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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION  FORM 10-K For Annual and Transition Reports Pursuant to Sections 13 or 15(d)
of the Securities Exchange Act of 1934 (Mark One)x
    
    ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934For the fiscal year ended January 31, 2004
 or o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934For the transition period from  to
 Commission file number 0-26732 GADZOOKS, INC.  Texas
    
    74-2261048(State or other jurisdiction of
    
    (I.R.S. Employerincorporation or organization)
    
    Identification No.)4121 International ParkwayCarrollton, Texas
    
    75007(Address of principal executive offices)
    
    (Zip Code)
 Registrants telephone number, including area code:
(972) 307-5555 Securities Registered Pursuant to Section 12(b) of the Act: NONE Securities Registered Pursuant to Section 12(g) of the Act: Title of Each Class 
 Common Stock, $0.01 par value 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 o 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 Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes o No x The aggregate market value of the voting and non-voting Common Stock held
by non-affiliates of the registrant as of August 2, 2003 (the last business day
of the registrants most recently completed second fiscal quarter) was
approximately $66,702,531. All outstanding shares of voting stock, except for
shares held by executive officers and members of the Board of Directors and
their affiliates, are deemed to be held by non-affiliates. On May 10, 2004, the registrant had 9,147,024 shares of Common Stock
outstanding. DOCUMENTS INCORPORATED BY REFERENCE Part III incorporates information by reference from the registrants
definitive proxy statement for the 2004 Annual Meeting of Shareholders, to be
filed with the Commission no later than 120 days after the end of the
registrants fiscal year covered by this Form 10-K.




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Gadzooks, Inc.
Index to Form 10-K PagePART IItem 1.
    
    Business
    
    
    3Item 2.
    
    Properties
    
    
    14Item 3.
    
    Legal Proceedings
    
    
    14Item 4.
    
    Submission of Matters to a Vote of Security Holders
    
    
    16PART IIItem 5.
    
    Market for
Registrants Common Equity and Related Stockholder Matters
    
    
    16Item 6.
    
    Selected Financial Data
    
    
    17Item 7.
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    18Item 7A.
    
    Quantitative and Qualitative Disclosures About Market Risk
    
    
    29Item 8.
    
    Financial Statements and Supplementary Data
    
    
    30Item 9.
    
    Changes In and Disagreements With Accountants on Accounting and Financial Disclosure
    
    
    49Item 9A.
    
    Controls and Procedures
    
    
    49PART IIIItem 10.
    
    Directors and Executive Officers of the Registrant
    
    
    49Item 11.
    
    Executive Compensation
    
    
    49Item 12.
    
    Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
    
    
    49Item 13.
    
    Certain Relationships and Related Transactions
    
    
    49Item 14.
    
    Principal Accountant Fees and Services
    
    
    49PART IVItem 15.
    
    Exhibits, Financial Statement Schedules, and Reports on Form 8-K
    
    
    50Debtor-In-Possession Loan and Security AgreementDebtor-In-Possession Revolving Credit NoteFirst Amendment to Loan and Security AgreementEmployee Retention and Incentive PlanEmployment Letter - Carolyn GreerConsent of PricewaterhouseCoopers LLPCertification Pursuant to Section 302Certification Pursuant to Section 302Certification Pursuant to Section 906Certification Pursuant to Section 906
  2




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PART I 
 ITEM 1. BUSINESS. Chapter 11 On February 3, 2004, Gadzooks, Inc. (the Company or Gadzooks) filed a
voluntary petition for reorganization (the Filing) under Chapter 11 of the
United States Bankruptcy Code (Chapter 11) in the United States Bankruptcy
Court for the Northern District of Dallas (the Court) and was assigned case
number 04-31486-hdh11. The filing was made in response to continued negative sales trends
stemming from the Companys completion of its conversion to an all-girl
merchandise assortment in the second half of fiscal 2003 and reduced factor and
vendor terms, both of which had a negative impact on the Companys cash flow.
Under Chapter 11, the Company expects to continue to operate its business as
debtor-in-possession (DIP) under court protection from its creditors and
claimants, while using the Chapter 11 process to complete the reorganization of
its core business around approximately 250 stores that were chosen to
strengthen its market share in the junior apparel business. Business Overview Gadzooks is a mall-based specialty retailer of casual apparel and related
accessories for young women, principally between the ages of 16 and 22. At the
end of fiscal 2003, the Company operated 406 Gadzooks stores in both
metropolitan and middle markets in 41 states. During fiscal 2003, the Company
opened one new Gadzooks store, one new Orchid store, closed 30 Gadzooks stores
and closed one Orchid store. During the first quarter of fiscal 2004, the
Company closed 158 stores. As of May 1, 2004, the Company operated 252 stores. On January 9, 2003, the Company announced plans to focus exclusively on
apparel and accessories for females. The conversion of the Gadzooks stores to
an all-female merchandise assortment took place early in the second half of
fiscal 2003. Prior to the conversion, all mens merchandise was liquidated.
Marketing and advertising campaigns were utilized to support the transition
with an emphasis on the grand reopening of Gadzooks as a female-only apparel
and accessory store. The Gadzooks store environment was also updated to have
more of a feminine appeal both in its signage and fixture presentations. In the second half of fiscal 2001, the Company began testing a new retail
concept with the opening of four Orchid stores in two states. The Orchid
concept catered to the innerwear and sleepwear needs of females between the
ages of 14 and 22. In January 2004, the Company decided to discontinue testing
the Orchid concept and liquidated those stores during the first quarter of
fiscal 2004. The Companys website, www.gadzooks.com, is primarily utilized to provide
an additional marketing opportunity for the Gadzooks stores. The site features
current fashion trends, a monthly calendar of events, in-store promotions,
on-line contests, music videos and an on-line store, which offers gift cards
and Von Dutch merchandise for purchase. The Company was incorporated in Texas in 1982. Its executive offices are
located at 4121 International Parkway, Carrollton, Texas 75007, and its
telephone number is (972) 307-5555. A copy of the Form 10-K, excluding
exhibits, as filed with the Securities and Exchange Commission, may be obtained
without charge upon written request to Investor Relations at the Companys
headquarters. Business Strategy The Company is a leading retailer of brand name casual apparel and related
accessories for teenage girls. The principal elements of the Companys
business strategy in its Gadzooks stores are:  Customer Focus.Historically, the Gadzooks concept
has focused on providing fashionable casual apparel
and accessories to both male and female teenage
customers. However, beginning in the second half of
fiscal 2003, Gadzooks converted its stores to an
all-female merchandise assortment. Gadzooks believes
that this conversion allows it to compete more
effectively by devoting all of its square footage to
the female customer and focusing all of the Companys
resources on meeting the needs of females between the
ages of 16 and 22. The Company is not new to the
female market; in fact, Gadzooks has been providing
casual apparel and related accessories for the junior
customer since its inception 21 years ago. The
Company hired a leading independent branding firm to
help plan and execute the marketing campaign used to
support Gadzooks new brand image. Additionally, the
Company hired a nationally recognized firm in store
design to lead the effort of tailoring the store 3




