Edgar Filing: REEDS JEWELERS INC

SECURITIES AND EXCHANGE COMMISSION
WASHINGTON DC 20549

------------

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTER ENDED AUGUST 31, 2001
COMMISSION FILE NUMBER 0-15247

REEDS JEWELERS, INC.
(Exact name of registrant as specified in its charter)

NORTH CAROLINA 56-1441702
(State or other jurisdiction of incorporation or (I.R.S. Employer Identification No.)
organization)

2525 SOUTH SEVENTEENTH STREET
WILMINGTON, NORTH CAROLINA 28401
(Address of principal executive offices) (Zip code)

REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE:
(910) 350-3100

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 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 the number of shares outstanding of each of the issuer's class of
common stock, as of the latest practicable date.

The number of outstanding shares of Common Stock, par value $0.10 per
share, as of October 15, 2001 was 8,476,372.

PART I

ITEM 1. FINANCIAL STATEMENTS

The consolidated financial statements included herein have been prepared by
Reeds Jewelers, Inc. (the "Company"), without audit, pursuant to the rules and
regulations of the Securities and Exchange Commission. Certain information and
footnote disclosures normally included in financial statements prepared in
accordance with generally accepted accounting principles have been condensed or
omitted pursuant to such rules and regulations; however, the Company believes
that the disclosures are adequate to make the information presented not
misleading. It is suggested that these consolidated financial statements be read
in conjunction with the financial statements and the notes thereto included in
the Company's latest annual report on Form 10-K for the fiscal year ended
February 28, 2001.

REEDS JEWELERS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS

FEBRUARY 28 AUGUST 31 AUGUST 31
2001 2001 2000
------------ ------------ ------------

ASSETS (UNAUDITED) (UNAUDITED)
Current assets:
Cash and cash equivalents .......................... $ 685,000 $ 776,000 $ 768,000
Accounts receivable:
Customers, less allowance for doubtful accounts
of $4,262,000, $3,730,000 and $3,800,000 ...... 49,008,000 42,902,000 45,879,000
Other ......................................... 1,191,000 993,000 748,000
Merchandise inventories ............................ 48,552,000 52,066,000 55,908,000
Income taxes receivable ............................ 604,000 2,421,000 1,011,000
Deferred income taxes, net of valuation allowance of
$149,000, 132,000 and $141,000 .................. 2,194,000 1,939,000 1,971,000
Other .............................................. 1,018,000 1,020,000 637,000
------------ ------------ ------------
Total current assets ........................ 103,252,000 102,117,000 106,922,000

Property, furniture and equipment:
Land and building .................................. 83,000 83,000 83,000
Furniture and equipment ............................ 25,421,000 27,362,000 26,170,000
Leasehold improvements ............................. 12,336,000 12,303,000 11,758,000
------------ ------------ ------------
37,840,000 39,748,000 38,011,000
Less accumulated depreciation and amortization ..... 19,662,000 20,654,000 20,337,000
------------ ------------ ------------
Net property, furniture and equipment ....... 18,178,000 19,094,000 17,674,000

Other assets:
Goodwill, net of accumulated amortization of
$2,993,000, $3,216,000 and $2,770,000 ............ 5,403,000 5,180,000 5,626,000
Deferred income taxes, net of valuation allowance of
$13,000, $19,000 and $13,000 ..................... 195,000 284,000 183,000
Restricted investments (Note C) .................... 2,580,000 2,367,000 2,539,000
Miscellaneous ...................................... 829,000 975,000 781,000
------------ ------------ ------------
9,007,000 8,806,000 9,129,000
------------ ------------ ------------
TOTAL ASSETS ........................................ $130,437,000 $130,017,000 $133,725,000
============ ============ ============

LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable ................................... $ 13,418,000 $ 21,944,000 $ 19,357,000
Accrued compensation ............................... 2,305,000 1,287,000 1,937,000
Accrued expenses ................................... 2,348,000 1,951,000 2,654,000
Deferred revenue (Note D) .......................... -- -- 81,000
Current portion of long-term debt (Note E) ......... -- 60,100,000 --
------------ ------------ ------------
Total current liabilities .................... 18,071,000 85,282,000 24,029,000

Revolving credit note (Note E) ...................... 63,761,000 -- 64,570,000
Subordinated notes payable to shareholders .......... 845,000 845,000 845,000
Deferred income taxes ............................... 2,517,000 2,095,000 1,000,000
Other long-term liabilities ......................... 211,000 874,000 213,000
------------ ------------ ------------
Total liabilities ............................ 85,405,000 89,096,000 90,657,000

Shareholders' equity:
Common stock, par value $0.10 per share;
25,000,000 shares authorized; 8,476,372 shares
issued and outstanding in 2001 and 2000 .......... 847,000 847,000 847,000
Additional paid-in capital .......................... 10,560,000 10,560,000 10,560,000
Retained earnings ................................... 33,625,000 29,514,000 31,661,000
------------ ------------ ------------
Total shareholders' equity ................... 45,032,000 40,921,000 43,068,000
------------ ------------ ------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY .......... $130,437,000 $130,017,000 $133,725,000
============ ============ ============

REEDS JEWELERS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED)

THREE MONTHS ENDED SIX MONTHS ENDED
AUGUST 31 AUGUST 31
2001 2000 2001 2000
------------ ------------ ------------ ------------

Net sales .................................. $ 22,306,000 $ 24,309,000 $ 43,599,000 $ 48,448,000
Cost of sales .............................. 12,146,000 12,225,000 23,029,000 23,951,000
------------ ------------ ------------ ------------
Gross profit ..................... 10,160,000 12,084,000 20,570,000 24,497,000
Selling, general and administrative expenses 11,532,000 11,563,000 22,395,000 22,873,000
Depreciation and amortization .............. 1,063,000 1,015,000 2,077,000 1,975,000
------------ ------------ ------------ ------------
Operating loss ................... (2,435,000) (494,000) (3,902,000) (351,000)
Interest expense ........................... 1,036,000 1,349,000 2,144,000 2,487,000
------------ ------------ ------------ ------------
Loss before income taxes ................... (3,471,000) (1,843,000) (6,046,000) (2,838,000)
Income tax benefit ......................... (1,111,000) (608,000) (1,935,000) (936,000)
------------ ------------ ------------ ------------
Net loss ................................... $ (2,360,000) $ (1,235,000) $ (4,111,000) $ (1,902,000)
============ ============ ============ ============

Basic and diluted net loss per common
share ...................................... $ (0.28) $ (0.15) $ (0.49) $ (0.22)
============ ============ ============ ============

Weighted average shares outstanding -
diluted .................................... 8,476,372 8,476,372 8,476,372 8,476,372
============ ============ ============ ============

REEDS JEWELERS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

SIX MONTHS ENDED SIX MONTHS ENDED
AUGUST 31, AUGUST 31,
2001 2000
------------ ------------

OPERATING ACTIVITIES
Net loss ................................................. $ (4,111,000) $ (1,902,000)
Adjustments to reconcile net loss to net cash provided by
(used in) operating activities:
Depreciation .................................... 1,796,000 1,714,000
Amortization .................................... 281,000 261,000
Loss on sale of property, furniture and equipment 18,000 130,000
Changes in operating assets and liabilities:
Accounts receivable ............................. 6,304,000 2,017,000
Merchandise inventories ......................... (3,514,000) (9,655,000)
Other current assets and other assets ........... (206,000) (237,000)
Accounts payable ................................ 8,526,000 6,502,000
Accrued compensation and expenses ............... (1,415,000) (1,690,000)
Deferred revenue ................................ -- (233,000)
Income taxes .................................... (2,073,000) (2,232,000)
Other long-term liabilities ..................... 663,000 --
------------ ------------
Net cash provided by (used in) operating activities ...... 6,269,000 (5,325,000)

