 2.5 2.8 ----- ----- ----- ----- Income before provision 2.2 0.5 3.4 0.9 Income tax provision 0.8 - 0.9 - ----- ----- ----- ----- Net income 1.4% 0.5% 2.6% 0.9% ===== ===== ===== ===== THREE MONTHS ENDED OCTOBER 29, 1995 AND OCTOBER 30, 1994 Sales for the third quarter ended October 29, 1995 were $131.5 million, an increase of 17.6% over sales of $111.8 million in the third quarter of fiscal 1994. This increase reflects a 10.1% comparable store sales gain during the quarter as well as five new stores opened since the third quarter of last year. The increase in comparable store percentage partially reflects the diminishing effect of eight competing warehouse home centers that opened primarily in the second half of fiscal 1993, which now have passed their anniversary. As a group, the stores which were impacted by the eight warehouse openings showed a positive comparable sales gain for the current quarter. Also, favorably affecting comparable store sales were the recent closing of four competing warehouse home centers, and the inclusion of sales gains achieved by 13 Orchard stores opened during last year which are now part of the comparable store base. Gross margin increased $6.5 million from $41.0 million for the third quarter of fiscal 1994 to $47.5 million for the comparable period this year. Gross margin as a percent of sales decreased from 36.7% for the third quarter of fiscal 1994 to 36.1% for the third quarter of fiscal 1995. The decrease in gross margin percentage is attributable primarily to a lower markup on merchandise purchased during the 1995 third quarter compared with an unusually high markup in the comparable period of 1994, partially offset by lower inventory shrinkage and the leveraging of warehouse operating costs as the number of stores has increased. Selling, general and administrative expenses for the third quarter of fiscal 1995 were 30.6% of sales compared with 32.8% of sales in the third quarter fiscal 1994. Operating efficiencies as well as the sales gain for the quarter resulted in a significant leveraging of payroll as a percentage of sales. Most other expense categories also experienced percent of sales reductions, although to a lesser degree. 8 9 Operating income for the third quarter of fiscal 1995 increased $2.2 million to $6.0 million from $3.8 million in last year's third quarter. Operating income before pre-opening expenses increased 65.3% to $7.2 million in the current year's third quarter from $4.4 million in the previous year's third quarter. Increased sales and the leveraging of expenses were primarily responsible for the increase in operating income. Pre-opening expenses in the third quarter of 1995 increased to $1.5 million from $0.6 million in the third quarter of 1994. The increase is primarily the result of two new stores being opened during the quarter of the current year and only one new store opened in the comparable quarter last year. The Company recorded an income tax provision for the third quarter of fiscal 1995 at an effective tax rate of 36.6% based on the estimated annual tax rate for fiscal 1995 which takes into account projected income and other factors. In the third quarter of 1994, the Company did not record an income tax provision as a result of the benefit of net operating loss carry forwards against which a valuation allowance had previously been provided. See Note 3 to the Condensed Consolidated Financial Statements. NINE MONTHS ENDED OCTOBER 29, 1995 AND OCTOBER 30, 1994 Sales for the nine months ended October 29, 1995 increased by 20.5% to $402.3 million from $333.9 million in the comparable period of fiscal 1994. The increase is attributable to a 6.3% gain in comparable store sales and a portion of the sales contributed by 18 stores opened since the beginning of fiscal 1994. As previously discussed, the comparable store sales increase reflects the diminishing effect of eight competing warehouse home centers that opened primarily in 1993, the recent closing of four competing warehouse home centers, and sales gains achieved by 13 Orchard stores opened last year which are now part of the comparable store base. Gross margin increased $24.9 million from $120.6 million for the first nine months of fiscal 1994 to $145.5 million for the comparable period of 1995. As a percentage of sales gross margin increased from 36.1% for the first nine months of fiscal 1994 to 36.2% for the first nine months of fiscal 1995. The increase in gross margin resulted primarily from reduced inventory shrinkage and leveraging of warehouse operating costs. Selling, general and administrative expenses increased by $17.9 million from $101.4 million for the first nine months of fiscal 1994 to $119.4 million for the first nine months of fiscal 1995. As a percentage of sales these expenses decreased from 30.4% for the first nine months of fiscal 1994 to 29.7% for the comparable period of 1995. Decreased payroll cost as a percentage of sales was offset partially by an increase in occupancy cost as a percentage of sales. Operating income increased by $11.6 million from $12.2 million in the first nine months of fiscal 1994 to $23.9 million in the first nine months of fiscal 1995. Operating income before pre-opening expenses for the first nine months of fiscal 1995 increased by $6.9 million or 36.0% from the comparable period of 1994. Sales increases and the leveraging of expenses were the main contributors to increased operating income. Pre-opening expenses decreased to $2.2 million for the first nine months of fiscal 1995 from $7.0 million for the comparable period of last year. The decrease in pre-opening expense is due to four new store openings in the first nine months of fiscal 1995 versus 13 stores in the same nine month period of last year. Interest expense increased by $0.8 million from $9.2 million for the first nine months of fiscal 1994 to $10.1 million for the first nine months of fiscal 1995. In the first nine months of fiscal 1994 the Company capitalized an additional $0.8 million of construction period interest on new store construction projects and realized $0.5 million more in interest income than in the comparable period of 1995. The 9 10 increase in interest expense was partially offset by a $0.4 expense reduction due to a decrease in long-term debt. The Company recorded an income tax provision for the first nine months of fiscal 1995 at an effective tax rate of 25.1% based on the estimated annual tax rate for fiscal 1995 which takes into account projected income and other factors. In the first nine months of fiscal 1994, the Company did not record an income tax provision as a result of the benefit of net operating loss carry forwards against which a valuation allowance had previously been provided. See Note 3 to the Condensed Consolidated Financial Statements. LIQUIDITY AND