10-K 1 asf10k.txt ANNUAL REPORT ON FORM 10-K FISCAL 2001 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ----------------------- FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED FEBRUARY 2, 2002 ------------------------------------------ COMMISSION FILE NUMBER 33-27126 ---------------- PEEBLES INC. (Exact name of registrant as specified in its charter) Virginia 54-0332635 --------- ------------ (STATE OF INCORPORATION) (I.R.S. EMPLOYER IDENTIFICATION NO.) One Peebles Street South Hill, Virginia 23970-5001 -------------------- ----------- (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE) Registrant's telephone number, including area code (434) 447-5200 -------------- Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: None Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X . No . Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] State the aggregate market value of the voting stock held by non-affiliates of the registrant $-0- (determined by including all shares of Peebles common stock owned by persons, (1) who hold less than 10% of the outstanding shares of common stock and (2) are not an executive officer of the registrant. Aggregate value is based upon the estimated fair value of common stock as of February 2, 2002.) As of April 1, 2002, 1,000 shares of common stock of Peebles Inc. were outstanding. DOCUMENTS INCORPORATED BY REFERENCE List hereunder the following documents if incorporated by reference and the Part of the Form 10-K into which the document is incorporated: (1) Any annual report to security holders; (2) Any proxy or information statement; and (3) Any prospectus filed pursuant to Rule 424(b) or (c) under the Securities Act of 1933. The listed documents should be clearly described for identification purposes. NONE PART I ITEM 1. BUSINESS. GENERAL Peebles Inc. ("Peebles" or the "Company") operates 137 specialty department stores offering predominately soft- apparel, fashion merchandise for the entire family and selected decorative home accessories. Founded in 1891, the Company operates primarily in smaller communities in 17 southeastern and mid-Atlantic states. Peebles positions itself as the leading fashion retailer in these communities, which typically do not have a traditional mall-based department store, and locates its stores in the primary shopping destinations in its markets. Peebles offers its customers consistent value by providing a broad assortment of moderately priced national brands supplemented with quality private label merchandise. Peebles' attractive stores and visual presentation, advertising and promotional programs further reinforce its image as the market's fashion leader. Peebles is a wholly owned subsidiary of PHC Retail Holding Company ("PHC Retail"). PHC Retail is a closely held company, which has no significant assets other than the shares of Peebles common stock it owns. All store locations operate under the Peebles name. The Company's corporate headquarters is located in South Hill, Virginia. The Company operates two distribution centers, one adjacent to the corporate offices, and the other in Knoxville, Tennessee. The Knoxville facility was acquired in June 1998 in connection with the acquisition of Ira A. Watson Co. ("Watson" or "Watson's"). References to 1997, 1998, 1999, 2000 and 2001 relate to the Company's fiscal years ended January 31, 1998, January 30, 1999, January 29, 2000, February 3, 2001 and February 2, 2002, respectively. Fiscal years include 52 weeks, except fiscal year 2000, which consisted of fifty-three weeks. OPERATING STRATEGY The following are key elements of Peebles' operating strategy: FOCUS ON SMALL MARKETS, DELIVER VALUE. Peebles locates its stores in smaller communities that typically do not have a fashion retailer. A Peebles market is generally between 10,000 and 25,000 households, but the Company is able to successfully operate in communities with as few as 5,000 households. Peebles provides the community with a shopping experience similar to that found in a larger, mall-based department store, but with a value emphasis. Lower initial markons and less promotional pricing result in a higher level of credibility with customers. Peebles' commitment to providing value to its customers is integral to developing repeat customers, a critical ingredient for success in smaller markets. OPERATE SMALLER, FLEXIBLE STORES. Peebles operates stores that are significantly smaller than the traditional full-line department store. Peebles' stores range in size from 11,000 to 72,000 square feet and average 28,000 gross square feet, 22,200 of which, on average, is devoted to selling. The Company operates profitably by varying the store size and layout to meet the needs of the individual market. A Peebles store remains as dynamic as the market, with space re-allocations performed regularly to meet changing customer demand. TAILOR FASHION TO LOCAL TASTES. The merchandise mix is tailored to individual stores to cater to local tastes and preferences. Soft-apparel fashion merchandise is predominate on the selling floor, as the Company emphasizes a broad selection of moderately-priced national brands and private label merchandise, which generally is not available through other retailers in the market. Cosmetics and selected home accessories are the primary complements to the apparel assortment, as fewer hard-line merchandise categories are offered. Customer feedback and store level, detailed sales information allow corporate buyers and store associates to work together to optimize the use of Peebles' smaller, yet flexible selling spaces to best meet customer demand. The store layout and visual presentation, customized to the individual market, targeted advertising and promotional programs, complete the Peebles image as the market's fashion leader. DEVOTION TO THE SALES FLOOR THROUGH A CENTRALIZED BACK OFFICE. Peebles believes successful operations are directly related to the time devoted to the sales floor. Store management and sales associates spend over 85% of their hours in a selling and customer service capacity. To make this possible, "back office" functions are generally centralized. ADAPT TO LOCAL REAL ESTATE OPPORTUNITIES. Smaller stores and a flexible store format give the Company the ability to locate in a variety of new or existing sites. As a result, Peebles' growth does not depend upon the development of new malls. Peebles attempts to position its stores in the primary shopping destination in its markets, which are typically strip shopping centers co-anchored by leading discount, grocery and drug retailers. The Company also operates successfully in enclosed malls and downtown locations. EXPANSION STRATEGY From February 1997 to February 2002, the Company has expanded from 77 stores to 137, by both developing new locations and acquiring existing stores. In addition, the Company has expanded sales capacity by relocating its stores within existing markets and by remodeling and reallocating selling space. The Company anticipates continued expansion as follows: DEVELOPING NEW LOCATIONS. The Company plans to open Peebles stores in five new markets in 2002. The new locations are planned in existing states and in contiguous markets where distribution efficiencies can be realized and where the Peebles concept and merchandise mix will correspond to local demographics. The Company explores a wider range of real estate options than retailers relying only on new shopping center development, and Peebles actively considers space vacated by other retailers. ACQUIRING EXISTING STORES. The Company is continually evaluating acquisitions of individual stores, groups of stores or entire chains for opportunities to compliment or expand existing markets. In 2001, the Company opened 11 acquired store locations. Although no acquisitions are currently planned for 2002, management believes the economic environment and financial condition of retailers will continue to present acquisition opportunities. Since February 1, 1997, the Company has acquired 40 store locations from other retailers. REMODELING AND RELOCATING STORES. The Company strives to ensure its customers experience an updated, pleasant and fashion-oriented shopping environment, planned specifically to meet the needs of the specific market. The Company regularly considers stores for major remodeling/space reallocations, less significant remodeling or fixture upgrades or, less frequently, relocation, all dependent on the market. In 2002, the Company currently plans to relocate one existing store within its the market, and three stores are scheduled for major remodeling/space reallocation. PEEBLES STORES Peebles stores are designed to create an appealing and satisfying shopping experience for the customer. The layout is bright, modern and accessible, with an emphasis on the visual presentation of the merchandise and the creation of cross-selling opportunities. The Company's stores are significantly smaller than the traditional full-line department store and do not have a standard format. Rather, they are designed for operational efficiency, including flexible inventory management adapted to meet the needs of the individual community. The Company targets communities having between 10,000 and 25,000 households, although the Company operates profitably in markets with as few as 5,000 households. In addition, the Company enters larger markets and suburban areas with 25,000 to 40,000 households where the customer base and competitive factors exhibit characteristics similar to markets where the Company's operating strategy has proven successful. The Company prefers to locate its stores in strip shopping centers and enclosed malls where other anchors such as a leading grocery, discount and drug retailers will create a destination shopping location. Of the 137 stores currently in operation, 106 are located in strip shopping centers, 21 in enclosed malls and 10 in downtown locations. MERCHANDISING The Company's merchandise, approximately 85% of which is apparel, is targeted to middle income customers shopping for their families and homes. The Company has fewer departments than a traditional full-line department store, but strives to carry a wide assortment of merchandise within its targeted categories in order to appeal to a broad range of customers. To position itself as the primary fashion retailer in the community with merchandise not found elsewhere in the market, the Company emphasizes moderately- priced national brands, supplemented by a limited selection of prestige brand names and a selection of quality private label merchandise. Peebles merchandise is fashion responsive rather than fashion forward, limiting the Company's inventory exposure. The Company's stores carry apparel for the entire family, accessories and cosmetics, and decorative home accessories. Management believes that brand name merchandise is a significant attraction to its customers and intends to continue emphasizing such merchandise in its stores. For example, the Company carries nationally branded cosmetics in as many of its stores as possible because Peebles is typically the only retailer in the community where consumers can purchase that merchandise. While the gross margins on cosmetics are typically lower than the Company's average gross margin, the availability of this merchandise generates store traffic, which facilitates the sale of higher margin merchandise. In 2001, a majority of the merchandise sold by the Company was nationally branded merchandise. Key brands featured by the Company include: Ladies Alfred Dunner, Koret, Etienne Aigner, Liz Claiborne, Kellwood, Halmode Apparel, Studio Direct, Woolrich, Playtex, Vanity Fair, Levi, Item Eyes; Men's Ralph Lauren, Haggar, Bombay Industries, Levi, Van Heusen, Foria International, Nike, Izod, Swank, Carhartt Inc.; Young Men's and Juniors Levi, Tommy Hilfiger Jeans, Currants Jeri-Jo, Union Bay, Global Gold, L.E.I/R.S.V. Sport, Byer of California, Nautica Jeans, Jones Apparel, Wrapper USA; Children's Tommy Hilfiger, H.H. Cutler, Levi, Kids Headquarters, Gerson & Gerson, Baby Togs, Samara Brothers, Fishman & Tobin, Byer California, William Carter; Shoes Nike, Reebok, Skechers, Nine West, Easy Spirit, Keds/Stride Rite, Brown Shoe, Aerosoles, Wolverine, Maxwell Shoe, Adidas; Home International Silver, Seymour Mann, PEM-America, Mikasa, Westpoint- Stevens, New Creative Enterprises, Pacific Rim, Baum Bothers The Manual Woodworker, Aceco Inc.; Cosmetics Estee Lauder, Elizabeth Arden, Clinique, Liz Claiborne, Calvin Klein, Belae Brands, Ralph Lauren Fragrances, Aramis, Fashion Fair, Markwins International; As a complement to its national brand merchandise, the Company