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 NOVEMBER 30, 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 (I.R.S. Employer Identification No.)
incorporation or 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 January 14, 2002 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 NOVEMBER 30 NOVEMBER 30
2001 2001 2000
------------- ------------- -------------
ASSETS (UNAUDITED) (UNAUDITED)

Current assets:
Cash and cash equivalents.............................. $ 685,000 $ 1,015,000 $ 919,000
Accounts receivable:
Customers, less allowance for doubtful accounts
of $4,262,000, $3,619,000 and $3,937,000......... 49,008,000 41,615,000 47,525,000
Other.............................................. 1,191,000 1,374,000 2,139,000
Merchandise inventories................................ 48,552,000 54,795,000 59,977,000
Income taxes receivable................................ 604,000 5,472,000 1,410,000
Deferred income taxes, net of valuation allowance of
$149,000, $109,000 and $142,000...................... 2,194,000 1,912,000 2,023,000
Other.................................................. 1,018,000 934,000 1,414,000
------------- ------------- -------------
Total current assets............................ 103,252,000 107,117,000 115,407,000

Property, furniture and equipment:
Land and building...................................... 83,000 83,000 83,000
Furniture and equipment................................ 25,421,000 24,893,000 26,679,000
Leasehold improvements................................. 12,336,000 12,534,000 11,912,000
------------- ------------- -------------
37,840,000 37,510,000 38,674,000
Less accumulated depreciation and amortization......... 19,662,000 20,858,000 19,615,000
------------- ------------- -------------
Net property, furniture and equipment........... 18,178,000 16,652,000 19,059,000

Other assets:
Goodwill, net of accumulated amortization of
$2,993,000, $0 and $2,882,000........................ 5,403,000 - 5,514,000
Deferred income taxes, net of valuation allowance of
$13,000, $39,000 and $11,000......................... 195,000 676,000 165,000
Restricted investments (Note C)........................ 2,580,000 - 2,628,000
Miscellaneous.......................................... 829,000 973,000 869,000
------------- ------------- -------------
9,007,000 1,649,000 9,176,000
------------- ------------- -------------
TOTAL ASSETS............................................ $ 130,437,000 $ 125,418,000 $ 143,642,000
============= ============= =============

LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable....................................... $ 13,418,000 $ 24,509,000 $ 30,442,000
Accrued compensation................................... 2,305,000 1,808,000 1,901,000
Accrued expenses....................................... 2,348,000 5,180,000 3,417,000
Deferred revenue (Note D).............................. - - 11,000
Current portion of long-term debt (Note E)............. - 59,125,000 -
------------- ------------- -------------
Total current liabilities........................ 18,071,000 90,622,000 35,771,000

Revolving credit note (Note E).......................... 63,761,000 - 62,689,000
Subordinated notes payable to shareholders.............. 845,000 845,000 845,000
Deferred income taxes................................... 2,517,000 1,268,000 1,823,000
Other long-term liabilities............................. 211,000 855,000 213,000
------------- ------------- -------------
Total liabilities................................ 85,405,000 93,590,000 101,341,000

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 20,421,000 30,894,000
------------- ------------- -------------
Total shareholders' equity....................... 45,032,000 31,828,000 42,301,000
------------- ------------- -------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY... $ 130,437,000 $ 125,418,000 $ 143,642,000
============= ============= =============

REEDS JEWELERS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED)

THREE MONTHS ENDED NINE MONTHS ENDED
NOVEMBER 30 NOVEMBER 30
2001 2000 2001 2000
------------- ------------- ------------- -------------

Net sales...................................... $ 24,670,000 $ 27,296,000 $ 68,269,000 $ 75,744,000
Cost of sales.................................. 13,056,000 14,168,000 36,085,000 38,119,000
------------- ------------- ------------- -------------
Gross profit......................... 11,614,000 13,128,000 32,184,000 37,625,000
Selling, general and administrative expenses... 12,415,000 11,904,000 34,810,000 34,777,000
Depreciation and amortization.................. 897,000 1,010,000 2,974,000 2,985,000
Restructuring charge (Note G).................. 4,864,000 - 4,864,000 -
Asset impairment charge (Note H)............... 5,983,000 - 5,983,000 -
------------- ------------- ------------- -------------
Operating (loss) earnings............ (12,545,000) 214,000 (16,447,000) (137,000)
Interest expense............................... 826,000 1,359,000 2,970,000 3,847,000
------------- ------------- ------------- -------------
Loss before income taxes....................... (13,371,000) (1,145,000) (19,417,000) (3,984,000)
Income tax benefit............................. (4,278,000) (378,000) (6,213,000) (1,315,000)
------------- ------------- ------------- -------------
Net loss....................................... $ (9,093,000) $ (767,000) $ (13,204,000) $ (2,669,000)
============= ============= ============= =============