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look. As an integral part of the transition, new fixtures, merchandise
displays and signage were utilized to give the store environment more of a
feminine appeal.  Multiple Merchandise Categories.A key component of
the Companys merchandising strategy is to limit its
dependence on any one fashion, style, brand or item
by offering products in a broad range of categories,
including woven and knit tops, jeans, shorts, junior
dresses, swimwear, t-shirts, footwear, sunglasses,
watches, jewelry and other accessory items. The
Company regularly monitors store sales by
classification, style, vendor and size to identify
emerging fashion trends, and manages the product mix
in its stores to respond to the spending patterns of
its customers. The Company believes that its success
is dependent upon its ability to meet the changing
fashion preferences of its customers.  Emphasis on Brand Name Merchandise Supplemented by
Private Brands. Another key feature of the Companys
merchandising strategy is to offer trendy brands as a
point of differentiation based on its belief that its
customers shop primarily for recognized labels and
designs. The Companys merchandise includes high
visibility names such as Von Dutch, Dollhouse, Roxy,
Hot Kiss and others. The Company is continuing to
grow its private brand business in order to better
meet the needs of its customers. Private brands
comprised 38% and 17% of net sales in 2003 and 2002,
respectively, and are expected to comprise between
25% and 30% of net sales in 2004. Private brands
allow the Company the opportunity to expand its
customer base by providing merchandise of comparable
quality to brand name merchandise at competitive
prices and to capitalize on fashion trends when
branded vendors are not offering the latest in
trends. The Company concentrates on being the
destination store for young women who want the latest
trends in casual apparel.  Metropolitan and Middle Market Locations.A central
aspect of the Companys strategy has been the
development of a store concept that is successful in
both metropolitan and middle markets. The Company
believes that its customers throughout the United
States frequently have similar fashion preferences as
a result of the influence of television programs,
sports, MTV and music and fashion magazines. As a
result, the Company has historically been able to
operate stores successfully across a broad range of
demographic and geographic markets, increasing the
number of potential sites available to the Company.  Attentive Customer Service.The Company is committed
to offering professional and attentive customer
service. Gadzooks strives to hire young, energetic,
service-oriented sales associates who understand its
customers and can relate to their changing needs and
preferences. The Company trains sales associates to
greet each customer personally, to inform the
customer about new fashion trends and to suggest
merchandise to suit the customers wardrobe and
lifestyle needs. The Company believes that the high
level of service given to its customers
differentiates Gadzooks from its competition.  Entertaining Store Environment.The Company believes
that its stores provide a fun and enjoyable shopping
experience for its customers. Gadzooks stores are
designed to create a high energy, fun environment
using television monitors featuring popular music
videos and creative, eye-catching signage. The
Company believes that its entertaining store design
encourages customers to visit the stores more
frequently and to shop in the stores for longer
periods of time.  Investment in Systems and Personnel.The Company is
committed to investing in information systems and
using current technology to help execute its
merchandising strategy. The Companys systems
provide its buyers and merchandise planners with
daily sales and inventory information by store,
style, vendor and size, allowing Gadzooks to respond
to changing customer preferences and to stock the
appropriate quantities and styles of merchandise at
each store. The Company uses a warehouse management
system to efficiently control all warehouse functions
and expedite the flow of merchandise to its stores.
The Company is also committed to attracting and
retaining highly qualified, service-oriented
management and sales associates and providing them
with career advancement opportunities. The corporate
culture at Gadzooks promotes the open exchange of new
ideas and information between all levels of the
Company, thereby enabling management to supplement
the data from its information systems with the
practical experience of its employees.  Distribution Capabilities.The Company believes that
its 207,000 square-foot facility in the Dallas area
can support the merchandising needs of more than 500
stores, providing the ability for significant store
expansion. 4




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Store Locations As of April 8, 2004, the Company operated 252 Gadzooks stores in 40
states. The stores are located in metropolitan markets such as Dallas,
Chicago, Atlanta, Boston and Kansas City, as well as middle markets such as
Amarillo, Texas; Biloxi, Mississippi; and Roanoke, Virginia. A list of stores
by state is as follows: # of
    
    
    
    # of
    
    
    
    # ofState
    
    Stores
    
    State
    
    Stores
    
    State
    
    StoresAlabama
    
    
    2
    
    
    Massachusetts
    
    
    3
    
    
    Oklahoma
    
    
    6Arizona
    
    
    1
    
    
    Michigan
    
    
    11
    
    
    Oregon
    
    
    1Arkansas
    
    
    5
    
    
    Minnesota
    
    
    6
    
    
    Pennsylvania
    
    
    14Colorado
    
    
    3
    
    
    Mississippi
    
    
    2
    
    
    Rhode Island
    
    
    1Delaware
    
    
    1
    
    
    Missouri
    
    
    7
    
    
    South Carolina
    
    
    5Florida
    
    
    17
    
    
    Nebraska
    
    
    1
    
    
    South Dakota
    
    
    2Georgia
    
    
    5
    
    
    New Hampshire
    
    
    1
    
    
    Tennessee
    
    
    8Illinois
    
    
    13
    
    
    New Jersey
    
    
    4
    
    
    Texas
    
    
    47Indiana
    
    
    9
    
    
    New Mexico
    
    
    2
    
    
    Utah
    
    
    1Iowa
    
    
    6
    
    
    New York
    
    
    2
    
    
    Virginia
    
    
    6Kansas
    
    
    4
    
    
    North Carolina
    
    
    7
    
    
    Washington
    
    
    2Kentucky
    
    
    6
    
    
    North Dakota
    
    
    2
    
    
    West Virginia
    
    
    5Louisiana
    
    
    10
    
    
    Ohio
    
    
    14
    
    
    Wisconsin
    
    
    7Maryland
    
    
    3
 Store Expansion The following table provides a history of the Gadzooks store expansion
program over the past five fiscal years, excluding Orchid stores. Fiscal Year2003
    
    2002
    
    2001
    
    2000
    
    1999Number of stores open at beginning of period
    
    
    435
    
    
    
    427
    
    
    
    375
    
    
    
    326
    
    
    
    312Number of new stores opened
    
    
    1
    
    
    
    11
    
    
    
    56
    
    
    
    52
    
    
    
    19Number of stores closed
    
    
    30
    
    
    
    3
    
    
    
    4
    
    
    
    3
    
    
    
    5Number of stores open at end of period
    
    
    406
    
    
    
    435
    
    
    
    427
    
    
    
    375
    
    
    
    326
 The Company opens stores in enclosed shopping malls in both metropolitan
and middle markets. Continued store expansion has been suspended pending the
Companys emergence from Chapter 11. The Company believes that the broad
appeal of the Gadzooks concept enables it to operate successfully in diverse
geographic and demographic markets, thereby increasing the total number of
potential sites available to the Company. The Company typically expands from existing markets into contiguous new
markets and attempts to cluster its stores within a market area in order to
achieve management and operating efficiencies and to enhance its name
recognition. The Companys existing stores average approximately 2,500 square
feet. The Company typically seeks a location of approximately 2,400 to 3,100
square feet with significant mall frontage. The Company closed 31
under-performing stores during fiscal 2003, liquidated 158 stores to-date in
fiscal 2004 as part of its reorganization under Chapter 11, and estimates that
an additional 15 to 20 stores will be closed during fiscal 2004. The Company
will continue to analyze stores for potential closing from time to time. 5




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Merchandising Historically, the Companys merchandising strategy has been to provide a
wide range of brand name casual apparel and related accessories that reflect
the fashion preferences of young men and women principally between the ages of
14 and 18. Effective early in the second half of fiscal 2003, the Company
began focusing exclusively on apparel and accessories for females between the
ages of 16 and 22 and has converted the Gadzooks stores to an all-female
merchandise assortment. Prior to the conversion, all of the mens merchandise
was liquidated. The Companys merchandise includes highly visible names such as Von Dutch,
Dollhouse, Roxy, Hot Kiss and others. The Company concentrates on being the
destination store for young women who want the latest trends in casual apparel. The Company has historically classified all its merchandise into one of
the following three categories, as well as Young Mens. As discussed above,
beginning with the second half of fiscal 2003, the Company discontinued the
mens business. Juniors:
    
    The Juniors category includes casual sportswear separates
designed for fashion-current teenage girls, such as knit
tops, woven shirts and vests, denim, dresses and swimwear.
Key brands in this category include Von Dutch, Dollhouse,
Hot Kiss, Billabong and Roxy.Accessories:
    
    The Accessories category includes a variety of accessories
including sunglasses, watches, hair accessories, backpacks,
necklaces, hats and other accessories. Key brands in this
category include Von Dutch, Dollhouse, Dickies, Disney and
Hot Kiss.Footwear:
    
    The Company offers a limited selection of footwear including
sandals and active footwear. Key brands in this category
include Converse, Roxy, Sugar and Chinese Laundry.
 The following table sets forth the Companys merchandise sales by category
as an approximate percentage of total net sales: Fiscal Year2003
    
    2002
    
    2001Juniors
    
    
    59
    %
    
    
    38
    %
    
    
    39
    %Young Mens
    
    
    17
    
    
    
    39
    
    
    
    40Accessories
    
    
    17
    
    
    
    18
    
    
    
    16Footwear
    
    
    7
    
    
    
    5
    
    
    