CAPITAL RESOURCES The Company's liquidity needs arise primarily from the funding of the Company's capital expenditures, working capital requirements, ongoing expansion program, and debt service on indebtedness. The Company's wholly-owned subsidiary, Orchard Supply Hardware Corporation ("Orchard Supply"), has funded debt obligations as of October 29, 1995 including (i) up to $40.0 million of revolving credit availability under Orchard Supply's senior revolving credit facility (with a $10.0 million sublimit for guarantees of letters of credit) (the "Financing Agreement") of which no borrowings and $5.9 million of guarantees of letters of credit were outstanding as of October 29, 1995, (ii) $20.2 million outstanding under a store mortgage facility, (iii) $12.8 million aggregate principal amount of warehouse mortgage notes, (iv) $1.0 million of store mortgage assumed in connection with the acquisition of a former Builders Emporium store site and (v) $100.0 million aggregate principal amount of 9 3/8% senior notes due February 15, 2002. Orchard Supply's debt instruments contain financial and operating covenants including, among other things, requirements that Orchard Supply maintain certain financial ratios and satisfy certain financial tests and limitations on Orchard Supply's ability to make capital expenditures, to incur other indebtedness, and to pay dividends. As of October 29, 1995, the Company and Orchard Supply were in compliance with all covenants contained in such debt instruments. Aggregate scheduled principal repayments on Orchard Supply's long term debt instruments, including capital leases, for fiscal 1995, 1996 and 1997 are $1.7 million, $2.0 million and $2.4 million, respectively. The Company's business strategy requires that it maintain broad product lines and large inventories, however, the effect of this strategy on working capital is somewhat minimized through the receipt of trade credit. The Company's working capital is also affected by accounts receivable arising from its proprietary credit card which had an average monthly balance for fiscal 1994 of $11.1 million. The Company will fund its working capital needs through a combination of funds from operations and borrowings under the Financing Agreement. The Financing Agreement permits borrowings based on percentages of the Company's eligible inventory and accounts receivable and is to be used for working capital and general corporate purposes. The Financing Agreement remains effective through May 1999. In connection with Orchard's expansion plans, the Company anticipates capital expenditures of approximately $900,000 for furniture, fixtures and equipment for each new store opened, a portion of which may be leased under operating leases. The Company expects that for its metropolitan Los Angeles stores, pre-opening expenses will range from approximately $500,000 to $600,000 (compared to $400,000 in its Northern and Central California markets). The initial inventory requirement for new stores, net of trade credit, is estimated at $900,000 per store. In the event that the Company is responsible for the renovation or remodeling of the existing space to be leased, the Company anticipates incurring additional capital expenditures of approximately $800,000 to $1,500,000 per store. If the 10 11 Company elects to purchase the real estate, the capital expenditure would range from approximately $2,500,000 for owned store improvements constructed on leased land to $4,000,000 - $6,000,000 if the entire property were to be owned by the Company. The Company's three-year capital expenditure plan for fiscal 1995, 1996 and 1997 provides for annual capital expenditures of $11.8 million, $19.6 million and $17.0 million, respectively. This capital expenditure plan includes the expenditures of approximately $4.0 million to $5.0 million annually for the maintenance of existing facilities. The remainder of the annual budgeted amounts will be used primarily for the opening of new stores, including fixtures and leasehold improvements with respect to the new stores, and computer equipment. The Company has historically obtained some of its equipment through operating leases, and expects to be able to procure such arrangements in the future. The inability of the Company to procure such arrangements for its capital expenditure program may have a negative impact on the ability of the Company to make capital expenditures. The Company believes that funds from operations, together with borrowings under the Financing Agreement and financing through operating leases, will be adequate to fund the Company's operating requirements and capital expenditure program and meet its debt and dividend obligations for the next several years. Any material shortfalls of operating cash flow could require the Company to reduce its expansion plans. EFFECT OF INFLATION The effect of inflation on the Company's result of operations has not been material in the periods discussed. IMPACT OF RECENT ACCOUNTING PRONOUNCEMENTS In March 1995, the FASB issued Statement of Financial Accounting Standards (SFAS) No. 121 "Accounting for the Impairment of Long- Lived Assets and for Long-Lived Assets to Be Disposed of." This pronouncement requires that long-lived assets and certain identifiable intangible assets be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. An impairment loss is to be recognized when the sum of undiscounted cash flows is less than the carrying amount of the asset. Measurement of the loss for assets that the entity expects to hold and use are to be based on the fair value of the asset. Although management does not expect this pronouncement to have a material impact on the Company's financial condition or results of operations at adoption, its provisions, when adopted, will be applicable to any future assessments of its long-lived assets. SFAS No. 121 must be adopted no later than fiscal 1996. 11 12 PART II - OTHER INFORMATION ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. (a) Exhibits. Exhibit Number 10.1 Eighth Amendment to Note Agreement dated as of August 7, 1995 by and among Orchard Supply Hardware Corporation, Orchard Supply Hardware Stores Corporation (formerly Orchard Holding Corporation) and Teachers Insurance and Annuity Association of America, with respect to the 10.64% Senior Secured Notes due 2002. 27 Financial data schedule for the nine months ended October 29, 1995. (b) Reports on Form 8-K. None. 12 13 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. ORCHARD SUPPLY HARDWARE STORES CORPORATION Date: December 11, 1995 By: /s/ Maynard Jenkins -------------------------------- Maynard Jenkins Chief Executive Officer Date: December 11, 1995 By: /s/ Stephen M. Hilberg -------------------------------- Stephen M. Hilberg Chief Financial Officer and Vice President-Finance 13