Basic and diluted net loss per common share.... $ (1.07) $ (0.09) $ (1.56) $ (0.31)
============= ============= ============= =============

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)

NINE MONTHS ENDED NINE MONTHS ENDED
NOVEMBER 30, NOVEMBER 30,
2001 2000
----------------- -----------------

OPERATING ACTIVITIES
Net loss..................................................... $ (13,204,000) $ (2,669,000)
Adjustments to reconcile net loss to net cash provided by
(used in) operating activities:
Asset impairment charge............................. 5,983,000 -
Depreciation........................................ 2,657,000 2,591,000
Amortization........................................ 317,000 394,000
Loss on sale of property, furniture and equipment... 659,000 278,000
Changes in operating assets and liabilities:
Accounts receivable................................. 7,210,000 (1,419,000)
Merchandise inventories............................. (6,243,000) (13,724,000)
Other current assets and other assets............... (154,000) (1,123,000)
Accounts payable.................................... 11,091,000 17,587,000
Accrued compensation and expenses................... 2,335,000 (963,000)
Deferred revenue.................................... - (303,000)
Income taxes........................................ (6,316,000) (1,443,000)
Other long-term liabilities......................... 644,000 -
------------- -------------
Net cash provided by (used in) operating activities.......... 4,979,000 (794,000)

INVESTING ACTIVITIES
Proceeds from sale of property, furniture and equipment...... 342,000 -
Purchases of property, furniture and equipment............... (2,935,000) (6,884,000)
Proceeds from sale of restricted investments................. 2,580,000 -
Purchase of restricted investments........................... - (2,628,000)
------------- -------------
Net cash used in investing activities........................ (13,000) (9,512,000)

FINANCING ACTIVITIES
Net (payments on) proceeds from revolving credit note........ (4,636,000) 10,330,000
------------- -------------
Net cash (used in) provided by financing activities.......... (4,636,000) 10,330,000
------------- -------------

Net increase in cash and cash equivalents.................... 330,000 24,000
Cash and cash equivalents at beginning of period............. 685,000 895,000
------------- -------------
Cash and cash equivalents at end of period................... $ 1,015,000 $ 919,000
============= =============

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest................................................. $ 3,070,000 $ 3,718,000
============= =============
Income taxes............................................. $ 19,000 $ 2,328,000
============= =============

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

--------------------------------------------------------------------------------
11/30/01 11/30/00
--------------------------------------------------------------------------------
Cash................................. $ - $ 45,000
Held-to-maturity investments......... - 2,523,000
Equity investment.................... - 60,000
--------- ----------
Total restricted investments..... $ - $2,628,000
========= ==========

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

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 at November 30, 2000, 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 November 30, 2000.

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 November 30, 2001 and 2000 of $0 and $64,000, 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 whereby 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 (2.15% at November 30, 2001) plus 200 basis points to 260 basis points or
the Prime Rate (5.00% at November 30, 2001), depending upon the Company's
debt-to-worth ratio. As of December 1, 2001, the Company's rate was the Prime
Rate. The Company had $59,125,000 outstanding on this revolver at November 30,
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 financial covenants
including those that limit dividend payments and additional borrowings and
prohibit new store openings if an event of default exists. The Company is in
compliance with these covenants, as amended or waived.