INVESTING ACTIVITIES
Purchases of property, furniture and equipment ........... (2,730,000) (4,474,000)
Proceeds from sale of restricted investments ............. 2,517,000 --
Purchase of restricted investments ....................... (2,304,000) (2,539,000)
------------ ------------
Net cash used in investing activities .................... (2,517,000) (7,013,000)

FINANCING ACTIVITIES
Net (payments on) proceeds from revolving credit note .... (3,661,000) 12,211,000
------------ ------------
Net cash (used in) provided by financing activities ...... (3,661,000) 12,211,000
------------ ------------

Net increase (decrease) in cash and cash equivalents ..... 91,000 (127,000)
Cash and cash equivalents at beginning of period ......... 685,000 895,000
------------ ------------
Cash and cash equivalents at end of period ............... $ 776,000 $ 768,000
============ ============

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest ............................................. $ 2,170,000 $ 2,348,000
============ ============
Income taxes ......................................... $ 53,000 $ 2,308,000
============ ============

REEDS JEWELERS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

A. MANAGEMENT'S OPINION

These consolidated financial statements should be read in conjunction with the
audited consolidated financial statements and notes thereto included in the
Company's Form 10-K for the fiscal year ended February 28, 2001.

Management of Reeds Jewelers, Inc. believes that the consolidated financial
statements contained herein contain all adjustments necessary to present fairly
the financial position, consolidated results of operations, and cash flows for
the interim period. Management also believes that all adjustments so made are of
a normal and recurring nature.

B. RECLASSIFICATIONS

Certain reclassifications were made to the 2000 financial statements to conform
to the classifications used in 2001. The reclassifications had no effect on net
loss or shareholders' equity as previously reported.

C. RESTRICTED INVESTMENTS

08/31/01 08/31/00
---------- ----------
Cash ........................... $2,307,000 $ 545,000
Held-to-maturity investments ... -- 1,934,000
Equity investment .............. 60,000 60,000
---------- ----------
Total restricted investments $2,367,000 $2,539,000
========== ==========

Restricted investments in the accompanying balance sheet represent cash, bonds
and stock held by the Company's subsidiary, First Retail Bank N.A., to comply
with the Federal Banking Regulations.

The held-to-maturity investments consist of Federal Home Loan Bank bonds. These
bonds are stated at cost, as the Company held these securities until maturity in
June 2001.

The Company's equity investment, carried at cost, consists of 1,200 shares of
Federal Reserve Bank stock with a $50 par value at August 31, 2001.

D. DEFERRED REVENUE

For the fiscal years ended prior to February 28, 1999, in accordance with FASB
Technical Bulletin 90-1, "Accounting for Separately Priced Extended Warranty and
Product Maintenance Contracts," revenue from these contracts was deferred and
recognized as income on a straight-line basis over the contract period. This
deferred revenue is classified as a current liability on the balance sheet.
Commission costs that were directly related to the acquisition of these
contracts were deferred and charged to expense in proportion to the revenue
recognized. All other costs, such as costs of services performed under the
contracts, general and administrative expenses, and advertising expenses, were
charged to expense as incurred.

During the first quarter of the fiscal year ended February 28, 1999, the Company
stopped selling its own extended service contracts and began selling such
contracts on behalf of unrelated third parties only. As a result of this change,
the Company continued to recognize existing deferred revenues from previously
sold contracts through January 31, 2001 and now recognizes commission revenue
for the unrelated third-party extended warranty plans at the time of sale.
Previously deferred extended service contract revenue recognized for the
quarters ended August 31, 2001 and 2000 of $0 and $93,000, respectively, has
been reflected as a reduction of selling, general, and administrative expenses.