    5100
    %
    
    
    100
    %
    
    
    100
    %
 By offering products in multiple categories, the Company is able to shift
its merchandise emphasis among and within its core categories to respond to
changing customer preferences. The Company expects to continue to adjust its
emphasis in particular categories in response to changing fashion trends and,
therefore, its merchandise mix may vary slightly from time to time. Since July
2003, the Company has focused exclusively on apparel and accessories for
females in connection with the conversion of the Gadzooks stores to an
all-female merchandise assortment. Prior to the conversion, all of the mens
merchandise was liquidated. 6




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The Company continues to supplement its national and teen branded
merchandise with private brand offerings in order to better meet the needs of
its customers. Private brands allow the Company the opportunity to expand its
customer base by providing merchandise of comparable quality to brand name
merchandise at competitive prices and to capitalize on fashion trends when
branded merchandise vendors are not offering the latest in trends. The private
brand merchandise is designed internally by the Companys product design team
and buying staff. This merchandise is primarily sourced domestically to allow
the buying staff to react quickly to developing trends. Private brand sales,
including merchandise designed and sourced by Gadzooks under the Candies
label, accounted for approximately 38 percent and 17 percent of the Companys
sales in fiscal 2003 and fiscal 2002, respectively. In an effort to keep the stores fresh and exciting, the Companys visual
merchandising department, in conjunction with the marketing and buying staff,
provides specific floor sets and merchandising ideas to the stores and
regularly instructs district and store managers on the creative display of
merchandise. The merchandise presentation in the stores, although changed each
month, is significantly changed four times each year to highlight specific
merchandise for each of the Companys spring, summer, back-to-school and
holiday selling seasons and to maintain a current look. In addition, the
Company maintains a constant flow of new merchandise to the stores through
shipments from its distribution center on a daily basis to encourage customers
to frequently visit its stores. To reduce the risk associated with the
introduction of new products, the Company tests certain products in selected
stores before determining if it will purchase the product for a broader group
of stores. Purchasing The Companys purchasing staff consists of a Chief Merchandising Officer,
General Merchandising Manager, Divisional Merchandising Managers, buyers and
assistant buyers. The purchasing staff analyzes current fashion directions by
visiting major fashion markets, maintaining close relationships with the
Companys vendors and utilizing focus groups in order to identify styles and
trends. The Chief Merchandising Officer, General Merchandising Manager,
Divisional Merchandising Managers and the buyers regularly monitor merchandise
flow through the stores and strive to maintain the appropriate merchandise mix
to meet customer demand. Due to changes in fashion trends and seasonality, the Company purchases
merchandise from numerous vendors throughout the year. During fiscal 2003, the
Company did business with approximately 550 vendors. No single vendor
accounted for more than ten percent of merchandise purchases. Gadzooks
believes that strong vendor relationships are important to the growth and
success of the Company. In addition, the Company uses private label merchandise to supplement its
primarily branded product line. Bad Kitty and Taunt are the private label
brands established for the juniors category. Planning and Allocation The Company continually strives to improve its merchandising,
distribution, planning and allocation methods to manage its inventory more
productively. The Companys planning and allocation staff work closely with
the buyers to determine the correct inventory levels for all stores and
merchandise categories. The Company divides its stores into different
categories based upon, among other things, geographic location, demographics,
sales volume, competition and store capacity. Merchandise allocation is based
in part on sales and inventory analysis of the stores by category. Information
from the Companys point-of-sale computer system is regularly reviewed and
analyzed to assist in making merchandise allocation and markdown decisions. In May 1997, the Company relocated its headquarters to a 207,000 square
foot site in the Dallas metropolitan area, which includes a distribution
facility and the Companys corporate offices. Vendors deliver merchandise to
this facility, where it is inspected, received into the Companys merchandising
system, allocated to stores and boxed for distribution to the Companys stores.
Merchandise is typically shipped to stores daily, providing Gadzooks stores
with a steady flow of new merchandise. For certain key products, the Company
maintains a backstock at its distribution center that is allocated and
distributed to the stores through an automated replenishment system. 7




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Store Operations Gadzooks stores are open seven days a week during normal mall hours. The
Companys store operations are managed by a Vice President of Store Operations,
Regional Sales Directors and District Sales Managers, who generally have
responsibility for eight to ten stores within a geographic district.
Individual stores are managed by a store manager and two assistant store
managers. A typical store has five to 12 part-time sales associates, depending
on the season. Gadzooks compensates its district and store managers with a
base salary and performance bonuses, based on store sales and shrink results.
Sales associates and assistant store managers are compensated on an hourly
basis. The Company believes that its continued success is dependent in part on
its ability to attract, retain and motivate quality employees. The Company has
an established training program for future district sales managers. Store
managers, many of whom are selected from among the Companys assistant
managers, currently complete a one-week training program with a designated
training store manager before taking responsibility for a store. A formalized
one-week training program for assistant managers was rolled out to the stores
in fiscal 2002. The hiring and training of new sales associates and assistant
managers are the responsibility of store managers, and the Company has
established training and operations manuals to assist them in this process. Management considers its employees knowledge of the Companys customers
and merchandise to be significant to its marketing approach and customer
satisfaction. While all Gadzooks store employees are responsible for the
general appearance of the store and merchandise presentation, the Companys
major emphasis in training its store employees is to give priority to customer
service and assistance. Sales associates regularly act as greeters, meeting
customers as they enter the store and offering assistance. The Company trains
its sales associates to inform the customer about new fashion trends and to
suggest merchandise that suits the customers wardrobe and lifestyle needs.
The Company monitors customer service at the store level through various
programs, including unannounced visits to the stores by store operations
personnel and by regularly reviewing and responding to customer feedback. Store Environment The Company believes that its stores provide a fun and enjoyable shopping
experience for its customers. Gadzooks stores are designed to create a high
energy, fun environment using television monitors featuring popular music
videos and creative, eye-catching signage. Historically, the Company has
displayed a significant amount of merchandise on the walls of the store, with
male merchandise along one side and female merchandise along the other. Early
in the second half of fiscal 2003, however, the Company converted the Gadzooks
stores to an all-female merchandise assortment. As a result of the conversion,
new fixtures and merchandise displays were utilized to give the store
environment more of a feminine appeal. Stores typically feature large windows
along the mall which provide an open view of the entire store to mall traffic
and are merchandised to draw customers into the store. Management Information Systems Each Gadzooks store is linked to the Companys headquarters through a
point-of-sale system that interfaces with an IBM RS6000 computer equipped with
an integrated merchandising, distribution and accounting software package. The
Companys point-of-sale computer system has several features, including
merchandise scanning, price look-up, updated sales reports and on-line credit
card approval. These features improve transaction accuracy, speed and checkout
time, increase overall store efficiency and enable the Company to track the
productivity of individual sales associates. The Companys management information and control systems enable the
Companys corporate headquarters personnel to promptly identify sales trends,
replenish depleted store inventories, reprice merchandise and monitor
merchandise mix and inventory shrinkage at individual stores and throughout the
Companys store network. Management believes that these systems provide a
number of benefits, including improved store inventory management, better
in-stock availability, higher operating efficiency and fewer markdowns. The Company believes that its current management information and control
systems are adequate to support the Companys existing and planned operations,
but regularly evaluates its systems to determine when upgrades or replacements
are needed. The Company implemented enhanced planning and allocation systems
in fiscal 2000. These changes allow the Company to more efficiently manage and
respond to merchandise mix changes at a chain and store level. The Company
implemented a new financial system that was fully operational by the end of the
third quarter of fiscal 2001. During fiscal 2002, a warehouse management
system was installed and implemented prior to the holiday season. Warehouse
productivity and accuracy have 8