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 nine-months ended November 30, 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 NOVEMBER 30, 2001
--------------------------------------------------------------------------------
NET SALES.......................... $ 24,670,000 $ - $ 24,670,000
OTHER REVENUES..................... 319,000 2,873,000 3,192,000
INTER-SEGMENT REVENUE.............. - 279,000 279,000
OPERATING (LOSS) EARNINGS.......... (13,159,000) 614,000 (12,545,000)
INTEREST EXPENSE................... 425,000 401,000 826,000
IDENTIFIABLE ASSETS................ 83,335,000 42,083,000 125,418,000
DEPRECIATION AND AMORTIZATION...... 863,000 34,000 897,000
CAPITAL EXPENDITURES............... 205,000 - 205,000
--------------------------------------------------------------------------------
For the quarter ended November 30, 2000
--------------------------------------------------------------------------------
Net Sales.......................... $ 27,296,000 $ - $ 27,296,000
Other revenues..................... 630,000 3,405,000 4,035,000
Inter-segment revenue.............. - 261,000 261,000
Operating (loss) earnings.......... (1,279,000) 1,493,000 214,000
Interest expense................... 551,000 808,000 1,359,000
Identifiable assets................ 93,163,000 50,479,000 143,642,000
Depreciation and amortization...... 960,000 50,000 1,010,000
Capital expenditures............... 2,339,000 3,000 2,342,000

--------------------------------------------------------------------------------
FOR THE NINE MONTHS ENDED NOVEMBER 30, 2001
--------------------------------------------------------------------------------
NET SALES.......................... $ 68,269,000 $ - $ 68,269,000
OTHER REVENUES..................... 1,080,000 9,535,000 10,615,000
INTER-SEGMENT REVENUE.............. - 690,000 690,000
OPERATING (LOSS) EARNINGS.......... (20,057,000) 3,610,000 (16,447,000)
INTEREST EXPENSE................... 1,470,000 1,500,000 2,970,000
IDENTIFIABLE ASSETS................ 83,335,000 42,083,000 125,418,000
DEPRECIATION AND AMORTIZATION...... 2,872,000 102,000 2,974,000
CAPITAL EXPENDITURES............... 2,935,000 - 2,935,000
--------------------------------------------------------------------------------
For the nine months ended November 30, 2000
--------------------------------------------------------------------------------
Net Sales.......................... $ 75,744,000 $ - $ 75,744,000
Other revenues..................... 1,905,000 9,556,000 11,461,000
Inter-segment revenue.............. - 714,000 714,000
Operating (loss) earnings.......... (4,258,000) 4,121,000 (137,000)
Interest expense................... 1,415,000 2,432,000 3,847,000
Identifiable assets................ 93,163,000 50,479,000 143,642,000
Depreciation and amortization...... 2,874,000 111,000 2,985,000
Capital expenditures............... 6,816,000 68,000 6,884,000

G. RESTRUCTURING CHARGE

In November 2001, the Company recorded $4,864,000 in restructuring costs
associated with the Company's exit from under-performing markets. These costs,
in accordance with EITF 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (including Certain
Costs Incurred in a Restructuring)", represent the cost of closing stores in
these markets. The amounts recorded consist of the costs associated with buying
out store leases, inventory liquidation costs, and the loss on the sale or
abandonment of leasehold improvements and furniture and fixtures. The charge
also includes the severance costs associated with reducing its corporate office
personnel by approximately 20% and its store personnel by approximately 17%. The
Company expects the execution of its restructuring plan to be completed during
fiscal year ended February 2003. The remaining liability as of November 30, 2001
was $2,763,000, which is included in accrued expenses on the balance sheet. As
of November 30, 2001, the following amounts were recorded:

Activity For the Quarter Ended November 30, 2001

BALANCE AT
WRITE-OFFS/ NOVEMBER 30,
ACCRUALS PAYMENTS 2001

Lease exit costs................... $ 1,242,000 $ 807,000 $ 435,000
Sale/disposal of fixed assets...... 1,966,000 608,000 1,358,000
Inventory liquidation costs........ 1,338,000 483,000 855,000
Severance costs.................... 318,000 203,000 115,000
----------- ----------- -----------
Totals........................ $ 4,864,000 $ 2,101,000 $ 2,763,000
=========== =========== ===========

H. ASSET IMPAIRMENT CHARGE

During the third quarter of fiscal year 2002, the Company recorded an asset
impairment charge of $5,983,000. The charge includes a $5,180,000 write-down of
goodwill due to the closing of a significant number of stores associated with
the goodwill and the decrease in expected future cash flows from the remaining
stores. The charge also includes an $803,000 reduction to fair value of the
historical cost of assets associated with the Company's e-commerce initiative as
a result of reduced revenues and earnings projections for Reeds.com.