E. DEBT

In April 1999, the Company, its existing banks, and three additional banks
entered into an amended revolving credit agreement pursuant to which the Company
may borrow up to $65,000,000 through June 30, 2002 based on its receivable and
inventory balances. Under this agreement, the Company pays interest monthly at
an interest rate ranging from the 30-day LIBOR rate (3.58% at August 31, 2001)
plus 200 basis points to 260 basis points or prime (6.50% at August 31, 2001),
depending upon the Company's debt-to-worth ratio. As of September 1, 2001, the
Company's rate was 30-day LIBOR plus 240 basis points. The Company had
$60,100,000 outstanding on this revolver at August 31, 2001, which is classified
as a current liability based on its expiration date. The revolving credit
agreement is collateralized by substantially all of the Company's assets. The
various loan agreements contain certain financial covenants, including those
that limit dividend payments, limit additional borrowings, and prohibit new
store openings if an event of default occurs under the agreement.

F. OPERATING SEGMENT INFORMATION

In accordance with SFAS No. 131, "Disclosure about Segments of an Enterprise and
Related Information," the Company reports two segments, retail operations and
credit operations. Separate financial information is produced internally and is
regularly reviewed by the chief operating decision-maker ("CODM"). The retail
operations segment consists of all store locations and corporate headquarters.
The stores have all been combined into one segment because they have similar
basic characteristics, such as the nature of products, and the class of
customers for their products. Corporate headquarters is included in this same
segment due to the fact that its revenues earned are incidental to the Company's
activities and it serves as a support system to the stores. The credit
operations segment is primarily engaged in providing and maintaining financing
for the Company's customers. This operation is segregated since the CODM
evaluates it separately. It also meets one of the three quantitative thresholds,
the asset test, since it represents 10.0% or more of the combined assets of all
operating segments.

The following table summarizes the net sales, revenues, operating earnings,
interest expense, assets, depreciation, and capital expenditures for each
reportable segment for the quarters and six-months ended August 31, 2001 and
2000. In the financial statements, other revenues are reflected as a reduction
of selling, general, and administrative expenses and inter-segment revenue
eliminates in consolidation.

RETAIL CREDIT
OPERATIONS OPERATIONS TOTAL
--------------------------------------------------------------------------------------------------

FOR THE QUARTER ENDED AUGUST 31, 2001
--------------------------------------------------------------------------------------------------
NET SALES .......................... $ 22,306,000 $ -- $ 22,306,000
OTHER REVENUES ..................... 367,000 3,233,000 3,600,000
INTER-SEGMENT REVENUE .............. -- 242,000 242,000
OPERATING (LOSS) EARNINGS .......... (3,818,000) 1,383,000 (2,435,000)
INTEREST EXPENSE ................... 557,000 479,000 1,036,000
IDENTIFIABLE ASSETS ................ 84,419,000 45,598,000 130,017,000
DEPRECIATION AND AMORTIZATION ...... 1,029,000 34,000 1,063,000
CAPITAL EXPENDITURES ............... 1,183,000 -- 1,183,000
--------------------------------------------------------------------------------------------------
For the quarter ended August 31, 2000
--------------------------------------------------------------------------------------------------
Net Sales .......................... $ 24,309,000 $ -- $ 24,309,000
Other revenues ..................... 625,000 3,173,000 3,798,000
Inter-segment revenue .............. -- 234,000 234,000
Operating (loss) earnings .......... (1,670,000) 1,176,000 (494,000)
Interest expense ................... 530,000 819,000 1,349,000
Identifiable assets ................ 84,928,000 48,797,000 133,725,000
Depreciation and amortization ...... 967,000 48,000 1,015,000
Capital expenditures ............... 2,383,000 33,000 2,416,000