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been improved with online, real-time, detailed task tracking and barcode
scanning through the use of wireless devices. In fiscal 2002, the Company
improved its communications with its regional and district store managers
through the implementation of remote access capabilities. Advertising and Promotion The Company relies primarily on mall traffic, the enthusiasm of its sales
associates and existing customers, highly visible store locations and
eye-catching signage to attract new customers to the stores. The Company has
generally found this approach to be more cost effective than more traditional
media advertising. During fiscal 2001, the Company began building an e-mail
database of customers. The database is used to advertise and promote
merchandise offerings and contests via e-mail blasts as a means to increase
customer traffic at the stores. During the fourth quarter of fiscal 2002, the
Company began building a mailing list of its customers. The mailing list,
which includes general demographic information, was utilized in a direct mail
campaign to support the Companys transition to an all-female merchandise
assortment in the second half of fiscal 2003. Additionally, the Company hired
a leading independent branding firm to help plan and execute the marketing and
advertising campaign used to support Gadzooks new brand image. The Company plans the opening of new stores to coincide with peak shopping
seasons and mall grand openings when customer traffic is greater. The Company
also uses promotions to generate repeat visits to its stores and plans on
continuing its advertisements in national magazines, such as Seventeen, YM,
Teen Vogue and Teen People, in partnership with certain of its vendors. The
Company also benefits from advertising by its vendors, especially where
Gadzooks is listed as a retailer of their products. The Companys redesigned
website features music videos, movie previews, horoscopes, current store
fashions and promotions to capture the attention of its target customers and
attract them to the stores. The Company has also been active in sponsoring
concerts and other teen-related promotional events. Trademarks The Company currently has pending applications for Bad Kitty and
Taunt. Each federal registration is renewable indefinitely if the mark is in
use at the time of the renewal. The Company is not aware of any claims of
infringement or other challenges to the Companys right to use its marks in the
United States. Competition The teenage retail apparel and accessories industry is highly competitive.
The Company competes with other retailers for customers, suitable retail
locations and qualified management personnel. Gadzooks currently competes with
traditional department stores, with national specialty chains such as Old Navy
and certain divisions of The Limited, with numerous other teen retailers such
as American Eagle Outfitters, The Buckle Pacific Sunwear, Abercrombie
& Fitch, , Charlotte Russe, Forever 21, Wet Seal and Hot Topic, with smaller chains and
local specialty stores, and to a lesser extent, with mass merchandisers and
companies providing shopping sites via the internet. Many of the Companys
competitors are larger and have substantially greater resources than the
Company. The principal competitive factors in the Companys business are
fashion, merchandise selection, customer service, price and store location. Employees On April 6, 2004, the Company had 974 full-time employees and 1,530
part-time employees. Of the Companys 2,504 employees, 104 were corporate
personnel, 88 were distribution center employees and 2,312 were store
employees. The number of part-time employees varies with seasonal needs. None
of the Companys employees are covered by a collective bargaining agreement.
The Company seeks to create a casual and supportive working environment and
believes its employee relations to be excellent. 9




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##### Table of Contents



RISK FACTORS This report contains certain forward-looking statements within the meaning
of Section 27A of the Securities Act of 1933 and Section 21E of the Securities
Exchange Act of 1934. When used in this report, words such as anticipate,
believe, estimate, expect, intend, predict, project, will and
similar expressions, as they relate to us or our management, identify
forward-looking statements. These forward-looking statements are based on
information currently available to our management. Actual results could differ
materially from those contemplated by the forward-looking statements as a
result of certain factors, including fluctuations in store sales results,
changes in economic conditions, fluctuations in quarterly results and other
factors described under the Risk Factors section. Such statements reflect
the current views of our management with respect to future events and are
subject to these and other risks, uncertainties and assumptions relating to our
operations, results of operations, growth strategy and liquidity. All
subsequent written and oral forward-looking statements attributable to us, or
persons acting on our behalf, are expressly qualified in their entirety by this
paragraph. We may not be able to continue as a going concern. On February 3, 2004, Gadzooks, Inc. filed a voluntary petition for
reorganization under Chapter 11 of the United States Bankruptcy Code in the
United States Bankruptcy Court for the Northern District of Dallas and was
assigned case number 04-31486-hdh11. The Company is using the Chapter 11 process to complete the reorganization
of its core business around approximately 250 stores chosen to strengthen its
market share in the junior apparel business. There is no assurance that the
Company will be able to reduce its corporate overhead to an appropriate level
in connection with the smaller store base. Although the Company expects to
continue to operate its business as debtor-in-possession under court protection
from its creditors and claimants, there can be no assurance that the Company
will be able to obtain approval of a plan of reorganization that will allow it
to emerge from Chapter 11 or that the Chapter 11 will not be converted to
Chapter 7. Any failure to meet the financial covenants specified under the DIP credit
facility could substantially harm our business. Our DIP credit facility contains a number of financial performance
covenants that must be met by the non-closing stores on a weekly or monthly
basis. The DIP credit facility covenants require specified levels of
performance for the following:  
    
    sales,
    
    disbursements,
    
    inventory levels,
    
    gross margin and
    
    earnings before interest, taxes, depreciation and amortization The occurrence of an event of default under the agreement governing our
debt would permit acceleration of the related debt, which could harm our
business, profitability and growth prospects. If we do not meet these
covenants, we could lose our DIP financing. We may not realize the increase in female business anticipated by
converting to an all female merchandise assortment. Early in the second half of fiscal 2003 we converted our Gadzooks stores
to an all-female merchandise assortment. Although we continue to believe that
the conversion will ultimately have a positive impact on our business due to
our historical performance and expertise in the juniors category, we cannot
assure you that sales and operating results will increase as planned or that
the conversion will be successful. If the anticipated increase in female
business does not occur as planned, our sales and operating results will
suffer. We have had significant fluctuations in comparable store sales results. Our comparable store sales results have varied significantly due to a
variety of factors, including our change to an all-female merchandise
assortment, economic conditions, fashion trends, the retail sales environment,
competition, sourcing and distribution of products and our ability to execute
our business strategy efficiently. The liquidation of our mens inventory and
subsequent change to an all-female merchandise assortment has caused unusual
fluctuations in comparable store sales results, particularly in fiscal 2003.
These fluctuations in comparable store sales may continue in fiscal 2004. Our
comparable store sales results were (10.6)%, (9.9)%, (31.4)% and (24.8)% in the
first, second, third and fourth quarters of fiscal 2003, respectively, (2.2)%,
(3.3)%, (5.1)% and (3.1)% in the first, second, third and fourth quarters of
fiscal 2002, respectively, and (4.6)%, (8.9)%, 10




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(3.2)% and (3.9)% in the first,
second, third and fourth quarters of fiscal 2001, respectively. If our
comparable store sales
results continue to fluctuate, it may cause our stock price to be
volatile. The financing mechanisms used by certain vendors could result in changes
in our payment obligations, which could adversely affect our liquidity. We believe that the majority of our merchandise vendors either enter into
factoring arrangements whereby factors purchase the vendors invoices, or enter
into agreements with factors to insure the payment of their invoices. This
financing mechanism allows Gadzooks vendors to receive payment in a shorter
period of time. Certain of these factors have modified the terms of agreements
with some of Gadzooks vendors and have accelerated the due dates for payments
by us, required us to provide standby letters of credit or refused to approve
shipments altogether. We believe that these factors may continue to materially
modify our payment terms. Further material modifications by factors could
materially adversely affect our ability to obtain new inventory, meet our cash
requirements and maintain necessary liquidity going forward. If our sales continue to decline, our business, financial condition,
results of operations and liquidity may suffer. Comparable store sales for fiscal 2003 and fiscal 2002 decreased by 19.3
percent and 3.4 percent from the prior year, respectively. In addition, we
have generated operating losses of $60.0 million and $2.0 million for fiscal
2003 and fiscal 2002, respectively. No assurance can be given that comparable
store sales will improve. Continuing declines in comparable store sales or
continuing operating losses could have a material adverse effect on our
business, financial condition, results of operations and liquidity. In addition, we have tax receivables totaling approximately $5.3 million,
as of January 31, 2004. Due to our operating losses and continuing same store
sales declines since conversion to an all-female concept, we recognized a
valuation allowance of approximately $25.0 million to reduce our deferred tax
assets and tax benefits generated during fiscal 2003. We do not anticipate
recording any tax benefit associated with operating losses in the foreseeable
future. We have substantial debt obligations that could restrict our operations. We have substantial indebtedness. As of January 31, 2004, our outstanding
debt was approximately $25.3 million. Our substantial indebtedness could have
adverse consequences, including, but not limited to the conversion from Chapter
11 to Chapter 7. If our cash flow and capital resources are insufficient to
fund a plan of reorganization that is acceptable to our unsecured creditors, we
may be forced to seek alternatives to address our liquidity concerns, including
seeking additional equity capital, restructuring our debt or a potential
liquidation under Chapter 7 of the U.S. Bankruptcy Code. We cannot assure you
that our cash flow and capital resources will be sufficient for payment of our
debt in the future, or that any such alternative measures would be successful
or would permit us to meet scheduled debt service obligations. Any failure to
meet our debt obligations could harm our business, profitability and growth
prospects. If we are unable to successfully anticipate changes in fashion trends, our
business, sales and image could suffer. Gadzooks profitability is largely dependent upon our ability to
anticipate the fashion tastes of our customers and to provide merchandise and
brands that appeal to their preferences in a timely manner. The fashion tastes
of our customers may change frequently. Our failure to anticipate, identify or
react appropriately to changes in styles, trends or brand preferences could
lead to, among other things, excess inventories and higher markdowns, which
could have a material adverse effect on our operating results, comparable store
sales results, liquidity and our image with our customers. If we are unable to successfully anticipate fashion trends with our
private label merchandise, our business, financial condition, results of
operations and liquidity may suffer. Sales from private label merchandise, including merchandise designed and
sourced by Gadzooks under the Candies label, accounted for approximately 38%
and 17% of net sales in fiscal 2003 and fiscal 2002, respectively. We expect
the percentage of net sales in private label merchandise to be between 25% and
30% of total net sales in the future, although there can be no assurance that
we will be able to achieve these percentages in private label merchandise sales
as a percentage of net sales. Because our private label merchandise generally
carries higher merchandise margins than our other merchandise, our failure to
anticipate, identify and react in a timely manner to fashion trends with our
private label merchandise, particularly if the percentage of net sales derived
from private label merchandise increases, may have a material adverse affect on
our business, financial condition, results of operations and liquidity. 11