offers private label merchandise in selected departments to give its customers a wider range of products. Management believes that its private label merchandise provides value to the Peebles customer by offering a quality merchandise alternative at prices lower than national brands. In addition, private label merchandise often has higher gross margins than brand name merchandise and allows the Company to avoid direct price competition. In order to efficiently utilize its selling space, Peebles tailors the merchandise selection at individual stores. The Company utilizes its knowledge of its markets and customers, along with input from the store managers and sales associates, to allocate merchandise to the stores. The Company also maintains an inventory tracking system, which provides daily information as to sales and inventory levels by store, department, vendor, class, style, size and color. Based on this information, the Company analyzes market trends, identifies fast or slow moving merchandise and makes reordering, reallocation and pricing decisions on a daily basis. Peebles emphasizes value pricing and is less promotional than the traditional department store. It is the Company's pricing strategy to use lower initial markons and promote less, thereby maintaining a high level of credibility with its customers. Peebles' commitment to providing value to its customers is integral to creating repeat customers, a critical ingredient for success in smaller markets. Peebles is committed to offering "Great Fashions, Great Prices, Everyday". With this program, Peebles prices merchandise as low as possible in order to generate sales. Products in this program are marketed through special point of sale displays and are featured in the Company's advertising. ADVERTISING AND PROMOTION The Company's advertising and promotion strategy is designed to support its marketing goals of providing quality merchandise at value-oriented prices and reinforces the Company's image as the leading fashion retailer in its markets. Peebles emphasizes direct mail and newsprint over television and radio, due to the size and nature of the markets served. Peebles uses both black and white advertisements and full color mailers to highlight promotional items and events as well as products in its "Great Fashions, Great Prices, Everyday" program. In addition, the Company's advertising and promotional staff organizes special events at the stores and arranges for all Grand Opening and Grand Reopening events. The Company's net advertising expenses in 1999, 2000 and 2001 were 2.7%, 2.2% and 2.0% of net sales, respectively, which the Company believes is lower than traditional department stores due to emphasis on an everyday fair price policy and a less promotional strategy. Net advertising expenses were higher in 1999 due to the significant number of new store locations added in 1998. PURCHASING AND DISTRIBUTION The Company employs 29 buyers and 6 merchandise managers who are responsible for most merchandising decisions including purchasing, pricing, sales promotions, inventory allocations and markdowns. While these decisions are made centrally, the Company endeavors to refine its merchandise assortment to appeal to the customers in each market. Peebles' buying staff has developed specific knowledge with regard to purchasing, inventory and promotions for the Company's smaller sized stores. The merchandising group participates in an incentive plan based on sales, gross margin dollars generated and inventory turnover. The Company places special emphasis on maintaining all merchandise in stock, particularly advertised and basic merchandise, to build and maintain credibility with its customers. By monitoring unit sale information by store, buyers are able to quickly determine the styles, colors and sizes of merchandise to be reordered and distributed to individual stores. The Company purchases its merchandise from over 1,200 suppliers and is not dependent on any single source of supply. The Company had been a member of an international cooperative buying service (the "Co-Operative"), which the Company used primarily as a resource for its imported private label merchandise. In 1998 and 1999, the Co- Operative was the Company's largest supplier, representing approximately 9% and 7%, respectively, of total purchases. In 2000, the Co-Operative ceased operation in the third fiscal quarter, and, as a result, represented approximately 3% of total purchases. The Company has obtained alternate sources to supply its private label programs. Any disruption to the flow of merchandise as a result of the Co- Operative no longer being available as a resource was not material to the overall purchasing process or the Company's merchandise mix. Virtually all merchandise is shipped directly from vendors to the Company's distribution centers. Working with its vendors, the Company actively pursues efficiencies by having merchandise shipped floor ready and packed by store. Otherwise, merchandise is shipped in bulk to the distribution centers where it is inspected, sorted, marked, ticketed and packed by store. The Company does not warehouse merchandise and has a three-day processing goal through the distribution centers. All merchandise is shipped floor ready to each store an average of twice a week on Company-owned trucks. The Company's distribution centers feature modern merchandise handling equipment and are located close to major interstates. Using one eight hour shift at each facility, the existing distribution centers can support future growth in existing and contiguous markets up to approximately 200 store locations. STORE OPERATIONS The Company has structured its store operations to maintain what management believes are key operating advantages, including a thorough knowledge of its customer base, the ability to share information between the stores, and cost efficient operations through centralization. Peebles performs as many traditional "back-office" functions as possible at the corporate level so that store management and sales associates can spend most of their time with customers. Non-sales store personnel are kept to a minimum due to control functions performed at the corporate offices, including sales associate scheduling, customer credit and merchandise ticketing. All stores use at least 85% of their total payroll hours in a selling capacity. Peebles encourages active participation of all store level management and sales associates in decisions affecting store operations and merchandise mix. Management regularly solicits input and suggestions from its employees who are closest to the customer. In addition to its management information systems, Peebles stays in close contact with store operations through its twelve regional managers. Each store manager reports to a regional manager. Regional managers visit their stores regularly to review merchandise presentation, personnel training and performance, enforcement of the Company's security procedures and adherence to Company operating procedures. Each quarter, corporate merchandising and operations executives meet with the regional managers to share information. The Company conducts a management training program, where on-the-job training with seasoned store management and regional managers is coordinated with instruction at the Company's corporate headquarters. The Company stresses promotion from within, and substantially all of the current store managers have been selected in this manner. Most stores typically employ several assistant managers and approximately 20 sales associates, a number of whom are part-time. All Peebles' store personnel, including assistant store managers and sales associates, participate in incentive plans. The Company uses periodic productivity reports and personal reviews to inform each employee of his or her performance. PEEBLES CHARGE CARD As a service to its customers, the Company offers credit through the use of its own Peebles Charge card. The Peebles Charge card customer usually resides in the local community immediately surrounding the individual store location and the Company does not require collateral. Peebles administers all aspects of its credit card program in-house. The Company believes Peebles Charge card customers are some of its most active and loyal customers, and these customers represent an important part of its advertising and marketing programs. The extension of credit is governed by risk models and matrices, which are developed and reviewed by corporate credit executives. A satellite communication network links the store locations to the corporate office, automating the extension of credit and the authorization of individual purchases. Credit applications entered at a store location are scored within minutes and the actual credit limit is assigned and available for purchases. Individual charge transactions are authorized through this communications network, checked against established open-to-buy limits for each Peebles Charge account. In addition, frequently asked questions from Peebles Charge customers can be answered by store sales associates at any register. These questions include total balance due, available credit, account number look-up, minimum payment amount due and the next payment date. Also supporting questions or concerns from Peebles Charge card customers is an in-house customer service department, which can be accessed directly by phone, through an automated voice response system and through the internet. The Company produces all monthly billing statements, processes all payments and performs all collection activities at the corporate office. Management believes this in-house credit program provides the Company with an important customer relations advantage over competing retailers which administer their credit programs from remote processing locations or contract for such services from unrelated third parties. In 1999, 2000 and 2001, 27.6%, 27.6% and 28.9%, respectively, of net sales were made using the Company's proprietary credit card. As of February 2, 2002, the Company had approximately 596,000 credit card accounts, of which 201,000 were billed that month. The Company collects income in the form of finance charges and late fees, and bears the risk related to uncollectible accounts. In 1999, 2000 and 2001, income from finance charges and late fees totaled $5.9 million, $6.9 million and $7.3 million, respectively. Uncollectible accounts considered bad debts totaled $1.6 million, $2.7 million and $3.2 million, respectively, in 1999, 2000 and 2001. MANAGEMENT INFORMATION SYSTEMS The Company's management information systems provide the daily financial and merchandising information to make timely and effective pricing decisions and for inventory control. The Company is able to allocate its inventory effectively as a result of its management information systems and can tailor the merchandise mix to meet the individual customer demands at each store. The Company maintains central information and data processing systems at its corporate headquarters. Each of its stores is equipped with compatible point-of-sale registers, which are polled every evening by the central system to gather sales, accounts receivable and inventory information. The Company's management information and data processing systems primarily use internally developed software. The Company believes this allows management to more closely control the quality, suitability and expense of information systems and data processing. The Company continues to make selected improvements in computer hardware technology as well as enhancements to software applications as needed. EMPLOYEES At February 2, 2002, the Company had 1,559 full-time employees and 2,081 part-time employees. None of the Company's employees is covered by a collective bargaining agreement. The Company considers its relations with its employees to be good. COMPETITION The retail industry is highly competitive, with selection, price, quality, service, location and store environment being the principal competitive factors. The Company competes with national and local retail stores, specialty apparel chains, department stores, discount stores and mail order merchandisers, many of which have substantially greater financial and marketing resources than the Company. Demographic changes may alter the character of the Company's markets, which can result in increased competition from other retailers. TRADEMARKS The Peebles name is registered as a trademark and a servicemark of the Company. Additionally, the Company has registered several merchandise labels as trademarks under which it sells quality merchandise such as Cape