--------------------------------------------------------------------------------------------------
FOR THE SIX MONTHS ENDED AUGUST 31, 2001
--------------------------------------------------------------------------------------------------
NET SALES .......................... $ 43,599,000 $ -- $ 43,599,000
OTHER REVENUES ..................... 761,000 6,662,000 7,423,000
INTER-SEGMENT REVENUE .............. -- 411,000 411,000
OPERATING (LOSS) EARNINGS .......... (6,898,000) 2,996,000 (3,902,000)
INTEREST EXPENSE ................... 1,045,000 1,099,000 2,144,000
IDENTIFIABLE ASSETS ................ 84,419,000 45,598,000 130,017,000
DEPRECIATION AND AMORTIZATION ...... 2,009,000 68,000 2,077,000
CAPITAL EXPENDITURES ............... 2,730,000 -- 2,730,000
--------------------------------------------------------------------------------------------------
For the six months ended August 31, 2000
--------------------------------------------------------------------------------------------------
Net Sales .......................... $ 48,448,000 $ -- $ 48,448,000
Other revenues ..................... 1,275,000 6,151,000 7,426,000
Inter-segment revenue .............. -- 453,000 453,000
Operating (loss) earnings .......... (2,979,000) 2,628,000 (351,000)
Interest expense ................... 863,000 1,624,000 2,487,000
Identifiable assets ................ 84,928,000 48,797,000 133,725,000
Depreciation and amortization ...... 1,914,000 61,000 1,975,000
Capital expenditures ............... 4,409,000 65,000 4,474,000

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

RESULTS OF OPERATIONS

Net Sales

Total net sales were down 8.2% to $22,306,000 for the second quarter ended
August 31, 2001, compared to $24,309,000 for the second quarter last year. Net
sales decreased 10.0% to $43,599,000 for the six months ended August 31, 2001
from $48,448,000 for the same period a year earlier. Same store sales, or stores
open in comparable periods, declined 10.7% in the second quarter this year and
12.5% during the six-month period this year. At August 31, 2001, the Company
operated 119 stores in 21 states compared to 115 stores in 19 states at August
31, 2000. In the second quarter of fiscal 2002, the Company opened three stores
and closed two stores. The Company has no commitments to open additional stores
in the remainder of this fiscal year.

The sales of a retail jeweler depend upon having the right mixture of
merchandise available in its stores. Core merchandise items are those that are
the most profitable and have the highest turnover. The Company averaged 95.7%
in-stock on its core items during second quarter fiscal 2002, compared to 96.1%
last year; it averaged 93.8% in-stock on its entire basic merchandise mix
compared to 94.4% during the same quarter a year ago. For the quarter ended
August 31, 2001, core merchandise accounted for 54.3% of net sales, 59.9% of the
items offered in the Company's basic merchandise mix, and 35.2% of its inventory
investment. During the same quarter last year, core merchandise accounted for
56.7% of net sales, 85.8% of the items offered in the Company's basic
merchandise mix, and 41.3% of its inventory investment. The average price of
each piece of merchandise sold in second quarter 2002 was $246, down from $249 a
year earlier.

Credit sales for the second quarter of fiscal 2002 accounted for 45.3% of net
sales compared to 50.4% a year earlier. Although the total transactions during
the quarter were down 10.6% compared to last year same quarter, the average
transaction size increased 6.7% for credit sales and 10.1% for cash sales.

Gross Profit

Gross margins were 45.5% during the quarter, down from 49.7% in the second
quarter last year. Year-to-date, gross margins were 47.2%, down from 50.6% for
the first six months last year. The decrease in gross margins can be attributed
to a variation in sales mix and a higher level of promotional activity
necessitated by the competitive environment.

Selling, General, and Administrative Expenses (SG&A)

Selling, general, and administrative expenses as a percentage of net sales were
51.7% and 47.6% for the quarters ended August 31, 2001 and 2000, respectively.
Significant expense categories are reflected on a normalized basis for the
second quarters of the last two fiscal years in the following table:

Quarter Ended Six Months Ended
08/31/01 08/31/00 08/31/01 08/31/00
-----------------------------------------------------------------------------------------------------