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Competition in the teen retailing market is intense and could reduce our
profitability, sales and liquidity. We operate in a highly competitive environment, which has experienced
aggressive growth in the number of competitors, the number of stores and the
amount of square footage dedicated specifically to teen retailing. We currently
compete with traditional department stores, with national specialty chains such
as Old Navy and certain divisions of The Limited, with numerous other teen
retailers, such as American Eagle Outfitters, The Buckle, Pacific Sunwear,
Abercrombie & Fitch, Charlotte Russe, Forever 21, Wet Seal and Hot Topic, with
smaller chains and local specialty stores, and to a lesser extent, with mass
merchandisers and companies providing shopping sites via the internet. Many of
these competitors are larger and have substantially greater resources than
Gadzooks. Direct competition with these and other retailers may increase
significantly in the future, which could require us, among other things, to
lower our prices and/or increase our advertising expenses. Increased
competition could have a material adverse effect on our profitability, sales
and liquidity. If our key vendors are unable to adequately supply us with our desired
merchandise on acceptable terms, our business and sales may suffer. Our business depends on our ability to purchase current season, brand name
apparel in sufficient quantities at competitive prices. The inability or
failure of key vendors to supply us with adequate quantities of desired
merchandise, the loss of one or more key vendors or a material change in our
current purchase terms could have a material adverse effect on our business and
liquidity. Many of our smaller vendors have limited resources, production
capacities and operating histories, and many have limited the distribution of
their merchandise in the past. We have no long-term purchase contracts or other
contractual assurances of continued supply, pricing or access to new products.
There can be no assurance that we will be able to acquire desired merchandise
in sufficient quantities on terms acceptable to us in the future. During our
2003 fiscal year, no single vendor accounted for more than 10% of our
merchandise purchases. Currently, one vendor does represent over 10% of our
sales in the first quarter of 2004. Depressed economic conditions or a decrease in mall traffic could
adversely affect our growth, sales, liquidity and profitability. Certain economic conditions affect the level of consumer spending on
merchandise we offer, including business conditions, interest rates, taxation
and consumer confidence in future economic conditions. If the demand for
apparel and related merchandise by our female customers declines, our business,
comparable store sales results, results of operations and liquidity would be
materially and adversely affected. Although we advertise on our website,
through e-mail blasts and to a limited extent in national magazines through
cooperative agreements with certain of our vendors, our stores rely principally
on mall traffic for customers. Therefore, we are dependent upon the continued
popularity of malls as a shopping destination and the ability of mall anchor
tenants and other attractions to generate customer traffic for our stores. A
decrease in mall traffic or a decline in economic conditions in the markets in
which our stores are located would adversely affect our growth, net sales,
comparable store sales results, liquidity and profitability. Any disruption in our distribution facility or growth beyond its
capabilities could cause our business and financial condition to suffer. Our distribution functions for all our stores are handled from a single
facility in Carrollton, Texas. Any significant interruption in the operation of
the distribution facility due to natural disasters, accidents, system failures
or other unforeseen causes could have a material adverse effect on our
business, financial condition and results of operations. There can be no
assurance that our distribution center will be adequate to support future
growth. 12




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Declines in tourism and mall traffic resulting from threats of, concerns
about and terrorist attacks could result in decreased sales. As a result of the war in Iraq and the lingering effects of the attacks on
September 11, 2001, security has been heightened in public areas, including the
regional shopping malls where our stores are located. Any further threat of
terrorist attacks or actual terrorist events could lead to lower customer
traffic in regional shopping malls. A continued decline in tourism in this
market could have a material effect on our sales, profitability and liquidity.
In addition, local authorities or mall management could close regional shopping
malls in response to any immediate security concern. For example, on September
11, 2001, substantially all our stores were closed early due to closure of the
malls in response to the terrorist attacks. Mall closures, as well as lower
customer traffic due to security concerns, could result in decreased sales that
would have a material adverse effect on our business, financial condition,
results of operations and liquidity. If we lose key employees on whom we depend, or are unable to attract
additional qualified personnel, our business could suffer. Our success depends largely on the efforts and abilities of senior
management. The loss of the services of any member of senior management could
have a material adverse effect on our business, financial condition and results
of operations. There can be no assurance that our existing management team will
be able to manage Gadzooks or that we will be able to retain current and
attract additional qualified personnel as needed in the future. If the market price of our common stock fluctuates significantly, you
could lose all or part of your investment. The market price of our common stock has fluctuated substantially since
our initial public offering in October 1995. Our common stock was delisted from
the Nasdaq Stock Market on February 12, 2004 and is currently quoted on the
Pink Sheets Electronic Quotation Service maintained by the National Quotation
Bureau, Inc. Our common stock has experienced, and is likely to experience in
the future, significant price and volume fluctuations due to market volatility,
which could adversely affect the market price of the common stock without
regard to our operating performance. In addition, we believe that factors such
as quarterly fluctuations in our financial results, our comparable store sales
results, announcements by other apparel retailers, the overall economy and the
condition of the financial markets could cause the price of our common stock to
fluctuate substantially. The price of our common stock could fluctuate based
upon factors that have little or nothing to do with our company and these
fluctuations could materially reduce our stock price. We have implemented anti-takeover provisions that may discourage a change
of control. Our Restated Articles of Incorporation and Bylaws contain provisions that
may have the effect of delaying, deterring or preventing a takeover of Gadzooks
that shareholders may consider to be in their best interests. Our Restated
Articles of Incorporation and Bylaws provide for a classified board of
directors serving staggered terms of three years, the prohibition of
shareholder action by written consent in certain circumstances and certain
fair price provisions. Additionally, the board of directors has the
authority to issue up to 1,000,000 shares of preferred stock having such
rights, preferences and privileges as designated by the board of directors
without shareholder approval. We also have a Shareholder Rights Plan, which is
intended to deter an unfriendly takeover of Gadzooks and to help ensure that
current shareholders receive fair value upon the sale of their stock to another
party seeking control of Gadzooks. These provisions and the rights plan may
have the effect of discouraging takeovers, even if the change of control might
be beneficial to our shareholders. 13