Classic(TM), Private Expressions(TM), Meherrin River Outfitters(TM) and Sonoma Bay(TM). REGULATION The Company is subject to federal, state and local laws and regulations affecting retail department stores generally. The Company believes that it is in substantial compliance with these laws and regulations. ITEM 2. PROPERTIES All but one of the Company's stores are leased, and most of the leases contain renewal options. In gross square footage, the stores range in size from 11,000 square feet to 72,000 square feet, and average 28,000 square feet. In net selling square footage by state at February 2, 2002, the Company's stores were as follows: State Stores Net SQ Ft State Stores Net SQ Ft ------ ------ --------- ----- ----------------- Virginia 35 773,177 Alabama 6 107,039 Tennessee 14 369,393 New York 4 95,086 North Carolina 14 270,223 Delaware 3 80,611 Kentucky 11 297,083 New Jersey 3 74,722 Ohio 16 250,668 Illinois 2 32,708 Maryland 7 207,904 Indiana 2 25,963 South Carolina 6 149,557 Missouri 1 24,625 Pennsylvania 6 134,933 Mississippi 1 15,781 West Virginia 6 130,580 --- --------- Totals 137 3,040,053 === ========= Store leases generally provide for a base rent of between $1.00 and $8.00 per square foot per year. Most leases also have formulas requiring the payment of additional rent based on a percentage of net sales above specified levels. In 1999, 2000 and 2001, the Company's aggregate rental payments on operating leases were approximately $15.3 million, $15.4 million and $15.8 million, respectively. The Company's owns, subject to deeds of trust and security interests granted in connection with the Company's Credit Agreement: the corporate headquarters and the 150,000 square foot distribution center facility located on 31 acres in South Hill, Virginia; and the 100,000 square foot distribution center in Knoxville, Tennessee. The Company believes these locations provide the Company with adequate undeveloped space to expand the corporate headquarters and/or distribution centers to meet future growth requirements. ITEM 3. LEGAL PROCEEDINGS The Company is from time to time involved in routine litigation. Based on consultations with legal counsel, the Company believes that none of the litigation in which it is currently involved is material to its financial condition or results of operations. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS MARKET INFORMATION All of the Company's common stock is owned by PHC Retail. See Item 12. "Security Ownership of Certain Beneficial Owners and Management." There is no existing market for the Common Stock, nor is the Common Stock listed or traded on any exchange or other market. All currently outstanding shares of common stock were issued pursuant to exemptions from registration under the Securities Act of 1933, as amended (the "Act"), and any resale of such shares of Common Stock can only be made pursuant to an effective registration statement or an exemption from the registration requirements of the Act. DIVIDENDS The Company's Credit Agreement limits, absent the consent of the lender, the payment of dividends, to the repurchase of PHC Retail common stock, not to exceed $750,000 in any fiscal year. In 2001, the Company paid dividends to PHC Retail of $696,000 for the repurchase of PHC Retail common stock from retiring management shareholders. The Company did not pay any dividends in 1999 and 2000 and does not expect to pay any dividends for the foreseeable future except for the repurchase of PHC Retail common stock (This space intentionally left blank) ITEM 6. SELECTED FINANCIAL DATA The following selected historical consolidated financial data for Peebles for the five fiscal years ended February 2, 2002 are derived from the Company's audited consolidated financial statements. The data should be read in conjunction with the consolidated financial statements, related notes and other financial information included on Page F-0 of this annual report on Form 10-K. (Dollars in thousands except shares and per share amounts and selected other data) Fiscal Fiscal Fiscal Fiscal Fiscal Year Year Year Year Year Ended Ended Ended Ended Ended January January January February February 31, 30, 29, 3, 2, 1998 1999 2000 2001 2002 ---- ---- ---- ---- ---- INCOME STATEMENT DATA: Net sales..... $217,694 $265,215 $300,839 $306,608 $308,317 Cost of sales. 130,820 159,067 178,657 181,681 179,708 ------- ------- ------- ------- ------- Gross margin.. 86,874 106,148 122,182 124,927 128,609 Selling, general and administrative expenses 60,324 76,402 86,139 85,616 85,601 Depreciation and amortization.. 6,648 8,057 9,926 10,534 11,523 Asset impairment.. -- -- 2,182 -- -- Operating income.. 19,902 21,689 23,935 28,777 31,485 Other income.. 444 9 -- 94 43 Interest expense.. 9,609 10,804 11,521 11,133 6,948 ------- ------- ------- ------- ------- Income before income taxes 10,737 10,894 12,414 17,738 24,580 Income taxes 4,687 4,837 5,385 7,627 10,078 ------- ------- ------- ------- ------- Net income ... $ 6,050 $ 6,057 $ 7,029 $ 10,111 $ 14,502 ======= ======= ======= ======= ======= Net income per share $ 6,050 $ 6,057 $ 7,029 $ 10,111 $ 14,502 Average common stock and common stock equivalents outstanding 1,000 1,000 1,000 1.000 1,000 SELECTED OTHER DATA: Net sales per store (000's) (1).. $ 2,835 $ 2,750 $ 2,705 $2,522 $2,425 Selling sq. ft. per store (1).. 24,550 24,305 24,070 23,585 23,339 Net sales per selling sq. ft. (1).. $113 $113 $112 $107 $104 Comparable store net sales increase (decrease) (1).. 5.3% 0.9% 1.3% .3% (3.3%) Number of stores (end of period).. 84 117 121 124 137 Total selling sq. ft. (end of period).. 2,022,000 2,803,000 2,880,000 2,913,000 3,040,053 Capital expenditures (000's).. $10,226 $13,394 $9,151 $4,797 $10,260 BALANCE SHEET DATA: January January January February February 31, 30, 29, 3, 2, 1998 1999 2000 2001 2002 ----- ----- ----- ----- ----- Working capital.. $63,459 $75,246 $78,495 $70,016 $83,619 Net property and Equipment.. 38,749 51,949 53,063 50,132 51,003 Total assets.. 172,456 208,286 211,060 202,849 216,803 Total debt (2).. 87,299 110,921 106,991 86,304 83,656 Stockholders' equity (3).. 55,473 61,530 68,559 78,670 92,450 SELECTED FINANCIAL DATA FOOTNOTE LEGEND --------------------------------------- 1) Only reflects data for comparable stores. Comparable stores for the current year are those stores which were open for the entire period in the immediately preceding year. 2) Includes the long-term portion of the capital lease obligations and the current portion of long-term debt. 3) Retained earnings, included in stockholders' equity has been accumulated since May 27, 1995. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The discussion and analysis included under the caption "Management's Discussion and Analysis of Financial Condition and Results of Operations" appears on Page F-13 of this annual report on Form 10-K. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Information with respect to this Item is included under the caption "Market Risk" on Page F-16 of this annual report on Form 10-K. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Information with respect to this Item is contained in the consolidated financial statements indicated on the indices on Page F-0 of this annual report on Form 10-K. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE NONE PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The Company's executive officers and Directors, their ages, positions and years with the Company as of April 1, 2002, are as follows: Years Name Age Position with the Company ---- --- -------- ------------- Michael F. Moorman 59 Chairman of the Board, 37 President and Chief Executive Officer Ronnie W. Palmore 52 Senior Vice President, 29 Merchandising and Assistant Secretary E. Randolph Lail 46 Senior Vice President, 14 Finance, Chief Financial Officer, Secretary and Treasurer Russell A. Lundy II 39 Senior Vice President, Stores 17 Marvin H. Thomas,Jr. 46 Senior Vice President, Operations 20 William C. DeRusha 52 Director 10 Malcolm S. McDonald 63 Director 10 Wellford L. Sanders, Jr. 56 Director 9 Thomas R. Wall, IV 43 Director 7 Frank T. Nickell 54 Director 7 Michael F. Moorman has been Chairman of the Board, Chief Executive Officer, President and a Director of PHC Retail since June 9, 1995. Mr. Moorman has also been Chairman of the Board of the Company since September 1989, Chief Executive Officer of the Company since May 1989 and President of the Company since June 1988. Mr. Moorman has been a Director of the Company since 1977. Mr. Moorman has been employed by the Company in various positions since 1964 including store manager and buyer. Ronnie W. Palmore has been Senior Vice President, Merchandising of PHC Retail since June 9, 1995 and of the Company since September 1989 and Assistant Secretary of the Company since 1988. Mr. Palmore has been employed by the Company in various positions since 1973 including store manager. E. Randolph Lail has been Senior Vice President, Finance, Chief Financial Officer, Secretary and Treasurer of PHC Retail since June 9, 1995. Mr. Lail has also been Senior Vice President, Finance of the Company since June 1993, Chief Financial Officer and Treasurer of the Company since June 1992 and Secretary of the Company since June 1990. Mr. Lail is a Certified Public Accountant and has been employed by the Company since January 1988. Russell A. Lundy II has been Senior Vice President, Stores of PHC Retail and the Company since June 1999. Mr. Lundy served as Vice President, Human Resources of PHC Retail from June 9, 1995 until June 1999 and of the Company from June 1990 until June 1999. Mr. Lundy has been employed by the Company in variance positions since 1983 including store manager. Marvin H. Thomas, Jr. has been Senior Vice President, Operations of PHC Retail since June 9, 1995 and of the Company since June 1993. Mr. Thomas has been employed by the Company in various positions since 1979 including store manager and buyer. William C. DeRusha has been a Director of PHC Retail since June 9, 1995 and of the Company since March 1992. Mr. DeRusha is the former Chairman of the Board and Chief Executive Officer of Heilig-Meyers Company. Malcolm S. McDonald has been a Director of PHC Retail since June 9, 1995 and of the Company since April 1992. Mr. McDonald has retired from First Union National Bank VA/MD/DC. Mr. McDonald is the former Chairman of the Board and Chief Executive Officer of Signet Banking Corporation Wellford L. Sanders, Jr. has been a Director of PHC Retail since June 9, 1995 and of the Company since February 1992. Mr. Sanders is a Managing Director of First Union Securities, Inc. Mr. Sanders is a former partner in the law firm of McGuireWoods, LLP. Thomas R. Wall, IV has been a Director of PHC Retail and the Company since June 9, 1995. Mr. Wall has been Managing Director of Kelso & Company since 1990 and prior thereto a General Partner of Kelso since 1989. Mr. Wall is also a director of Citation Corporation, Consolidated Vision Group, Inc., Key Components, Inc.; Mitchell Supreme Fuel Company, Mosler Inc., TransDigm, Inc. and 21st Century Newspapers, Inc. Frank T. Nickell has been a Director of PHC Retail and the Company since June 9, 1995. Mr. Nickell has been President and a director of Kelso & Company since March 1989 and Chief Executive Officer since September 1997. He is also a director of Blackrock, Inc., Earle M. Jorgensen Company and The Bear Stearns Companies, Inc. Executive officers of Peebles are elected annually and serve at the discretion of the Board of Directors. Directors serve one-year terms. DIRECTORS COMPENSATION Mr. DeRusha, Mr. McDonald and Mr. Sanders are paid an annual retainer of $20,000, payable quarterly in arrears. No other Director is paid a fee for serving as a Director. All Directors are reimbursed for expenses incurred in attending meetings of the Board of Directors. AGREEMENTS TO INDEMNIFY Peebles has entered into agreements with each of its Directors and officers pursuant to which Peebles has agreed to indemnify such Director or officer from claims, liabilities, damages, expenses, losses, costs, penalties or amounts paid in settlement incurred by such Director or officer and arising out of his capacity as a Director, officer, employee and/or agent of the corporation of which he is a director or officer to the maximum extent provided by applicable law. In addition, such Director or officer shall be entitled to an advance of expenses to the maximum extent authorized or permitted by law to meet the obligations indemnified against. Such agreements also obligate the Company to purchase and maintain insurance for the benefit and on behalf of its Directors and officers insuring against all liabilities that may be incurred by such director or officer, in or arising out of his capacity as a director, officer, employee and/or agent of the Company. ITEM 11. EXECUTIVE COMPENSATION The following tables set forth a summary of compensation paid by the Company to its five highest paid executive officers (the "Named Executives") and during 1999, 2000 and 2001.