Compensation - salaries & hourly wages ........ 23.9 % 21.4 % 24.6 % 20.9 %
Compensation - bonuses & commissions .......... 3.3 % 3.9 % 3.1 % 3.8 %
Compensation - benefits & other personnel costs 4.9 % 5.9 % 5.2 % 5.8 %
Rents for space ............................... 13.9 % 11.6 % 13.9 % 11.5 %
Advertising ................................... 2.7 % 2.5 % 3.3 % 3.9 %
Bad debt ...................................... 6.6 % 5.6 % 5.9 % 5.2 %
Finance charges ............................... (10.1)% (9.1)% (10.7)% (9.2)%
Late charge income ............................ (3.2)% (2.4)% (3.3)% (1.9)%
-----------------------------------------------------------------------------------------------------

Selling, general, and administrative expenses were 51.7% of net sales compared
to 47.6% a year ago due, in large part, to a lower sales volume. However, total
SG&A expenses have decreased $31,000 or 0.3% for the quarter and $478,000 or
2.1% year-to-date over the prior year. The lower SG&A expenses are a result of
decreased variable expenses relating to sales, as well as management's effort to
control other expenses. Fixed costs, on a per store basis, including occupancy,
base compensation, and benefits decreased 2.0% from the second quarter of the
prior year and year-to-date costs per store remain unchanged.

Bad debt increased to $1,478,000 from $1,355,000 and rose to 6.6% of net sales
for the quarter compared to 5.6% a year earlier. Gross write-offs for bad debts
were $1,952,000 versus $1,645,000 in the same quarter last year. Net write-offs,
after recovery of amounts previously written off, were $1,651,000 and $1,400,000
for the second quarter of the current and prior fiscal year, respectively. The
allowance for doubtful accounts was 8.00% and 7.65% of gross customer
receivables at the end of the second fiscal quarter of 2002 and 2001,
respectively. The average delinquent account (accounts more than 90 days past
due) represented 13.3% and 10.5% of the Company's accounts receivable portfolio
for the second quarter of fiscal 2002 and 2001, respectively. The average
approval rate on applications was 44.8% for the second quarter of the current
year and 47.8% for the second quarter last year. The Company's policies and
procedures regarding credit authorization, collection, and write-offs have not
changed significantly during each of the two periods.

In the first quarter of fiscal 1999 the Company began selling extended service
agreements on behalf of an unrelated third party versus selling them in-house.
The Company recognized deferred revenue from extended service agreements
previously sold by the Company through January 31, 2001. The Company now
recognizes commission revenue for the unrelated third-party extended service
agreements at the time of sale. Previously deferred extended service agreements
revenue recognized for the quarters ended August 31, 2001 and 2000 of $0 and
$93,000, respectively, as well as commission revenues of $367,000 and $625,000,
respectively, have been reflected as a reduction of selling, general, and
administrative expenses. Extended service agreements equaled 1.6% and 2.6% of
net sales during the quarters ended August 31, 2001 and 2000, respectively.

Interest Expense

The average borrowings under the Company's line of credit dropped 1.1% over
prior year. The Company's effective pre-tax interest rate during the quarter
dropped to 6.5% from 8.4% for the same period in the previous year as a result
of the drop in the LIBOR rate. Interest expense for the quarter was $1,036,000,
23.2% lower than the same quarter last year.

Income Taxes

The benefit from income taxes was $1,111,000 and $608,000 during the second
quarters of fiscal 2002 and 2001, respectively. The Company's estimated net
effective tax rate was 32.0% during the second quarter ended August 31, 2001 and
33.0% in the second quarter of the previous year.

LIQUIDITY AND CAPITAL RESOURCES

The Company requires cash for purchasing inventory, opening new stores,
remodeling existing stores, enhancing technology, and servicing debt. Working
capital needs normally peak in the fall as the Company increases inventories to
meet anticipated demand during the Christmas selling season. Working capital
requirements will be financed by funds generated from operations, bank lines,
and other steps described below. Cash provided by operations for the first half
of the current year was $6,269,000 and cash used in operations was $5,325,000
for the first half of last year.