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Our discretion in some matters is limited by our DIP credit facility
restrictive covenants, and any default on our debt agreements could harm our
business, profitability and growth prospects. Our DIP facility contains a number of covenants that limit the discretion
of our management with respect to certain business matters. The credit
facility covenants, among other things, restrict our ability to:  
    
    incur additional indebtedness;
    
    declare or pay dividends or other distributions;
    
    create liens;
    
    make certain investments or acquisitions;
    
    enter into mergers and consolidations;
    
    make sales of assets; and
    
    engage in certain transactions with affiliates. The occurrence of an event of default under the agreements governing our
debt would permit acceleration of the related debt, which could harm our
business, profitability and growth prospects. Shareholders may experience dilution of their investment. As a result of our efforts to raise additional capital in Chapter 11, our
shareholders may experience dilution of their investment due to the additional
number of shares of our common stock in the public market. Further, if we
issue any equity securities in connection with our emergence from bankruptcy,
our existing shareholders may experience further dilution. This dilution could
cause the market price of our common stock to decline. In addition, the sale
of these shares could impair our ability to raise capital through the sale of
additional common or preferred stock. Assuming we receive shareholder approval
for the issuance of shares over 20% of our shares outstanding and the
conversion of the principal balance of the outstanding convertible subordinated
notes into 2,800,000 shares of common stock, we will have 11,947,024 shares of
common stock outstanding, which represents an increase of 30.6% over the
9,147,024 shares outstanding as of May 10, 2004. In addition, you may
experience further dilution if interest accrues on the notes and is
subsequently converted into shares of common stock. 
 ITEM 2. PROPERTIES. All of the existing stores are leased by the Company, with lease terms
(excluding renewal option periods exercisable by the Company at escalating
rents) expiring between April 2004 and January 2014. The leases for most of
the existing stores are for terms of ten years and provide for contingent rent
based upon a percent of sales in excess of specified minimums. The Company leases its office and distribution center located in
Carrollton, Texas under a lease that is scheduled to expire on May 1, 2007. 
 ITEM 3. LEGAL PROCEEDINGS. On February 3, 2004, Gadzooks filed a voluntary petition for
reorganization under Chapter 11 of the United States Bankruptcy Code in the
United States Bankruptcy Court for the Northern District of Dallas and was
assigned case number 04-31486-hdh11. As a debtor-in-possession, the Company is
authorized to continue operating as an ongoing business, but may not engage in
transactions outside the ordinary course of business without the approval of
the Court, after notice and an opportunity for a hearing. At first day hearings held on February 3 and 4, 2004, the Court entered
orders granting authority to the Company to, among other things, pay
pre-petition and post-petition employee wages, salaries, benefits and other
employee obligations, to pay vendors and other providers in the ordinary course
for goods and services received from January 24, 2004, and to honor customer
service programs, including returns, store credits and gift cards. On February
3, 2004, the Court also gave interim approval for a debtor-in-possession
revolving credit facility, referred to as the DIP Facility, with Wells Fargo
Retail Finance, LLC in the aggregate amount of $30 million for the payment of
permitted pre-petition claims, working capital needs, letters of credit and
other general corporate purposes. On February 25, 2004, the Court gave final
approval on the DIP Facility underwritten by Wells Fargo Retail Finance, LLC.
A description of the DIP Facility appears in Item 7. Managements Discussion
and Analysis  Long-Term Debt and Credit Agreement. 14




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Background of Filing -In January 2003, the Company announced its decision
to convert the Gadzooks stores to an all-female merchandise assortment early in
the second half of fiscal 2003. The Company anticipated an operating loss
during the transition phase in fiscal 2003, with expectations of returning to
profitability in fiscal 2004. However, as a result of a rapid decline in
liquidity resulting from below-plan sales and earnings performance in the
second half of fiscal 2003, an erosion of supplier confidence, intense
competition and unsuccessful sales and marketing initiatives, the Company filed
a voluntary petition for reorganization under Chapter 11 of the Bankruptcy Code
in the Bankruptcy Court, on February 3, 2004. Under Chapter 11, the Company
expects to continue to operate its business as debtor-in-possession under court
protection from its creditors and claimants, while using the Chapter 11 process
to complete the reorganization of its core business around approximately 250
stores that were chosen to strengthen its market share in the junior apparel
business. Consequence of Filing  As a consequence of the Chapter 11 filing, all
pending claims against the Company are stayed and no party may take any action
to realize its pre-petition claims except pursuant to an order of the
Bankruptcy Court. It is the Companys intention to address all of its
pre-petition claims in a plan of reorganization to be voted upon by creditors
and equity holders and approved by the Court. Restructuring Activities  Since filing for bankruptcy protection,
management has been actively engaged in restructuring the Companys operations.
With the assistance of an independent consulting firm specializing in
restructuring operations, management analyzed all of the Companys stores based
on a number of factors including, but not limited to, historical sales results,
expected future sales results, occupancy cost, and mix of juniors versus mens
business to identify the optimal set of stores to retain and operate.
Management continues to evaluate the operating results of all the Companys
stores. The cost to terminate leases on stores identified for closure could be
as much as $15.0 million, but the Company believes the ultimate liability could
be much less than that amount. The Company is currently operating
approximately 250 stores, but there can be no guarantee that additional stores
will not be closed, or that stores already closed will not be reopened with an
improved occupancy structure. Management retained an independent real estate
consulting firm to assist the Company in achieving the most cost effective
strategy for exiting stores targeted for closure. The real estate consultant
has also assisted management in its efforts to negotiate reduced rents for
certain properties. Those real estate initiatives are ongoing. Management also
thoroughly evaluated its merchandising activities in an effort to improve the
Companys sales, merchandise margin and inventory turnover metrics. Under the
supervision of a new President and Chief Merchandising Officer (assumed the
position in February 2004), the Companys merchandising group has implemented a
number of new strategies including, but not limited to, the following:  
    
    an increased emphasis on establishing leadership positions in the mall in certain product categories,
    
    the accelerated identification and liquidation of slow-moving items,
    
    an increased emphasis on popular brands,
    
    more appropriate utilization of the Companys private brands,
    
    an increased emphasis on offering products that customers are
inclined to purchase for immediate use (buy now, wear now),
    
    the maintenance of more appropriate inventory mix metrics
(e.g., tops to bottoms ratio),
    
    maintaining lower inventory levels to promote faster inventory
turns and a more desirable shopping experience in the stores and
    
    providing for more frequent changes to store visuals and
merchandise presentations. Management has also significantly reduced the Companys fixed cost
structure primarily by eliminating approximately 65 field management and
corporate positions in fiscal 2004 and, accordingly, the Company will recognize
any severance related expenses in fiscal 2004. Management expects that the
cost reductions the Company has implemented will result in annualized expense
savings in excess of $10 million. Management believes it will be necessary to
raise additional capital to liquidate and/or restructure the Companys
pre-petition obligations, to satisfy the Companys lease termination
liabilities arising from the rejection of store leases and to adequately
capitalize the business. The Company has engaged an investment banker to assist
it in determining and satisfying its capital needs. At this time it is not
possible to predict the exact amount or nature of such new capital. In
addition, there can be no guarantee that additional capital will be available
to the Company, or that such capital will be available on terms favorable to
the Company. Raising additional capital could result in the significant
dilution of current equity interests, but it is not possible to predict the
extent of such potential dilution at this time. Generally, under the provisions of the Bankruptcy Code, holders of equity
interests may not participate under a plan of reorganization unless the claims
of creditors are satisfied in full under the plan or unless creditors accept a
reorganization plan that permits holders of equity interests to participate.
Although the Company expects to file a reorganization plan that provides 15




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for
emergence from bankruptcy in the second half of 2004, there can be no assurance
that a reorganization plan will be proposed by the Company or confirmed by the
Court, or that any such plan will be consummated. As such, it is currently
impossible to
predict with any degree of certainty how the plan will treat pre-petition
claims and the impact the Chapter 11 filing and any reorganization plan may
have on shares of common stock of Gadzooks. In the ordinary course of its business, the Company is periodically a
party to lawsuits. The Company does not believe that any resulting liability
from such existing legal proceedings, individually or in the aggregate, will
have a material adverse effect on its operations or financial condition.
However, there can be no assurance that future costs will not be material to
operating results and liquidity. 
 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. No matters were submitted to a vote of the Companys shareholders during
the fourth quarter of the fiscal year covered by this report. 
 PART II 
 ITEM 5. MARKET FOR REGISTRANTS COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. The following table sets forth, for the quarterly periods indicated, the
high and low sales prices per share of common stock as reported on The Nasdaq
Stock Market: 2003
    
    2002High
    
    Low
    
    High
    
    LowFiscal Quarters:First Quarter
    
    $
    4.76
    
    
    $
    2.03
    
    
    $
    18.55
    
    
    $
    12.95Second Quarter
    
    
    7.77
    
    
    
    3.49
    
    
    
    14.45
    
    
    
    8.25Third Quarter
    
    
    8.00
    
    
    
    3.60
    
    
    
    8.60
    
    
    