OPTION GRANT TABLE. There were no options granted by the Company to the Named Executives during 2001. OPTION EXERCISE TABLE. The following table sets forth information concerning the exercise of stock options during 2001 by each of the Named Executives and the year-end value of unexercised options. OPTIONS EXERCISED IN 2001 ------------------------- Value of Number of Unexercised in Unexercised Money Options at Shares Options at Year Year End Name and Acquired Value End Exercisable/ Exercisable/ Principal Position on Exercised Realized Unexercisable(2) Unexercisable ------------------ ------------ -------- ---------------- -------------- MICHAEL F. MOORMAN 0 $0 0 $0 Chairman of the Board, President And Chief Executive Officer RONNIE W. PALMORE 0 $0 0 $0 Senior Vice President, Merchandising, Assistant Secretary E. RANDOLPH LAIL 0 $0 0 $0 Senior Vice President, Finance, Chief Financial Officer, Secretary and Treasurer RUSSELL A. LUNDY, II 0 $0 0 $0 Senior Vice President, Stores MARVIN H. THOMAS, JR. 0 $0 0 $0 Senior Vice President, Operations -------------------------------- (1) There were no stock options exercised by the Named Executives in 2001. (2) There were no unexercised options at year-end. As of the fiscal year ended February 2, 2002, there were no projected long-term incentive payouts. PENSION PLAN Prior to 1998, the Company sponsored a Pension Plan (subsequently known as Plan I) that covered substantially all employees. In 1997, the Board of Directors approved the adoption of The Employees Retirement Plan II of Peebles Inc. ("Plan II") effective February 1, 1998. The Plan I benefits of certain participants were frozen and spun-off to Plan II and no further benefits would accrue under Plan II. Further, Plan I and Plan II were closed to new participants at February 1, 1998. Plan II was terminated and all Plan II participant benefits were disbursed by January 30, 1999. Mr. Moorman, Mr. Palmore, Mr. Lail, Mr. Lundy II and Mr. Thomas have no accrued benefits under Plan I but each received a distribution from the terminated Plan II in January 1998. The Company maintains a supplemental benefits program designed to provide certain key executives retirement benefits. The Executive Employee Supplemental Retirement Plan (the "SERP"), maintained for certain designated executives, includes Mr. Moorman and Mr. Palmore. The SERP is a non-qualified retirement plan that provides each participant with retirement income based on 60% of the participant's earnings during the five consecutive calendar years which produce the highest average reduced by the sum of the benefits payable to the participant under the Plan I, Plan II, the Executive Employee Benefit Restoration Plan (the "Restoration Plan") and Social Security. Benefits under the SERP are fully vested upon the earliest of the participant's completion of five years of service with the Company, the participant's permanent disability or the date on which there is a change of control of the Company. The Restoration Plan is a non-qualified plan designed to provide supplemental benefits to certain employees, including Mr. Moorman, whose accrued benefits under Plan I were transferred to and distributed from Plan II. The benefit under the Restoration Plan is payable in a single lump sum. A participant's benefits are forfeited under the SERP and Restoration Plan if his employment is terminated for cause. COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION The Company has a Compensation Committee of the Board of Directors. For 2001, the Board of Directors established compensation for the Company's officers for such year. Michael F. Moorman, the sole officer or employee of the Company who is also a member of the Board of Directors, made recommendations to the Board of Directors concerning executive compensation but did not otherwise participate in or vote upon the executive compensation decisions made by the Board of Directors for such year. Mr. Moorman is not a member of the Compensation Committee. No interlocking relationship currently exists between any member of the Compensation Committee and any member of any other company's board of directors or compensation committee, nor did any such interlocking relationship exist during 2001. CERTAIN RELATIONSHIPS Frank T. Nickell and Thomas R. Wall, IV, members of the Board of Directors of the Company, are affiliated with Kelso & Company, which rendered management services to the Company during 2001 and affiliates of which own substantially all the common stock of PHC Retail. From time to time Kelso & Company has provided financial advice to the Company for which the Company has reimbursed certain of Kelso & Company's expenses. EMPLOYMENT AGREEMENTS Mr. Lail, Mr. Lundy and Mr. Thomas participate in split dollar insurance arrangements with the Company. The executive owns, and therefore has a vested interest in, the cash surrender value of the policy in excess of the Company's premium investment. At retirement, the executive can either use the cash value for retirement income or keep the death benefit or a combination of the two. The Company would recover its cost at retirement. In the event of a change in control, the executive would have a nonforfeitable right to the Company's share of the cash surrender value of the policy. The Company's officers are parties to employment agreements with PHC Retail that among other things contain certain change of control provisions. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. All of the outstanding common stock of the Company is owned by PHC Retail. The following table sets forth certain information regarding the beneficial ownership of Common Stock of PHC Retail, as of April 1, 2002, by (a) each person known by the Company to be the beneficial owner of more than 5% of the outstanding shares of Common Stock, (b) each of the Company's Directors and Named Executives who owns shares of Common Stock and (c) all Directors and Named Executives of the Company as a group. Unless otherwise noted in the footnotes to the table, the persons named in the table have sole voting and investing power with respect to all shares of Common Stock indicated as being beneficially owned by them. CAPITAL STOCK OF PHC RETAIL SHARES OF SHARES OF VOTING COMMON PERCENT NONVOTING PERCENT OF NAME OF BENEFICIAL OWNER (1) STOCK OF CLASS COMMON STOCK CLASS ---------------------------- ----- -------- ------------ ----- Kelso Investment Associates V,L.P.(2)(3) 1,803,693(3) 90.04 0 0 Kelso Equity Partners V, L.P. (2),(3) 67,973 3.39 0 0 Michael F. Moorman (6) 52,500 2.62 0 0 Ronnie W. Palmore (6) 14,968 * 0 0 E. Randolph Lail (6) 7,800 * 0 0 Russell A. Lundy II (6) 4,456 * 0 0 Marvin H. Thomas, Jr. (6) 6,015 * 0 0 William C. DeRusha 0 0 2,000 8.17 Malcolm S. McDonald 0 0 2,000 8.17 Wellford L. Sanders, Jr. 0 0 2,500 10.22 Joseph S. Schuchert (2),(3) 1,871,666(3) 93.44 0 0 Frank T. Nickell (2),(3) 1,873,514(4) 93.53 0 0 George E. Matelich (2),(3) 1,871,666(3) 93.44 0 0 Thomas R. Wall, IV (2),(3) 1,872,000(5) 93.45 0 0 Michael B. Goldberg (2),(3) 1,871,666(3) 93.44 0 0 David I. Wahrhaftig (2),(3) 1,871,993(3) 93.45 0 0 Frank K. Bynum, Jr. (2),(3) 1,871,666(3) 93.44 0 0 Philip E. Berney (2),(3) 1,871,666(3) 93.44 0 0 All Directors and Named Executives as a group (10 persons) (6) 1,959,587 97.83 6,500 26.56 * Less than 1 Percent (1) The information as to beneficial ownership is based on statements furnished to the Company by the beneficial owners. As used in this table, "beneficial ownership" means the sole or shared power to vote, or direct the voting of a security, or the sole or shared investment power with respect to a security (i.e., the power to dispose of , or direct the disposition of). A person is deemed as of any date to have "beneficial ownership" of any security that such person has the right to acquire within 60 days after such date. For purposes of computing the percentage of outstanding shares held by each person named above, any security that such person has the right to acquire within 60 days of the date of calculation is deemed to be outstanding but is not deemed to be outstanding for purposes of computing the percentage of any other person. (2) The business address for such person(s) is C/O Kelso & Company, 320 Park Avenue, 24th Floor, New York, New York 10022. (3) Messrs. Schuchert, Nickell, Matelich, Wall, Goldberg, Wahrhaftig, Bynum and Berney may be deemed to share beneficial ownership of shares of PHC Common Stock owned of record by Kelso Investment Associates V, L.P. ("KIA V") and Kelso Equity Partners V, L.P. ("KEP V"), by virtue of their status as general partners of such partnerships. Messrs. Schuchert, Nickell, Matelich, Wall, Goldberg, Wahrhaftig, Bynum and Berney share investment and voting power with respect to securities owned by other Kelso affiliates. Messrs. Schuchert, Nickell, Matelich, Wall, Goldberg, Wahrhaftig, Bynum and Berney disclaim beneficial ownership of the shares of PHC Common Stock owned of record by KIA V and KEP V and the securities owned by other Kelso affiliates. (4) Includes 1,848 shares of PHC Common Stock held by trusts of which Mr. Nickell is trustee, as to which shares Mr. Nickell disclaims beneficial ownership. (5) Includes 334 shares of PHC Common Stock held by trusts of which Mr. Wall is trustee, as to which shares Mr. Wall disclaims beneficial ownership. (6) Includes unexercised vested stock options for the purchase of PHC Common Stock in the amount of 17,500, 5,500, 4,500, 2,850, and 2,874 for Messrs. Moorman, Palmore, Lail, Lundy, II and Thomas, respectively. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. See "Item 10. Directors and Executive Officers of the Registrant" and "Item 11. Executive Compensation" for a description of certain arrangements with respect to present and former executive officers and directors of Peebles. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K. (a) 1. Financial statements. --------------------- Information with respect to this Item is contained in the consolidated financial statements indicated on the indices on page F-0 of this annual report on Form 10-K. 2. Financial statement schedules. ------------------------------ Schedule II Valuation and Qualifying Accounts appears in Note J on page F-13 of this annual report on Form 10-K; All other schedules for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission are not required under the related instructions or are inapplicable and therefore have been omitted. 3. Exhibits. --------- The exhibits listed on the accompanying index to exhibits are filed as part of this annual report on Form 10-K. (b) Reports on Form 8-K. -------------------- NONE (c) Exhibits. --------- 2.1*** Form of Agreement and Plan of Merger dated April 3, 1995 among PHC Retail Holding Company, Peebles Acquisition Corp. and Peebles Inc., exclusive of exhibits and schedules. The Registrant hereby undertakes to furnish to the Commission supplementally upon request a copy of any omitted exhibit or schedule. 3.1+ Form of Amended and Restated Articles of Incorporation of Peebles Inc. 3.2+ Form of Amended and Restated Bylaws of Peebles Inc. 3.3*** Amendment to Amended and Restated Articles of Incorporation dated May 3, 1993 3.4*+ Amendment to Amended and Restated Bylaws of Peebles Inc. dated June 9, 1995. 3.5*+ Amendment to Amended and Restated Articles of Incorporation dated June 9, 1995 10.1**+ Amended and Restated Credit Agreement, dated as of June 29, 1998 by and among Peebles Inc., Fleet Bank, N.A., as agent, and the financial institutions as parties thereto, exclusive of exhibits and schedules. The Registrant hereby undertakes to furnish the Commission supplementally upon request a copy of any omitted exhibit or schedule. 10.2 First Amendment and Consent to Amended and Restated Credit Agreement dated October 31, 2001 (filed herewith). 