The Company has slowed payments to its suppliers as a result of several factors
including the continuing weakness in net sales. The decreased net sales also
have resulted in lower accounts receivables as customer payments are exceeding
new charge sales. In addition, the Company has reduced inventory purchases
because of the slowdown in consumer spending on discretionary items. The
reductions in accounts receivable and inventories have reduced the amount of
borrowings the Company can make under its revolving credit facility, so that
only $62 - $63 million of its $65 million line is presently available.

As a result of the decreased profitability during the last eighteen months and
the reduced liquidity that the Company is experiencing, the Board of Directors
and management have carefully evaluated the Company's operating strategy and
balance sheet structure, and decided to take the following steps: 1) close a
number of stores that are unprofitable and have a negative cash flow; 2) reduce
personnel costs; and 3) restructure its balance sheet.

The Company will be closing 14 locations via sales, lease terminations, and
lease expirations. The Company has also negotiated the termination of three
leases associated with stores to be opened during the fall of this year. The
Company incurred costs to obtain the lease terminations, and will realize a
write-down of the associated fixed assets when the stores are closed in December
and January. The Company is taking steps to close additional under-performing
stores. If the Company is successful in closing all the targeted stores, it
expects to realize annual improvements in operating cash flows of approximately
$1.5 million and in pre-tax earnings of approximately $2.5 million. The Company
expects that capital expenditures in the fiscal year ending February 28, 2003
will be less than $1 million.

During the second quarter, the Company reduced its corporate office personnel
costs by approximately 20%. The resulting annual cost savings for the reductions
in the corporate office are expected to be approximately $1 million. The Company
anticipates for each store closed, the annual personnel cost savings will
approximate $150,000.

The Company has decided that it is appropriate to take steps to reduce the
Company's debt level and corresponding debt-to-equity ratio. As part of its
strategy, the Company believes that it should turn to a third-party to both own
and service its proprietary credit portfolio. The Company plans to close the
sale of its proprietary credit card portfolio before the end of this fiscal year
and does not expect to record any write-down from the net stated value of the
portfolio.

In anticipation of the sale of its proprietary credit card portfolio, the
Company is in the process of unwinding its subsidiary, First Retail Bank, NA.
This subsidiary will be liquidated on or about October 30, 2001, and, as a
result, the $2.3 million of associated restricted investments, required to be
maintained by banking regulations, will immediately become available for general
corporate purposes.

In conjunction with the sale of its receivables, the Company is presently
negotiating with an asset-based lender for a new revolving bank facility. The
facility is expected to be for a term of 2-3 years and would advance against
inventories at rates consistent with traditional asset-based lending
arrangements. The Company does not expect the interest rate to differ
significantly from its existing facility. The Company has not yet received a
commitment letter from the asset-based lender, but does expect that it will
close on a new facility before the end of the current fiscal year. The lead bank
in the Company's current syndication has indicated its interest to participate
in the new facility. By implementing its strategic plan, the Company anticipates
that it will violate certain covenants under its existing credit facility and is
presently negotiating with its existing bank group for covenant modifications.

The balance sheet restructuring is expected to result in one-time charges of
between $7 million and $12 million, depending on the number of stores that are
closed. All such closings are planned to occur before the end of the current
fiscal year. The one-time charges are expected to include a write-off of
goodwill of approximately $5 million. If the Company meets its objectives, it
expects that its debt-to-equity ratio would drop from more than 1.5 to
approximately 1.0.

Debt

Borrowings under the Company's revolving credit facility averaged $62.4 million
during the second quarter of fiscal 2002 and $63.1 million during the second
quarter of fiscal 2001. The maximum borrowings outstanding under the facility at
any time during each of the quarters were $64.7 million and $65.0 million,
respectively.