    3.51Fourth Quarter
    
    
    7.24
    
    
    
    .90
    
    
    
    5.98
    
    
    
    3.25
 As of February 12, 2004, the common stock of the Company was suspended
from trading by The Nasdaq Stock Market and delisted from the exchange. The
stock is now quoted on the Pink Sheets Electronic Quotation Service maintained
by the National Quotation Bureau, Inc. On April 8, 2004 the closing sales
price on the Pink Sheets Electronic Quotation Service was $1.64. As of April
8, 2004, the approximate number of common shareholders of record was 92,
although the Company believes that the actual number of beneficial owners is
significantly higher. The Company presently intends to retain earnings, if
any, for use in its business and therefore does not anticipate declaring a
cash dividend in the near future. 16




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ITEM 6. SELECTED FINANCIAL DATA. The following selected financial data should be read in conjunction with
Managements Discussion and Analysis of Financial Condition and Results of
Operations and the Consolidated Financial Statements and Notes thereto
included elsewhere in this Annual Report on Form 10-K. Fiscal Year Ended($ in thousands, except operating data
    
    January 31,
    
    February 1,
    
    February 2,
    
    February 3,
    
    January 29,and per share amounts)
    
    2004
    
    2003
    
    2002
    
    2001
    
    2000Statement of Operations Data:Net sales
    
    $
    258,506
    
    
    $
    325,521
    
    
    $
    313,823
    
    
    $
    288,411
    
    
    $
    240,253Cost of goods sold
    
    
    227,849
    
    
    
    244,321
    
    
    
    234,054
    
    
    
    205,505
    
    
    
    173,778Gross profit
    
    
    30,657
    
    
    
    81,200
    
    
    
    79,769
    
    
    
    82,906
    
    
    
    66,475Selling, general and
administrative expenses
    
    
    81,688
    
    
    
    77,337
    
    
    
    69,758
    
    
    
    63,450
    
    
    
    55,558Long-lived asset impairments
    
    
    8,974
    
    
    
    5,870
    
    
    
    563
    
    
    
    
    
    
    
    1,721Operating income (loss)
    
    
    (60,005
    )
    
    
    (2,007
    )
    
    
    9,448
    
    
    
    19,456
    
    
    
    9,196Interest income (expense), net
    
    
    (828
    )
    
    
    74
    
    
    
    294
    
    
    
    792
    
    
    
    496Income (loss) before income taxes
    
    
    (60,833
    )
    
    
    (1,933
    )
    
    
    9,742
    
    
    
    20,248
    
    
    
    9,692Provision (benefit) for income taxes
    
    
    1,144
    
    
    
    (675
    )
    
    
    3,733
    
    
    
    7,458
    
    
    
    3,622Net income (loss)
    
    $
    (61,977
    )
    
    $
    (1,258
    )
    
    $
    6,009
    
    
    $
    12,790
    
    
    $
    6,070Net income (loss) per shareBasic
    
    $
    (6.78
    )
    
    $
    (0.14
    )
    
    $
    0.66
    
    
    $
    1.44
    
    
    $
    0.68Diluted
    
    $
    (6.78
    )
    
    $
    (0.14
    )
    
    $
    0.65
    
    
    $
    1.38
    
    
    $
    0.67Average shares outstandingBasic
    
    
    9,136
    
    
    
    9,126
    
    
    
    9,040
    
    
    
    8,911
    
    
    
    8,910Diluted
    
    
    9,136
    
    
    
    9,126
    
    
    
    9,304
    
    
    
    9,293
    
    
    
    9,043Selected Operating Data:Comparable store sales change (1)
    
    
    (19.3
    )%
    
    
    (3.4
    )%
    
    
    (5.1
    )%
    
    
    7.6
    %
    
    
    5.4
    %Number of stores at year end
    
    
    410
    
    
    
    439
    
    
    
    431
    
    
    
    375
    
    
    
    326Average net sales per store
    
    $
    611,000
    
    
    $
    743,000
    
    
    $
    767,000
    
    
    $
    826,000
    
    
    $
    746,000Average net sales per square foot
    
    $
    247
    
    
    $
    300
    
    
    $
    312
    
    
    $
    345
    
    
    $
    315Total square footage at end of period
    
    
    1,017,000
    
    
    
    1,087,000
    
    
    
    1,064,000
    
    
    
    908,000
    
    
    
    772,000Operating income (loss) ratio
    
    
    (23.2
    )%
    
    
    (0.6
    )%
    
    
    3.0
    %
    
    
    6.7
    %
    
    
    3.8
    %Capital expenditures (in thousands)
    
    $
    9,124
    
    
    $
    9,688
    
    
    $
    14,275
    
    
    $
    12,936
    
    
    $
    7,008Balance Sheet Data:Working capital
    
    $
    3,996
    
    
    $
    50,773
    
    
    $
    47,040
    
    
    $
    44,986
    
    
    $
    38,367Total assets
    
    
    76,220
    
    
    
    125,127
    
    
    
    125,681
    
    
    
    118,794
    
    
    
    96,662Total debt
    
    
    24,024
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Shareholders equity
    
    
    25,805
    
    
    
    86,358
    
    
    
    86,853
    
    
    
    79,388
    
    
    
    66,145
 (1) A store becomes comparable after it has been open for 14 full fiscal
months. 17




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ITEM 7.
    MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS. General Gadzooks is a mall-based specialty retailer of casual apparel and related
accessories for young women, principally between the ages of 16 and 22. On
January 9, 2003, the Company announced plans to focus exclusively on apparel
and accessories for females. The conversion of the Gadzooks stores to an
all-female merchandise assortment took place early in the second half of fiscal
2003. In the second half of fiscal 2001, the Company began testing a new
retail concept with the opening of four Orchid stores. The Orchid concept
catered to the innerwear and sleepwear needs of females between the ages of 14
and 22. In January 2004, the Company decided to discontinue testing the Orchid
concept and liquidated those stores during the first quarter of fiscal 2004.
The Company opened its first store in 1983, and at fiscal year-end 2003,
operated 406 Gadzooks stores and four Orchid stores in 41 states. The Company
opened one Gadzooks store and one Orchid store in fiscal 2003, 11 Gadzooks
stores in fiscal 2002 and 56 Gadzooks stores and four Orchid stores in fiscal
2001. Thirty Gadzooks stores and one Orchid store were closed during fiscal
2003, three Gadzooks stores were closed during fiscal 2002 and four Gadzooks
stores were closed during fiscal 2001. During the first quarter of fiscal
2004, the Company closed 158 stores. As of May 1, 2004, the Company operates
252 stores. Subsequent Event  Voluntary Bankruptcy Filing On February 3, 2004, Gadzooks filed a voluntary petition for
reorganization under Chapter 11 of the United States Bankruptcy Code in the
United States Bankruptcy Court for the Northern District of Dallas and was
assigned case number 04-31486-hdh11. As a debtor-in-possession, the Company is
authorized to continue to operate as an ongoing business, but may not engage in
transactions outside the ordinary course of business without the approval of
the Court, after notice and an opportunity for a hearing. At first day hearings held on February 3 and 4, 2004, the Court entered
orders granting authority to the Company to, among other things, pay
pre-petition and post-petition employee wages, salaries, benefits and other
employee obligations, to pay vendors and other providers in the ordinary course
for goods and services received from January 24, 2004, and to honor customer
service programs, including returns, store credits and gift cards. On February
3, 2004, the Court also gave interim approval for a debtor-in-possession
revolving credit facility, referred to as the DIP Facility, with Wells Fargo
Retail Finance, LLC in the aggregate amount of $30 million for the payment of
permitted pre-petition claims, working capital needs, letters of credit and
other general corporate purposes. On February 25, 2004, the Court gave final
approval on the DIP Facility underwritten by Wells Fargo Retail Finance, LLC.
A description of the DIP Facility appears in Item 7. Managements Discussion
and Analysis  Long-Term Debt and Credit Agreement. Background of Filing  In January 2003, the Company announced its decision
to convert the Gadzooks stores to an all-female merchandise assortment early in
the second half of fiscal 2003. The Company anticipated an operating loss
during the transition phase in fiscal 2003, with expectations of returning to
profitability in fiscal 2004. However, as a result of a rapid decline in
liquidity resulting from below-plan sales and earnings performance in the
second half of fiscal 2003, an erosion of supplier confidence, intense
competition and unsuccessful sales and marketing initiatives, the Company filed
a voluntary petition for reorganization under Chapter 11 of the Bankruptcy Code
in the Bankruptcy Court, on February 3, 2004. Under Chapter 11, the Company
expects to continue to operate its business as debtor-in-possession under court
protection from its creditors and claimants, while using the Chapter 11 process
to complete the reorganization of its core business around approximately 250
stores that were chosen to strengthen its market share in the junior apparel
business. Consequence of Filing  As a consequence of the Chapter 11 filing, all
pending claims against the Company are stayed and no party may take any action
to realize its pre-petition claims except pursuant to an order of the
Bankruptcy Court. It is the Companys intention to address all of its
pre-petition claims in a plan of reorganization to be voted upon by creditors
and equity holders and approved by the Court. Restructuring Activities  Since filing for bankruptcy protection,
management has been actively engaged in restructuring the Companys operations.
With the assistance of an independent consulting firm specializing in
restructuring operations, management analyzed all of the Companys stores based
on a number of factors including, but not limited to, historical sales results,
expected future sales results, occupancy cost, and mix of juniors versus mens
business to identify the optimal set of stores to retain and operate.
Management continues to evaluate the operating results of all the Companys
stores. The cost to terminate leases on stores identified for closure could be
as much as $15.0 million, but the Company believes the ultimate liability could
be much less than that amount. The Company is currently operating
approximately 250 stores, but there can be 18