10.11*+ Form of Indemnification, Guarantee and Contribution Agreement dated as of August 23, 1995 among PHC Retail Holding Company, Peebles Inc. and each of the directors and officers of Peebles Inc. 21 Subsidiaries of the Registrant. ---------------------------- * Incorporated by reference from the Registration Statement of PBL and Peebles on Form S-1 (Registration No. 33-27126), which was declared effective by the Commission on July 14, 1989. + Incorporated by reference from the Form 10-K of the Company for the fiscal year ended February 1, 1992. *** Incorporated by reference from the Form 10-K of the Company for the fiscal year ended January 28, 1995. *+ Incorporated by reference from the Form 10-K of the Company for the fiscal year ended February 3, 1996. **+ Incorporated by reference from Exhibit 10.68 to the Company's Quarterly Report on Form 10-Q for the quarter ended August 1, 1998. (d) Financial Statement Schedules ----------------------------- Schedule II Valuation and Qualifying Accounts appears in Note J on page F-13 of this annual report on Form 10-K. All other schedules for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission are not required under the related instructions or are inapplicable and therefore have been omitted. SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. PEEBLES INC. --------------------------------------- (Registrant) By /s/ Michael F. Moorman Date: April 5, 2002 ------------------------------- Michael F. Moorman, President and Chief Executive Officer (Principal Executive Officer) By /s/ E. Randolph Lail Date: April 5, 2002 ------------------------------- E. Randolph Lail, Senior Vice President Finance, CFO, (Principal Financial and Accounting Officer) Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. By /s/ Wellford L. Sanders, Jr. Date: April 5, 2002 ------------------------------- Wellford L. Sanders, Jr., Director By /s/ William C. DeRusha Date: April 5, 2002 ------------------------------- William C. DeRusha, Director By /s/ Malcolm S. McDonald Date: April 5, 2002 ------------------------------- Malcolm S. McDonald, Director By /s/ Frank T. Nickell Date: April 5, 2002 ------------------------------- Frank T. Nickell, Director By /s/ Thomas R. Wall Date: April 5, 2002 ------------------------------- Thomas R. Wall, IV, Director SUPPLEMENTAL INFORMATION TO BE FURNISHED WITH REPORTS FILED PURSUANT TO SECTION 15(d) OF THE ACT BY REGISTRANTS WHICH HAVE NOT REGISTERED SECURITIES PURSUANT TO SECTION 12 OF THE ACT. Exhibit 21 Subsidiaries of Registrant Name of Subsidiary Jurisdiction in which organized ------------------- ------------------------------- Ira A. Watson, Co. Delaware AUDITED CONSOLIDATED FINANCIAL STATEMENTS PEEBLES INC. FEBRUARY 2, 2002 Report of Independent Auditors F-1 Consolidated Balance Sheets F-2 Consolidated Statements of Income F-3 Consolidated Statements of Changes in Stockholders' Equity F-4 Consolidated Statements of Cash Flow F-5 Notes to Consolidated Financial Statements F-6 Management's Discussion and Analysis of Financial Condition and Results of Operations F-15 F-0 REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS Board of Directors Peebles Inc. We have audited the accompanying consolidated balance sheets of Peebles Inc. and subsidiaries as of February 2, 2002 and February 3, 2001, and the related consolidated statements of income and cash flows for each of the three fiscal years in the period ended February 2, 2002. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Peebles Inc. and subsidiaries at February 2, 2002 and February 3, 2001, and the consolidated results of their operations and their cash flows for each of the three fiscal years in the period ended February 2, 2002 in conformity with accounting principles generally accepted in the United States. /s/ Ernst & Young LLP ----------------------- Richmond, Virginia March 8, 2002 F-1 CONSOLIDATED BALANCE SHEETS PEEBLES INC. (in thousands, except shares and per share amounts) FEBRUARY 2, FEBRUARY 3, 2002 2001 ---- ---- ASSETS CURRENT ASSETS Cash $ 1,773 $ 1,686 Accounts receivable, net 41,661 37,340 Merchandise inventories 79,061 70,580 Prepaid expenses 1,701 1,746 Other 361 147 -------- -------- TOTAL CURRENT ASSETS 124,557 111,499 PROPERTY AND EQUIPMENT Fixtures and equipment 79,346 78,245 Land and building 13,863 14,453 Leasehold improvements 1,548 1,669 -------- -------- 94,757 94,367 Accumulated depreciation and amortization 43,754 44,235 -------- -------- 51,003 50,132 OTHER ASSETS Excess of cost over net assets acquired, Net 35,223 37,140 Deferred financing costs, net 472 1,018 Beneficial leaseholds, net 2,521 422 Sundry 3,027 2,638 -------- -------- 41,243 41,218 -------- -------- $216,803 $202,849 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES Accounts payable $ 16,915 $ 15,162 Accrued compensation and other expenses 7,851 7,226 Deferred income taxes 1,346 1,711 Current maturities of long-term debt 10,061 13,471 Other 4,765 3,913 -------- -------- TOTAL CURRENT LIABILITIES 40,938 41,483 LONG-TERM DEBT 73,225 72,334 LONG-TERM CAPITAL LEASE OBLIGATIONS 370 499 DEFERRED INCOME TAXES 9,820 9,863 STOCKHOLDERS' EQUITY Preferred stock-no par value, authorized 1,000,000 shares, none issued or outstanding -- -- Common stock--par value $.10 per share, authorized 5,000,000 shares, 1,000 issued and outstanding 1 1 Additional capital 59,490 59,307 Accumulated other comprehensive income (loss) (209) -- Retained earnings: accumulated from May 27, 1995 33,168 19,362 -------- -------- 92,450 78,670 -------- -------- $216,803 $202,849 ======== ======== See notes to consolidated financial statements. F-2 CONSOLIDATED STATEMENTS OF INCOME PEEBLES INC. (in thousands, except shares and per share amounts) Fiscal Years Ended ------------------------------- FEBRUARY FEBRUARY JANUARY 2, 3, 29, 2002 2001 2000 --------- --------- --------- NET SALES $ 308,317 $ 306,608 $ 300,839 COSTS AND EXPENSES Cost of sales 179,708 181,681 178,657 Selling, general and administrative expenses 85,601 85,616 86,139 Depreciation and amortization 11,523 10,534 9,926 Asset impairment -- -- 2,182 --------- --------- --------- OPERATING INCOME 31,485 28,777 23,935 OTHER INCOME 43 94 -- INTEREST EXPENSE 6,948 11,133 11,521 --------- --------- --------- INCOME BEFORE INCOME TAXES (BENEFIT) 24,580 17,738 12,414 INCOME TAXES (BENEFIT) Current 10,359 7,075 3,786 Deferred (281) 552 1,599 --------- --------- --------- 10,078 7,627 5,385 --------- --------- --------- NET INCOME $ 14,502 $ 10,111 $ 7,029 ========= ========= ========= NET INCOME PER SHARE $ 14,502 $ 10,111 $ 7,029 ========= ========= ========= Weighted average common stock outstanding 1,000 1,000 1,000 ========= ========= ========= See notes to consolidated financial statements. F-3 CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY PEEBLES INC. (dollars in thousands, except per share amounts) ACCUMULATED COMMON STOCK OTHER ---------------- COMPREHENSIVE PAR ADDITIONAL INCOME RETAINED SHARES VALUE CAPITAL (LOSS) EARNINGS -------- ------- ------- ------ -------- BALANCE JANUARY 30, 1999 1,000 $ 1 $59,307 $ -- $ 2,222 Net income -- -- -- -- 7,029 ----- ----- ------ ----- ------- BALANCE JANUARY 29, 2000 1,000 $ 1 $59,307 $ -- $ 9,251 Net income -- -- -- -- 10,111 ----- ----- ------ ----- ------- BALANCE FEBRUARY 3, 2001 1,000 $ 1 $59,307 $ -- $19,362 Dividend to PHC Retail for Share Repurchase -- -- -- -- (696) Exercise of PHC Retail stock options -- -- 183 -- -- Unrealized loss on Interest Rate Swap -- -- -- (209) -- Net income -- -- -- -- 14,502 ----- ----- ------ ----- ------- BALANCE FEBRUARY 2, 2002 1,000 $ 1 $59,490 $ (209) $33,168 ===== ===== ====== ====== ======= See notes to condensed consolidated financial statements. F-4 CONSOLIDATED STATEMENTS OF CASH FLOWS PEEBLES INC. (in thousands) FISCAL YEARS ENDED --------------------------------- FEBRUARY FEBRUARY JANUARY 2, 3, 29, 2002 2001 2000 ----- ----- ----- OPERATING ACTIVITIES Net income $ 14,502 $ 10,111 $ 7,029 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation 8,592 7,758 7,305 Amortization 3,477 3,747 4,015 Deferred income taxes (281) 552 1,599 Provision for doubtful accounts 3,568 3,320 1,663 LIFO/market reserve adjustment (222) (769) (371) Asset impairment -- -- 2,182 Changes in operating assets and liabilities: Accounts receivable (7,889) (2,711) (6,217) Merchandise inventories (8,259) 370 1,923 Accounts payable 1,753 1,524 (4,721) Other assets and liabilities 792 2,180 (546) ------- ------- ------- NET CASH PROVIDED BY OPERATING ACTIVITIES 16,033 26,082 13,861 INVESTING ACTIVITIES Purchase of property and equipment (10,260) (4,797) (9,151) Acquisition of New Store Locations (2,375) -- -- Other (96) (35) (217) ------- ------- ------- NET CASH USED IN INVESTING ACTIVITIES (12,731) (4,832) (9,368) FINANCING ACTIVITIES Proceeds from revolving line of credit and long-term debt 494,457 429,643 420,528 Reduction in revolving line of credit and long-term debt (496,976) (450,215) (424,077) Dividend to PHC Retail (696) -- -- ------- ------- ------- NET CASH USED IN FINANCING ACTIVITIES (3,215) (20,572) (3,549) ------- ------- ------- INCREASE IN CASH AND CASH EQUIVALENTS 87 678 944 Cash beginning of period $ 1,686 1,008 64 ------- ------- ------- CASH END OF PERIOD $ 1,773 $ 1,686 $ 1,008 ======= ======= ======= See notes to consolidated financial statements. F-5 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS PEEBLES INC. February 2, 2002 (in thousands, except shares and per share amounts) NOTE A-SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES NATURE OF OPERATIONS: Peebles Inc. ("Peebles" or the "Company") operates retail department stores offering predominately fashion merchandise for the entire family and selected home accessories. At February 2, 2002, the Company was operating 137 stores located primarily in small and medium sized communities which typically do not have a mall-based department store. The stores serve communities in 17 states, located primarily in the Southeast and Mid-Atlantic. ORGANIZATION AND BASIS OF FINANCIAL STATEMENT PRESENTATION: Consolidation: Peebles Inc. is a wholly owned subsidiary of PHC Retail Holding Company ("PHC Retail"). PHC Retail, a closely held company, has no significant assets other than the entire equity interest of Peebles Inc. common stock, $.10 par value (the "Common Stock"). The consolidated financial statements include the accounts of Peebles Inc. and its wholly owned subsidiaries. All significant intercompany balances and transactions have been eliminated. FISCAL YEAR: The Company's fiscal year ends on the Saturday nearest January 31. Fiscal years 2001, 2000 and 1999 ended on February 2, 2002, February 3, 2001 and January 29, 2000, respectively. Results of operations consisted of fifty-two weeks in 2001 and 1999, and fifty-three weeks in 2000. References to years relate to fiscal years rather than calendar years. Certain amounts in the 2000 and 1999 consolidated financial statements have been reclassified to conform to the 2001 presentation. USE OF ESTIMATES: The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. CASH AND CASH EQUIVALENTS: Peebles considers all highly liquid investments maturing within three months of purchase to be cash equivalents. There were no cash equivalents at February 2, 2002 or February 3, 2001. FAIR VALUE OF FINANCIAL INSTRUMENTS: The carrying amounts of accounts receivables and accounts payable approximate fair value due to their short maturities. The carrying amount of long-term debt approximates fair value as the stated interest rates approximate market rates. The carrying amount of cash flow hedges approximate fair value, based upon quoted market prices. MERCHANDISE INVENTORIES: Merchandise inventories are accounted for by the retail inventory method applied on a last in, first out ("LIFO") basis. PROPERTY AND EQUIPMENT: Property and equipment is stated on the basis of cost. Depreciation of property and equipment is provided primarily by the straight-line method over the estimated useful lives of the related assets, generally 7 to 10 years for fixtures and equipment and 20 years for buildings. The cost of leasehold improvements is amortized over the shorter of the economic lives or the terms of the leases by the straight-line method. Amortization of buildings under capital leases is computed by the straight-line method over the lease term and is included in depreciation and amortization expense. LONG-LIVED ASSETS: The Company periodically reviews the carrying value of long-lived assets to determine if impairment has occurred. The primary indicators of impairment are, but not limited to, significant changes in competition or demographics, recent historical operating profitability and projected profitability. In general, the carrying value of long-lived assets is considered recoverable if it is less than the related future projected undiscounted cash flows. If the carrying value were found to be greater, the carrying value would be reduced to fair value. Projections included in this review are based on management's best estimates of future performance. F-6 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued PEEBLES INC. NOTE