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

RESULTS OF OPERATIONS

Net Sales

Net sales decreased 9.6% to $24,670,000 for the third quarter ended November 30,
2001, compared to $27,296,000 for the same quarter last year. Net sales for the
nine months ended November 30, 2001 decreased 9.9% to $68,269,000 from
$75,744,000 for the same period a year earlier. Same store sales, or stores open
in comparable periods, declined 10.6% in the third quarter this year and 11.9%
during the nine-month period this year. At November 30, 2001, the Company
operated 115 stores in 21 states compared to 120 stores in 19 states at November
30, 2000. During the third quarter of fiscal 2001, the company closed four under
performing stores in the Orlando FL, Tallahassee FL, Atlanta GA, and Nashville
TN markets. The Company did not open any new stores during the third quarter
this year and has no commitments to open stores in the remainder of this fiscal
year. The Company is committed to opening one store in Durham NC in March 2002.

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 96.3%
in-stock on its core items during third quarter fiscal 2002, compared to 96.0%
last year; it averaged 93.3% in-stock on its entire basic merchandise mix
compared to 94.1% during the same quarter a year ago. For the quarter ended
November 30, 2001, core merchandise accounted for 51.4% of net sales, 56.3% of
the items offered in the Company's basic merchandise mix, and 31.6% of its
inventory investment. During the same quarter last year, core merchandise
accounted for 54.8% of net sales, 82.4% of the items offered in the Company's
basic merchandise mix, and 39.7% of its inventory investment. The average price
of each piece of merchandise sold in the third quarter 2002 was $243, down from
$249 a year earlier.

Credit sales for the third quarter of fiscal 2002 accounted for 41.8% of net
sales compared to 49.3% a year earlier. Although the total transactions during
the quarter were down 13.0% compared to last year same quarter, the average
transaction size increased 5.8% for credit sales and 15.2% for cash sales.

Gross Profit

Gross margins were 47.1% during the quarter, down from 48.1% in the third
quarter last year. Year-to-date, gross margins were 47.1%, down from 49.7% for
the first nine months last year. The decrease in gross margins can be attributed
to a higher level of promotional activity necessitated by the weak economy and
the decrease in discretionary spending by consumers.

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

Selling, general, and administrative expenses as a percentage of net sales were
50.3% and 43.6% for the quarters ended November 30, 2001 and 2000, respectively.
The increase as a percentage of net sales is attributable to the lower sales
volume. Fixed costs, on a per store basis, including occupancy, base
compensation, and benefits decreased 3.7% from the third quarter of the prior
year, and year-to-date costs per store decreased 1.2%. Significant expense
categories are reflected on a normalized basis for the third quarters of the
last two fiscal years in the following table:

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

Quarter Ended Nine Months Ended
11/30/01 11/30/00 11/30/01 11/30/00
--------------------------------------------------------------------------------

Compensation - salaries & hourly wages... 20.1 % 20.1 % 23.0 % 20.6 %
Compensation - bonuses & commissions..... 3.1 % 3.6 % 3.1 % 3.7 %
Compensation - benefits & other
personnel costs........................ 4.2 % 4.3 % 4.8 % 5.3 %
Rents for space.......................... 12.0 % 10.6 % 13.2 % 11.2 %
Advertising.............................. 5.3 % 4.7 % 4.0 % 4.2 %
Bad debt................................. 7.6 % 5.6 % 6.6 % 5.3 %
Finance charges.......................... (8.4)% (8.4)% (9.9)% (8.9)%
Late charge income....................... (2.3)% (2.8)% (2.9)% (2.2)%

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

Bad debt increased to $1,887,000 from $1,522,000 and rose to 7.6% of net sales
for the quarter compared to 5.6% a year earlier. Gross write-offs for bad debts
were $2,212,000 versus $1,607,000 in the same quarter last year. Net write-offs,
after recovery of amounts previously written off, were $1,999,000 and $1,385,000
for the third 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 third fiscal quarter of 2002 and 2001,
respectively. The average delinquent account (accounts more than 90 days past
due) represented 13.9% and 11.1% of the Company's accounts receivable portfolio
for the third quarter of fiscal 2002 and 2001, respectively. The average
approval rate on applications was 40.3% for the third quarter of the current
year and 44.0% for the third 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. The Company has entered
into a purchase agreement to sell its proprietary credit card portfolio. The
Company expects to close the sale 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 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 November 30, 2001 and 2000 of $0 and
$64,000, respectively, as well as commission revenues of $319,000 and $566,000,
respectively, have been reflected as a reduction of selling, general, and
administrative expenses. Extended service agreements equaled 1.3% and 2.3% of
net sales during the quarters ended November 30, 2001 and 2000, respectively.