In April 1999, the Company, its existing banks, and three additional banks
entered into an amended revolving credit agreement pursuant to which the Company
may borrow up to $65,000,000 through June 30, 2002. Under this agreement, the
Company pays interest monthly at an interest rate ranging from the 30-day LIBOR
rate (3.58% at August 31, 2001) plus 200 basis points to 260 basis points or
prime (6.50% at August 31, 2001), depending upon the Company's debt-to-worth
ratio. As of September 1, 2001, the Company's rate was 30-day LIBOR plus 240
basis points.

The Company had $60,100,000 outstanding on this revolver at August 31, 2001,
which is classified as a current liability based on its expiration date. The
revolving credit agreement is collateralized by substantially all of the
Company's assets. The various loan agreements contain certain financial
covenants, including those that limit dividend payments, limit additional
borrowings, and prohibit new store openings if an event of default occurs under
the agreement. As discussed above, the Company is presently negotiating for a
new revolving credit facility with an asset-based lender.

The Company also has subordinated notes totaling $845,000 with three related
parties, with interest payable monthly at the prime rate (6.50% at August 31,
2001) quoted in The Wall Street Journal. The notes are unsecured and are
subordinate to the revolving credit facility, which is collateralized by
substantially all of the Company's assets.

Working Capital

Working capital was $16,835,000 at August 31, 2001 compared to $82,893,000 at
August 31, 2000 due to the reclassification of the revolving credit agreement to
a current liability. The resulting ratio of current assets to current
liabilities as of August 31, 2001 was 1.2 to 1, compared to 4.4 to 1 the same
time last year. Capital expenditures totaled $2,730,000 and $4,474,000 for the
six months ended August 31, 2001 and 2000, respectively. The Company opened
three stores during the quarter ended May 31, 2001 and three stores in the
quarter ended August 31, 2001. The Company has no commitments to open additional
stores in the remainder of this fiscal year.

DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS

The Private Securities Litigation Reform Act of 1995 provides a "safe harbor"
for forward-looking statements to encourage companies to provide prospective
information about their companies without fear of litigation so long as those
statements are identified as forward-looking and are accompanied by meaningful
cautionary statements identifying important factors that could cause actual
results to differ materially from those projected in the statement. Various
forward-looking statements have been made throughout this discussion, including
comments about:

(i) planned store openings and closings;
(ii) potential sale and any potential write-off of the Company's
proprietary credit card portfolio;
(iii) potential financing arrangements with banks;
(iv) potential write-off of goodwill;
(v) other elements of the Company's restructuring plans; and
(vi) the future effects of these actions on cash flow and earnings.

Accordingly, Reeds Jewelers, Inc. hereby identifies the following important
factors that could cause its actual financial results to differ materially from
those projected by the Company in forward-looking statements:

(i) availability of favorable locations on terms acceptable to the
Company;
(ii) unexpected changes in the marketing and pricing strategies of
competitors;
(iii) adverse changes in the political environments of countries
providing raw materials for the jewelry industry;
(iv) adverse changes in consumer spending or consumer
credit-worthiness;
(v) significant changes in interest rates; or (vi) the loss of key
executives.

IMPACT OF INFLATION

In management's opinion, changes in net sales and net earnings that have
resulted from inflation and changing prices have not been material during the
periods presented. There is no assurance, however, that inflation will not
materially affect the Company in the future.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings.

The Company is from time to time involved in routine litigation
incidental to the conduct of its business. The Company believes that no
currently pending litigation to which it is a party will have a
material adverse effect on its consolidated financial condition or
results of operations.

Item 2. Changes in Securities.

Not applicable.

Item 3. Defaults Upon Senior Securities.

Not applicable.

Item 4. Submission of Matters to a Vote of Security Holders.

Not applicable.

Item 5. Other Information.

Not applicable.

Item 6. Exhibits and Reports on Form 8-K.

(a) Exhibits.

Not applicable.

(b) Reports on Form 8-K.

Not applicable.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.

REEDS JEWELERS, INC.

October 15, 2001 /s/ James R. Rouse
--------------------------------
James R. Rouse
Treasurer and
Chief Financial Officer