A-SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES-Continued EXCESS OF COST OVER NET ASSETS ACQUIRED: Through February 2,2002, the excess of cost over net assets acquired ("Goodwill") was being amortized on a straight-line basis over a twenty-five year period. Goodwill amortization expense for 2001, 2000 and 1999 was $1,917, $1,960 and $1,917, respectively. Accumulated amortization was $12,734 and $10,817 at February 2, 2002 and February 3, 2001 respectively. DEFERRED FINANCING COSTS: Deferred financing costs are amortized by the interest method over a period consistent with the related financing. Amortization expense of $546, $877 and $1,394, is included in interest expense for 2001, 2000 and 1999, respectively. Accumulated amortization at February 2, 2002 and February 3, 2001 was $6,388 and $5,842, respectively. REVENUE: Retail sales are of merchandise. "Net Sales" as shown are net of actual returns for the period and exclude all taxes. Revenue from in-store services and finance charges on credit balances are recorded as a reduction to selling, general and administrative expenses. ADVERTISING COSTS: Advertising costs, charged to selling, general and administrative expenses as incurred, were $6,174, $6,707 and $8,015 for 2001, 2000 and 1999, respectively. INCOME TAXES: The Company provides for deferred income taxes under the liability method. Under the liability method, deferred taxes are determined based on the differences between the financial statement and tax bases of assets and liabilities using enacted tax rates is effect in the years the differences are expected to reverse. NET INCOME PER SHARE: Net income per share is based on the weighted-average number of shares outstanding. STORE OPENING COSTS: Store opening costs are charged to selling, general and administrative expenses as incurred. DERIVATIVE FINANCIAL INSTRUMENTS: The Company adopted the provisions of Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Financial Instruments and Hedging Activities", as amended by SFAS No. 138, effective February 4, 2001. For derivative financial instruments qualifying as a cash flow hedge, changes in the fair value of the effective portion of the derivative instrument are recognized in Other Comprehensive Income ("OCI"). The Company enters into interest rate swap agreements to manage exposure to interest rate fluctuations. ACCOUNTING PRONOUNCEMENTS: In June 2001, the Financial Accounting Standards Board issued Statement No. 142, "Goodwill and Other Intangible Assets" ("SFAS No. 142"). Under the provisions of SFAS No. 142, goodwill and certain other indefinite-lived intangible assets will cease to be amortized, and instead, will be tested for impairment on at least an annual basis or at any time certain indicators of impairment arise. The Company is in the process of performing the procedures required under SFAS No. 142 for adoption in the first fiscal quarter of 2002. The Company currently expects the only impact on the consolidated financial statements of adopting SFAS No. 142 to be a decrease in fiscal 2002 amortization expense of $1,917, representing the scheduled amortization of Goodwill. NOTE B-ACCOUNTS RECEIVABLE Accounts receivable are shown net of $2,800 and $2,400, representing the allowance for uncollectible accounts at February 2, 2002 and February 3, 2001, respectively. The provision for doubtful accounts was $3,568, $3,320 and $1,663 for 2001, 2000 and 1999, respectively. Finance charges and late fees on credit sales, included as a reduction of selling, general and administrative expenses, were $7,306, $6,895 and $5,862 for 2001, 2000 and 1999, respectively. F-7 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued PEEBLES INC. NOTE B-ACCOUNTS RECEIVABLE--Continued As a service to its customers, the Company offers credit through the use of its own charge card and certain major credit cards. The Peebles' customer usually resides in the local community immediately surrounding the store location. Peebles stores serve these local customers in 17 states. The Company does not require collateral from its customers. NOTE C-MERCHANDISE INVENTORIES Merchandise inventories are accounted for by the retail inventory method applied on a last-in, first-out ("LIFO") basis. In connection with an acquisition of the Company in May 1995 accounted for using the purchase method, the then existing LIFO reserve was eliminated and a new LIFO base year was established which included an adjustment to fair value (the "Fair Value Adjustment"). The "LIFO/Market Reserve" adjusts inventory to the lower of LIFO cost or market. Merchandise inventories consisted of the following: February 2, February 3, 2002 2001 ------------- ------------ Merchandise inventories at FIFO cost $ 71,625 $ 63,366 Fair Value Adjustment 7,436 7,436 LIFO/Market Reserve -- (222) ------- ------- Merchandise inventories at lower of cost or market $ 79,061 $ 70,580 ======== ======== NOTE D-LONG-TERM DEBT Long-term debt consisted of the following: February 2, 2002 February 3, 2001 ---------------- ---------------- Senior Revolving Facility $ 35,500 $ 26,145 Senior Term Note A 2,002 5,988 Senior Term Note B 43,987 53,372 Swingline Facility 1,597 -- Other 200 300 --------- --------- 83,286 85,805 Less current maturities: Scheduled principal payments 2,367 3,700 Excess Cash Flow Prepayment Amount 7,694 9,771 --------- --------- Total current maturities 10,061 13,471 --------- --------- Long-term debt $ 73,225 $ 72,334 ========= ========= The Company has a credit facility (the "Credit Agreement"), which provides a Senior Term Facility, a Senior Revolving Facility, and a Swingline Facility. The Credit Agreement is secured by a first priority security interest in substantially all the personal and real property of Peebles. The Senior Term Facility includes two notes, Senior Term Note A and Senior Term Note B. Senior Term Note A and Senior Term Note B accrue interest quarterly in arrears at a LIBOR based rate which is expected to vary 25 to 50 basis points, dependent primarily on the Company's operating performance in relation to outstanding debt at the end of each fiscal quarter. Senior Term Note A and Senior Term Note B currently bear interest at LIBOR plus 2.00% and LIBOR plus 2.50%, respectively. Scheduled principal payments are payable quarterly in arrears. F-8 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued PEEBLES INC. NOTE D-LONG-TERM DEBT-Continued The Credit Agreement requires that 75% of annual excess cash flow, as defined by the Credit Agreement, is used to reduce borrowings under the Senior Term Facility as an excess cash flow ("ECF") prepayment amount. The ECF prepayment amount, payable at the end of the first fiscal quarter of the subsequent fiscal year, was $7,694 and $9,771 for 2001 and 2000, respectively. The ECF prepayments are funded through the Revolver and reduce Senior Term Note A and Senior Term Note B ratably. Senior Term Note A will be retired October 31, 2002. Senior Term Note B is scheduled to mature April 30, 2004. The total amount available under the Senior Revolving Facility (the "Revolver") and the Swingline Facility is determined by a defined asset based formula with maximum borrowings limited to $75,000, less outstanding amounts under letters of credit. At February 2, 2002, the total amount available to borrow was $73,150, of which $37,097 was in use. The Revolver matures on April 30, 2003 and has no specific paydown provisions. The Company pays a fee of 1/2 of 1% per annum on any unused portion of the Revolver. The Revolver currently bears interest at LIBOR plus 2.00%. In November 2001, the Company entered into two interest rate swap agreements (together, the "Swap Agreements") with notional amounts of $10,000 and $40,000, respectively, and expiration dates of November 20, 2002 and 2003, respectively. The Swap Agreements meet the definition of a cash flow hedge under the provisions of SFAS No. 133. In 2001, interest expense was increased by $148, representing the difference between the Swap Agreements fixed rates and the floating rate, the 30-day LIBOR rate. At February 2, 2002, the Company recorded a $336 current liability and a $209 unrealized loss, net of $127 income tax benefit, in OCI based on the estimated fair value of the Swap Agreements at that date. Loans under the Swingline Facility are drawn and repaid daily based on the operating activity of the Company. Aggregate amounts outstanding under the Swingline Facility cannot exceed $5 million. Excess borrowings or funding outside these amounts revert to the Revolver. The Swingline Facility currently bears interest at prime plus .75% and has no LIBOR conversion option. The Company had commitments under letters of credit of $1,850 and $1,719 at February 2, 2002 and February 3, 2001, respectively. The letters of credit, issued by a bank, are primarily to secure international shipments of merchandise. Restrictive debt covenants of the Credit Agreement limit the payment of cash dividends. Cash dividends may only be paid from the Company to PHC Retail to repurchase PHC Retail common stock and are limited to $750 in any fiscal year. In 2001, $696 of PHC Retail common stock was repurchased from retiring management stockholders. The Company made cash interest payments of $6,653, $10,266 and $9,952 for 2001, 2000 and 1999, respectively. Aggregate scheduled principal payments, exclusive of any ECF prepayments, on the long-term debt are as follows: 2002 -- $2,367; 2003 -- $37,797; 2004 -- $35,428; 2005 and thereafter -- $0. NOTE E-ACQUISITION OF NEW STORE LOCATIONS In 2001, the Company acquired eleven store locations in an auction. The leases related to these store locations were below fair market value, and the entire purchase price of $2,375 has been capitalized as beneficial leaseholds. Beneficial leaseholds are amortized on a straight-line basis over approximately 12 years, the estimated composite useful lives of the related leases. F-9 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued PEEBLES INC. NOTE F-LEASES The Company leases substantially all of its store locations under capital and operating leases with initial terms ranging from 1 to 25 years and renewal options of 1 to 10 years expiring at various dates through 2052. Total rental expense under operating leases was as follows: 2001 2000 1999 ---- ---- ---- Minimum $15,580 $15,088 $14,924 Contingent 243 273 392 ------- ------- ------- $15,823 $15,361 $15,316 ======= ======= ======= Contingent rentals are based upon a percentage of annual sales in excess of specified amounts. Future minimum lease payments under capital leases and noncancellable operating leases at February 2, 2002 were as follows: Capital Operating Fiscal Year Leases Leases ------------ ---------- ------------ 2002 $ 180 $ 13,504 2003 180 12,030 2004 181 10,645 2005 60 9,368 2006 0 8,011 Thereafter 0 40,545 ------ ------- Total minimum lease payments 601 $94,103 ======= Less: amounts representing interest (102) ------ Present value of net minimum lease payments, including current maturities of $129, with an interest rate of 12.0% $ 499 ====== NOTE G-ASSET IMPAIRMENT In 1999, the Company determined that an investment in a co- operative buying office, included in "Sundry" on the consolidated balance sheets in prior years, no longer had any economic fair value. The resulting impairment, representing the Company's entire investment in the buying office, reduced both 1999 operating income and income before income taxes by $2,182, and reduced current income taxes by $866. NOTE H-EMPLOYEE BENEFIT PLANS The Company sponsors one defined benefit pension plan, The Employees Retirement Plan of Peebles Inc. (the "Plan"), and several Supplemental Benefits Programs. The Plan covers certain participants who in 1997 had reached certain age and years of service requirements. The Plan was closed to new participants at February 1, 1998. The Supplemental Benefits Programs provide certain key executives supplemental retirement income equal to 60% of final average compensation. The Company's funding policy for all plans is to make minimum annual contributions required by applicable regulations. F-10 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued PEEBLES INC. NOTE H-EMPLOYEE BENEFIT PLANS--Continued The following information relative to the above plans is disclosed in accordance with the requirements of SFAS No. 132, "Employers' Disclosures about Pensions and Other Postretirement Benefits". 