Interest Expense

The average borrowings on the Company's line of credit dropped 5.8% over prior
year. The Company continues to benefit from the general reduction of interest
rates. The Company's effective pre-tax interest rate during the quarter dropped
to 5.4% from 8.4% for the same period in the previous year. As a result,
interest expense for the quarter was $826,000, 39.2% lower than the same quarter
last year.

Income Taxes

The benefit for income taxes was $4,278,000 and $378,000 during the third
quarters of fiscal 2002 and 2001, respectively. The Company's anticipated net
effective tax rate was 32.0% during the third quarter ended November 30, 2001
and 33.0% in the third 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 nine
months of the current year was $4,979,000 and cash used in operations was
$794,000 for the first nine months of last year.

Decreased net sales 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 $58 - $60 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 has experienced, the Board of Directors
and management have implemented a restructuring plan that involves: 1) closing a
number of stores that are unprofitable and have a negative cash flow; 2)
reducing personnel costs; and 3) restructuring its balance sheet.

The Company has entered into a purchase agreement to sell its proprietary credit
card portfolio. The sale is contingent upon the Company having a $30 million
two-year revolving bank facility in place by the date of the transaction. The
Company expects to close the sale 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 liquidated its subsidiary, First Retail Bank, NA on October 30, 2001,
and, as a result, the $2.3 million of associated restricted investments,
required to be maintained by banking regulations, became available for general
corporate purposes. In conjunction with the sale of its receivables, the Company
is negotiating with its lenders for an extension of its revolving bank facility
through February 2004.

During the third quarter, Reeds closed four under-performing stores in the
following locations: Orlando FL, Atlanta GA, Tallahassee FL, and Nashville TN.
In the fourth quarter, the Company will be closing at least 15 additional
locations via sales, lease terminations, and lease expirations. The Company
recorded a $4.9 million restructuring charge in the third quarter, which
included the associated lease termination fees, write-down of fixed assets,
costs of closing 19 stores (including severance costs), as well as reducing the
corporate headquarters personnel costs by 20%.

The impairment charge includes a $5.2 million write-down of goodwill due to the
closing of a significant number of stores associated with the goodwill and the
decrease in expected future cash flows from the remaining stores. The charge
also includes an $800,000 reduction to fair value of the historical cost of
assets associated with the Company's e-commerce initiative as a result of
reduced revenues and earnings projections for Reeds.com. The non-recurring
charges related to restructuring and impairment total $10.8 million.

Debt

Borrowings under the Company's revolving credit facility averaged $60.4 million
during the third quarter of fiscal 2002 and $64.2 million during the same
quarter a year ago. The maximum borrowings outstanding under the facility at any
time during each of the quarters were $61.9 million and $65.0 million,
respectively.

The Company had $59,125,000 outstanding on this revolver at November 30, 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 financial covenants
including those that limit dividend payments and additional borrowings and
prohibit new store openings if an event of default exists. The Company is in
compliance with these covenants, as amended or waived.

The Company also has subordinated notes totaling $845,000 with three related
parties, with interest payable monthly at the prime rate (5.00% at November 30,
2001) quoted in The Wall Street Journal. The notes are unsecured and are
subordinate to the revolving bank note, which is collateralized by substantially
all of the Company's assets.

Working Capital

Working capital was $16,495,000 at November 30, 2001 compared to $79,636,000 at
November 30, 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 November 30, 2001 was 1.2 to 1, compared to 3.2 to 1 the same
time last year. Capital expenditures totaled $2,935,000 and $6,884,000 for the
nine months ended November 30, 2001 and 2000, respectively. The Company opened
three stores during the quarter ended May 31, 2001; three stores in the quarter
ended August 31, 2001 and no new stores were opened during the quarter ended
November 30, 2001. The Company does not plan to open any additional stores
during 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) other elements of the Company's restructuring plans; and

(v) 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.

January 14, 2002 /s/ James R. Rouse
------------------------------- -------------------------
James R. Rouse
Treasurer and
Chief Financial Officer