2001 2000 -------- -------- CHANGE IN BENEFIT OBLIGATION: Benefit obligation at beginning of year $ 7,568 $ 6,336 Service cost 226 204 Interest cost 534 484 Actuarial (gain) loss (403) 1,066 Benefit payments (1,274) (522) ------- ------- Benefit obligation at end of year $ 6,651 $ 7,568 ======= ======= CHANGE IN PLAN ASSETS: Fair value of plan assets at beginning of year $ 4,707 $ 5,083 Actual return on plan assets (366) 146 Employer contribution -- -- Benefit payments (1,274) (522) ------- ------- Fair value of plan assets at end of year $ 3,067 $ 4,707 ======= ======= FUNDED STATUS: Funded status $ (3,584) $ (2,861) Unrecognized actuarial loss 1,816 1,494 Unrecognized prior service cost 421 492 ------- ------- Accrued pension liability $ (1,347) $ (875) ======= ======= COMPONENTS OF NET PERIODIC PENSION COST: Service cost $ 226 $ 204 Interest cost 534 484 Expected return on plan assets (384) (431) Prior service cost recognized 70 70 Recognized losses 322 4 ======= ====== Net periodic pension cost $ 768 $ 331 ======= ====== Weighted Average Assumptions as of Measurement Date: Discount rate 7.00% 7.50% Expected return on plan assets 9.00% 9.00% Rate of compensation increase 5.00% 5.00% The projected benefit obligation, accumulated benefit obligation, and fair value of plan assets for the Supplemental Benefits Program with accumulated benefit obligations in excess of plan assets were $3,299, $2,144 and $0, respectively, as of February 2, 2002 and $3,511, $1,499 and $0, respectively, as of February 1, 2003. F-11 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued PEEBLES INC. NOTE H-EMPLOYEE BENEFIT PLANS-Continued The Company also maintains a qualified profit sharing and retirement savings plan, The Peebles Inc. 401 (k) Profit Sharing Plan, which under Section 401 (k) of the Internal Revenue Code, allows tax deferred contributions from eligible employees of up to 12% of their annual compensation. The Company matches employee contributions up to 50% of an employee's first 6% of eligible compensation. The Company's matching contributions, included in selling, general and administrative expenses, totaled $346, $363 and $325 in 2001, 2000 and 1999, respectively. NOTE I - INCOME TAXES The provisions for income taxes consisted of the following: 2001 2000 1999 ------ ------ ----- Current:Federal $ 8,593 $ 5,926 $ 3,161 State 1,766 1,149 625 Deferred:Federal (233) 460 1,335 State (48) 92 264 -------- -------- -------- $ 10,078 $ 7,627 $ 5,385 ======== ======== ======== Income taxes differ from the amounts computed by applying the applicable federal statutory rates due to the following: 2001 2000 1999 ------ ------ ------ Taxes at the federal statutory rate $ 8,603 $ 6,208 $ 4,345 Increases (decreases): State income taxes, net of federal tax 1,086 806 581 Amortization of Goodwill 531 544 531 Other (142) 69 (72) ------- ------- ------- $10,078 $ 7,627 $ 5,385 ======= ======= ======= At February 2, 2002, the Company has net operating loss carryforwards of approximately $2,300 for income tax purposes, which expire in 2010. Due to Internal Revenue Service regulations, utilization of the net operating loss carryforwards may be limited in a particular year. F-12 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued PEEBLES INC. NOTE I - INCOME TAXES-Continued Significant components of deferred tax liabilities and assets are as follows: February 2, 2002 February 3, 2001 ---------------- ---------------- Deferred tax liabilities: Inventory valuation $ 2,005 $ 1,883 Depreciation and amortization 11,612 11,447 Accounts receivable valuation -- 389 Other 474 359 --------- --------- 14,091 14,078 Deferred tax assets: Doubtful accounts (1,103) (945) Net operating loss carryforwards (907) (1,150) Other (915) (409) --------- --------- (2,925) (2,504) --------- --------- Net deferred tax liabilities $ 11,166 $ 11,574 ========= ========= Peebles made cash income tax payments of $9,336, $5,650 and $5,316 for 2001, 2000 and 1999, respectively. NOTE J - VALUATION AND QUALIFYING ACCOUNTS Activity related to valuation and qualifying accounts is as follows: Allowance for Net LIFO/ Doubtful Market Accounts Reserve ------------ ---------- BALANCE JANUARY 30, 1999 $ 1,700 $ 1,362 Charges (credits) to expense 1,663 (371) Deductions - net write-off of uncollectible accounts (1,563) -- -------- ------- BALANCE JANUARY 29, 2000 1,800 991 Charges (credits) to expense 3,320 (769) Deductions - net write-off of uncollectible accounts (2,720) -- --------- ------- BALANCE FEBRUARY 3, 2001 2,400 222 Charges (credits) to expense 3,568 (222) Deductions - net write-off of uncollectible accounts (3,168) -- --------- ------- BALANCE FEBRUARY 2, 2002 $ 2,800 $ -- ========= ======= F-13 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued PEEBLES INC. NOTE K - QUARTERLY FINANCIAL DATA (UNAUDITED)

F-14 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RESULTS OF OPERATIONS Peebles operates specialty department stores offering predominately fashion merchandise for the entire family and other selected home accessories to small and medium sized communities that do not typically have a mall-based department store. At February 2, 2002, the Company operated 137 stores in 17 states, located primarily in the Southeast and Mid-Atlantic regions. The Company defines a comparable store as having operations for the entire twelve-month period in both the current and previous fiscal year. Consolidated net sales and results of consolidated operations of the Company, expressed as percentages of net sales, are presented below for the 2001, 2000 and 1999 fiscal years. Consolidated operations included 52 weeks in 2001 and 1999, and 53 weeks in 2000. (dollars in thousands) 2001 2000 1999 ------- ------- ------- Net sales $308,317 $306,608 $300,839 % increase .6% 1.9% 13.4% Comparable stores % (decrease) increase in sales: (3.3)% .3% 1.3% Total stores in operation at period end 137 124 121 Operations as a Percentage of Net Sales: --------------------------------- Cost of sales 58.3% 59.3% 59.4% Selling, general & administrative expenses 27.8 27.9 28.6 Depreciation and amortization 3.7 3.4 3.3 Asset impairment -- -- .7 -------- -------- -------- OPERATING INCOME 10.2 9.4 8.0 Interest expense 2.2 3.6 3.8 Provision for income taxes 3.3 2.5 1.9 -------- -------- -------- Net Income 4.7% 3.3% 2.3% ======== ======== ======== F-15 Net sales increased .6%, comparing the 52-week current year to the 53-week prior year. For the 52-week periods ended February 2, 2002 and February 3, 2001 net sales increased 1.9%. New store growth accounted for the increase in both comparisons. The Company opened 17 new stores in 2001, with 10 openings in August and 7 openings in November. During 2001, the Company closed 4 marginally profitable stores, 1 in September 2001 and 3 in January 2002. In 2000, the Company opened 4 new stores, and closed 1 store. All costs related to a store closing are included in selling, general and administrative expenses. At comparable stores, net sales decreased 3.3% in comparing the 52-week current year to the 53-week prior year. For the 52-week periods ended February 2, 2002 and February 3, 2001, net sales at comparable stores decreased 2.0%. Comparable store net sales increases (decreases) by fiscal quarter as a percentage of the prior year comparable quarter, are presented in the table below. Fiscal Quarter ------------------------------------------------ First Second Third Fourth Total Year ------ ------ ----- ------ ---------- 2001 vs. 2000 (1.1%) (5.4%) (1.4%) (3.8%) (3.3%) 2000 vs. 1999 (3.6%) 1.0% 1.5% 2.7% .3% 1999 vs. 1998 (2.6%) 3.6% 0.4% 3.2% 1.3% Throughout 2001, consumer demand for the Company's soft apparel was weak. In comparing the fiscal quarters of any one year to another, unseasonable weather variations influence "buy now, wear now" consumer demand, but weather related variations have not been considered significant to net sales in total for any fiscal year. The timing of "Mother's Day" sales influenced the comparisons in the first two fiscal quarters. In both 2001 and 1999, Mother's Day sales fell primarily in the first fiscal quarter. In 2000, those sales were primarily in the second fiscal quarter. Aggregating the first two fiscal quarters, comparable store net sales declined 4.0% in comparing 2001 to 2000. In comparing the same six-month periods in 2000 to 1999, comparable store net sales decreased 1.3%. In the third fiscal quarter of 2001, consumer demand appeared to be strengthening as comparable store net sales in August had increased in comparison to 2000. The tragic events of September 11, 2001 adversely affected customer traffic, and for the 3-week period ended September 22, 2001, comparable store net sales were down 8.9%. During October 2001, consumer demand stabilized, and for the entire third fiscal quarter, comparable store net sales were off only 1.4% in comparison to 2000. In the fourth fiscal quarter of 2001, "Holiday" net sales were strongest in comparison to 2000 immediately before and after Christmas. Eliminating the effect of the 5-week January in 2000, the comparable store net sales in the fourth quarter of 2001 were flat with 2000. Cost of sales as a percentage of net sales were 58.3%, 59.3% and 59.4%, in 2001, 2000 and 1999, respectively. Overall, the Company's commitment to a less promotional, value priced, merchandise strategy has favorably influenced cost of sales during periods of inconsistent consumer demand and significant store growth. The Company controlled inventory levels in response to the weaker consumer demand, and as a result, 2001 clearance markdowns did not increase over the prior year. Further, the continued maturation of new and acquired stores in 1998 has had a positive impact on gross margin in each of the past three fiscal years. New and acquired stores typically run a higher cost of sales percentage relative to mature stores, especially those in markets new to the Company, due to a stronger promotional effort and lack of comparable sales history. After approximately 24 to 36 months of operation, a new location generally attains the Company's mature store average cost of sales. A net 33 new and acquired store locations were opened during 1998, versus only 5 in 1999 and a net 3 in 2000. Selling, general and administrative ("SG&A") expenses, exclusive of depreciation and amortization, were 27.8%, 27.9% and 28.6% of net sales in 2001, 2000 and 1999, respectively. The benefit of strict cost controls and economies of scale offset higher expenses at the 17 new locations opened in the third and fourth fiscal quarters. New and acquired stores typically have higher occupancy costs, and a higher expense structure than mature stores for the first 12 to 18 months after opening, as advertising and payroll expenses are planned at a higher percentage of sales to achieve a market presence. Depreciation and amortization expenses as a percentage of net sales were 3.7%, 3.4% and 3.3% in 2001, 2000 and 1999, respectively. Capital expenditures related to new store locations have been the primary reason for the increase. Depreciation expense as a percentage of net sales was 2.8%, 2.5% and 2.4% in 2001, 2000 and 1999, respectively. In 1999, the asset impairment as a percentage of net sales was .7%, or $2,182. The asset impairment represented the Company's entire investment in a co-operative buying office. As a result of the factors discussed above, operating income in 2001, 2000 and 1999 as a percentage of net sales was 10.2%, 9.4% and 8.0%, respectively. Interest expense as a percentage of net sales was 2.2%, 3.6% and 3.8%, for 2001, 2000 and 1999, respectively. The significant decrease in comparing 2001 to 2000 was primarily a result of lower interest rates, as the Credit Agreement bears interest at a variable rate, based primarily on LIBOR. In addition, increasingly profitable operations in both 2001 and 2000 resulted in lower average borrowings. Total income taxes as a percentage of net sales were 3.3%, 2.5% and 1.9% in 2001, 2000 and 1999, respectively. The effective tax rate for 2001, 2000 and 1999 was 41.0%, 43.0% and 43.4%, respectively. The effective tax rate in all three fiscal years is higher than statutory rates because of non-deductible amortization of intangible assets. As a result of the above factors, the Company had net income as a percentage of net sales of 4.7%, 3.3%and 2.3% in 2001, 2000 and 1999, respectively. LIQUIDITY AND CAPITAL RESOURCES The Company's primary cash requirements are for working capital needs, and for capital expenditures associated with new stores and the remodeling of existing stores. The Company's primary sources of funds are cash flow from continuing operations, borrowings under the Credit Agreement and trade accounts payable. The Company's inventory levels typically build throughout the fall, peaking during the Christmas selling season, while accounts receivable peak during December and decrease during the first quarter. Capital expenditures typically occur evenly throughout the first three quarters of each year. The Company's operating activities provided net cash of $16,033, $26,082 and $13,861 in 2001, 2000 and 1999. In comparing 2001 to 2000, greater profitability and use of vendor financing were offset by an increase in working capital requirements, primarily as a result of the 17 new store locations. Working capital increased to $83,619 at February 2, 2002, up from $70,016 at February 3, 2001 and $78,495 at January 29, 2000. At February 2, 20002, merchandise inventories increased $8,259 in comparison to February 3, 2001, with 2001 new store locations carrying merchandise inventory of approximately $6,300. Vendor financing through accounts payable provided cash of $1,753. Accounts receivable, primarily related to the Company's proprietary Peebles Charge card, used net operating cash of $4,321. Of this net use of cash, the 2001 new store locations represented $1,425. Peebles Charge sales increased from 27.6% of net sales in 2000 to 28.9% in 2001, primarily due to increases at maturing stores and, in general, due to the weakness in the general economy. The timing of realization of certain other net assets provided less cash in 2001 than in 2000. Net cash used in investing activities was $12,731, $4,832 and $9,368 in 2001, 2000 and 1999, respectively. In 2001, the Company acquired 11 of the 17 new store locations in an auction for $2,375. Capital expenditures totaled $10,260, $4,797 and $9,151, in 2001, 2000 and 1999, respectively. In 2001, new store locations required $4,550 of capital expenditures. In addition, remodeling and space reallocation at existing stores totaled $3,550 and upgrades to point of sale equipment totaled $1,255. The remaining 2001 capital expenditures were for upgrades to distribution center handling equipment and general office equipment. Capital expenditures for 2000 were significantly lower than 1999 as only 4 new locations were opened during the fiscal year, and the majority of the capital improvements required by stores opened in 1998 and 1999 was completed in 1999. In 2000, capital expenditures included $1,500 at the four new store locations, and $1,300 for major remodeling and space reallocation. The remaining 2000 expenditures were primarily for routine fixture upgrades at existing stores. The Company used cash to reduce outstanding borrowings by $2,519, $20,572 and $3,549 in 2001, 2000 and 1999, respectively. In 2001, the Company used cash of $696 to repurchase PHC Retail common stock from management shareholders. Scheduled debt service, primarily principal payments on the Senior Term Facility, used $3,700 in 2001, 2000 and 1999. The ECF Prepayments, $9,771 paid in 2001 and $5,739 paid in 2000, decreased amounts outstanding under the Senior Term Facility and were funded through the Revolver. The 2001 ECF Prepayment of $7,694 will be paid in the first fiscal quarter of 2002. In 2002, the Company's capital expenditures are expected to total approximately $7,300. The Company plans to open five new store locations, adding approximately 86,000 square feet, with total fixtures and equipment of $2,400. In addition, current plans for 2002 include the relocation of one existing store and the major remodeling/space reallocation of three stores, with related capital expenditures of $2,600. Of the remaining 2002 capital expenditures, approximately $1,400 is planned for routine fixture/POS equipment upgrades at existing stores, and $900 for capital equipment at the corporate office and distribution centers. As of March 2002, the Company had signed leases for three of the 2002 new store locations. The Company has identified four existing store locations which may be closed in 2002. Each of the stores is at a lease renewal period and is considered marginally profitable. The Company expects to continue to lease its stores, and the typical new store is anticipated to average approximately 21,600 square feet but may vary depending on the individual market and real estate opportunity. Based on historical experience, the Company estimates that the cost of opening a new store will include capital expenditures of approximately $425 for leasehold improvements and fixtures and approximately $425 for initial inventory, approximately one-third of which is normally financed through vendor credit. Accounts receivable for new stores typically build to 11% of net sales or approximately $275 within 24 months of the store opening. The Company may also incur capital expenditures to acquire existing stores. The Company finances its operations, capital expenditures, and debt service payments in part with funds available under its Revolver. The maximum amount available under the Revolver is $75 million less amounts outstanding under letters of credit. The actual amount available is determined by an asset-based formula. The Company believes the cash flow generated from operating activities together with funds available under the Revolver will be sufficient to fund its investing activities and the debt service of the Credit Agreement. At February 2, 2002, the contractual cash obligations of the Company were as follows: Payments Due by Period --------------------------- Less Contractual than 1 1 - 3 4 - 5 After 5 Obligations Total year years years years --------------------------------------------------------------------- Long-term debt $ 83,286 $ 10,061 $ 73,225 $ 0 $ 0 Capital lease Obligations 601 180 361 60 0 Operating leases 94,103 13,504 22,675 17,379 40,545 ------- ------- ------- ------ ------- Total Contractual Cash Obligations $177,990 $ 23,745 $ 96,261 $ 17,439 $ 40,545 ======== ======= ======= ======= ======= SEASONALITY AND INFLATION As a retailer offering predominately soft-apparel and selected home accessories, the Company's business is seasonal, although less heavily weighted in the fourth quarter than retailers with comparable offerings of merchandise. Over the past six fiscal years, quarterly sales as a percentage of total sales have been consistent at approximately 20%, 23%, 24% and 33% for the first through fourth quarters, respectively. Peebles' positioning of its stores in small to medium sized communities with limited competition, along with the Company's less promotional, every day fair value, pricing strategy, produces operations less dependent on the fourth quarter. However, the third and fourth quarters are generally bolstered by the back-to-school and Christmas holiday selling seasons. The Company does not believe that inflation has had a material effect on its results of operations during the past three fiscal years. Peebles uses the retail inventory method applied on a LIFO basis in accounting for its inventories. Under this method, the cost of products sold reported in the financial statements approximates current costs and thus reduces the likelihood of a material impact that increases costs. However, there can be no assurance that the Company's business will not be impacted by inflation in the future. MARKET RISK The Company's interest expense is affected by changes in short- term interest on the debt outstanding under the Credit Agreement. The Credit Agreement bears interest at rates based on both the LIBOR and prime lending rates (the "Borrowing Rates"). At February 2, 2002, long-term debt totaled $83,286. Although the total debt varies throughout the year based on the Company's operations and seasonal fluctuations, the balance outstanding is not expected to drop below $50,000 in 2002 or below $40,000 in 2003. The Company has two interest rate swaps with notional amounts of $10,000 and $40,000, and expiration dates of November 20, 2002 and 2003, respectively, to hedge exposure to interest rate fluctuations. Therefore, with $50,000 of the long-term debt effectively bearing a fixed rate of interest, and assuming the Borrowing Rates vary by 100 basis points from their current levels in any given fiscal month, the $33,286 of variable debt subject to the Borrowing Rates, interest expense would vary by approximately $28 for that fiscal month. CRITICAL ACCOUNTING POLICIES The Company's significant accounting policies are summarized in Note A to these consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the Untied States. The preparation of these consolidated financial statements requires management to select and apply accounting policies involving estimates and judgment. Listed below are those accounting policies requiring a higher degree of judgment and/or where estimates have the greatest impact on the consolidated financial statements. Allowance for Uncollectible Accounts: Peebles maintains allowances for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments. The allowance is determined using historical experience, aging of receivables, and an evaluation of the current and expected economic environment. If the financial condition of individual customers, regions in which the Company operates, or the general economy were to vary materially from the assumptions used by management, the allowance would require adjustment. The Company evaluates the adequacy of the allowance on a regular basis, adjusting its assumptions and updating the historical experience accordingly. Merchandise Inventories: The Company uses the retail inventory method, applied on a last-in, first-out ("LIFO") basis, to account for merchandise inventories. The retail inventory value must represent the best estimation of saleable value in order to state merchandise inventories at the lower of cost or market. The saleable value assigned to specific inventory units is determined by management using detailed analysis of historical experience and expected consumer demand. If actual consumer demand for the Company's apparel varies significantly from expectations, realization of the merchandise inventories will affect the cost of sales. Long-Lived Assets: The Company records these assets, which include property and equipment, finite-lived and indefinite- lived intangible assets at cost, or calculated cost, as applicable, and assigns a useful economic life. The assets are depreciated or amortized, generally on a straight-line basis, over the assigned useful economic life. The Company periodically reviews the net carrying value of long-lived assets and the useful economic life remaining to determine if impairment has occurred, resulting in a revaluation. The economic useful life is assigned based on the assets, expected contribution to future operations. If the Company experiences significant unforeseen changes in competition, market demographics, or technology rendering the Company's existing technology obsolete, useful economic lives may be shortened and/or carrying values reduced, adversely affecting operating profitability. The Company will adopt SFAS No. 142 in the first fiscal quarter of 2002. Under the provisions of SFAS No. 142, Goodwill and certain other indefinite-lived assets will cease to be amortized, and instead, will be tested for impairment on at least an annual basis, or at any time indicators of impairment exist. At February 2, 2002, net Goodwill was $35,224, or 16.2% of total assets. Through February 2, 2002, Goodwill was amortized on a straight-line basis, and a useful economic life of twenty-five years had been assigned. Annual amortization expense in a fifty-two week fiscal year would have been $1,917. The Company currently expects the only impact of adopting SFAS No. 142 to be a reduction in amortization expense of $1,917. However, if unforeseen changes in competition, market demographics or the economy adversely impact the fair value of the Company, Goodwill and other indefinite-lived intangible assets may require revaluation. FORWARD-LOOKING STATEMENTS Certain statements in this annual report are forward- looking, based on the Company's evaluation of historical information and judgments on future events, based on the best information available at the time. Underlying these statements are risks and uncertainties which could cause actual results to differ materially from those forward- looking statements. These risks and uncertainties include, but are not limited to: i) consumer demand for the Company's soft-apparel merchandise; ii) competitive and consumer demographic shifts within the Company's markets; iii) the Company's access to, and cost of, capital; iv) the Company's ability to locate and open new store locations on a timely and profitable basis; v) the Company's ability to integrate acquired stores into Peebles' overall operations on a timely basis; and vi) the successful management of inventory levels, related costs and selling, general and administrative costs.

PEEBLES INC 10-K