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no guarantee that additional stores will not be closed, or that stores
already closed will not be reopened with an improved occupancy structure.
Management retained an independent real estate consulting firm to assist the
Company in achieving the most cost effective strategy for exiting stores
targeted for closure. The real estate consultant has also assisted management
in its efforts to negotiate reduced rents for certain properties. Those real
estate initiatives are ongoing. Management also thoroughly evaluated its
merchandising activities in an effort to improve the Companys sales,
merchandise margin and inventory turnover metrics. Under the supervision of a
new President and Chief Merchandising Officer (assumed the position in February
2004), the Companys merchandising group has implemented a number of new
strategies including, but not limited to, the following:  
    
    an increased emphasis on establishing leadership positions in the mall in certain product categories,
    
    the accelerated identification and liquidation of slow-moving items,
    
    an increased emphasis on popular brands,
    
    more appropriate utilization of the Companys private brands,
    
    an increased emphasis on offering products that customers are
inclined to purchase for immediate use (buy now, wear now),
    
    the maintenance of more appropriate inventory mix metrics
(e.g., tops to bottoms ratio),
    
    maintaining lower inventory levels to promote faster inventory
turns and a more desirable shopping experience in the stores and
    
    providing for more frequent changes to store visuals and
merchandise presentations. Management has also significantly reduced the Companys fixed cost
structure primarily by eliminating approximately 65 field management and
corporate positions in fiscal 2004 and, accordingly, the Company will recognize
any severance related expenses in fiscal 2004. Management expects that the
cost reductions the Company has implemented will result in annualized expense
savings in excess of $10 million. Management believes it will be necessary to
raise additional capital to liquidate and/or restructure the Companys
pre-petition obligations, to satisfy the Companys lease termination
liabilities arising from the rejection of store leases and to adequately
capitalize the business. The Company has engaged an investment banker to assist
it in determining and satisfying its capital needs. At this time it is not
possible to predict the exact amount or nature of such new capital. In
addition, there can be no guarantee that additional capital will be available
to the Company, or that such capital will be available on terms favorable to
the Company. Raising additional capital could result in the significant
dilution of current equity interests, but it is not possible to predict the
extent of such potential dilution at this time. Generally, under the provisions of the Bankruptcy Code, holders of equity
interests may not participate under a plan of reorganization unless the claims
of creditors are satisfied in full under the plan or unless creditors accept a
reorganization plan that permits holders of equity interests to participate.
Although the Company expects to file a reorganization plan that provides for
emergence from bankruptcy in the second half of 2004, there can be no assurance
that a reorganization plan will be proposed by the Company or confirmed by the
Court, or that any such plan will be consummated. As such, it is currently
impossible to predict with any degree of certainty how the plan will treat
pre-petition claims and the impact the Chapter 11 filing and any reorganization
plan may have on shares of common stock of Gadzooks. The accompanying Consolidated Financial Statements have been prepared on a
going concern basis, which contemplates continuity of operations, realization
of assets and liquidation of liabilities in the ordinary course of business.
The filing of Chapter 11 raises substantial doubt about the Companys ability
to continue as a going concern. Further, a plan of reorganization could
materially change the amounts and classifications reported in the consolidated
financial statements, which do not give effect to any adjustments to the
carrying value or the classification of assets or liabilities that might be
necessary as a consequence of a plan of reorganization. All of the Companys pre-petition debt is now in default due to the
Chapter 11 filing. Accordingly, the accompanying Consolidated Balance Sheet as
of January 31, 2004 reflects the classification of the Companys pre-petition
debt as current. Accounting Impact  Beginning in the first quarter of fiscal 2004, the
Company will be required to follow Statement of Position 90-7 (SOP 90-7),
Financial Reporting by Entities in Reorganization under the Bankruptcy Code.
Pursuant to SOP 90-7, the Companys pre-petition liabilities that are subject
to compromise will be reported separately on the balance sheet at an estimate
of the amount that will ultimately be allowed by the Bankruptcy Court. SOP
90-7 also requires separate reporting of certain expenses, realized gains and
losses, and provisions for losses related to the Chapter 11 filing as
reorganization items. In January 2004, the Company entered into an agreement with a consulting
firm to help with the complete liquidation of its inventory in 37
under-performing stores. All amounts paid or payable to the firm pursuant to
the contract are contingent upon the firms ability to meet certain minimum
levels of sales performance. During the fourth quarter of fiscal 2003, the
Company 19




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recognized approximately $133,000 owed to the firm (or paid to the
firm) based on sales through year-end as selling, general
and administrative expense pursuant to the contract. In addition, during
the fourth quarter of fiscal 2003, the Company recognized $546,000 in cost of
sales in order to write-down inventory to its estimated net realizable value at
the applicable stores that had not been liquidated as of year-end. Six of
these stores were closed during fiscal 2003 and the remaining stores were
closed during the first quarter of fiscal 2004. During the first quarter of
fiscal 2004, the Company performed one of the following on all of the store
closures: 1) exercised early termination provision of the lease, 2) closed the
store due to a lease expiration or 3) rejected the lease. In February 2004, the Company entered into an agreement with a consulting
firm to help with the complete liquidation of its inventory in 127 under
performing stores. Under the terms of the agreement, the Company was
guaranteed a certain percentage of the aggregate retail price of the
merchandise as determined by the contract and was reimbursed for store level
operating expenses of the respective stores for the term of the liquidation. A
total of $2.5 million was recorded as cost of goods sold through a write-down
of the respective inventory to its estimated net realizable value during the
fourth quarter of fiscal 2003 pursuant to this agreement. All of these stores
were closed during the first quarter of fiscal 2004. The Company and
liquidation firm are negotiating the final settlement and amounts owed pursuant
to the contract. During the first quarter of fiscal 2004, the Company
performed one of the following on all but three of the store closures: 1)
exercised early termination provision of the lease, 2) closed the store due to
a lease expiration or 3) rejected the lease. Critical Accounting Policies and Estimates The preparation of Gadzooks consolidated financial statements in
conformity with accounting principles generally accepted in the United States
of America requires management to make estimates and assumptions that affect
the reported amounts of assets and liabilities and disclosure of contingent
assets and liabilities at the balance sheet date, as well as the reported
amounts of revenues and expenses during the reporting period. On an ongoing
basis, management evaluates such estimates including sales return rates,
inventory reserves, impairment of long-lived assets, income taxes and accrued
expenses. Actual results may differ from these estimates. Gadzooks accounting policies are generally straightforward, however, the
following require more significant management judgments and estimates. Revenue Recognition.As discussed in Note 2 to the consolidated financial
statements, retail merchandise sales are recognized at the point of sale less
sales returns and employee discounts. Management records a provision for
estimated sales returns based on historical return rates. If sales return
rates increase, an additional allowance may be required. Inventory Valuation.As discussed in Note 2 to the consolidated financial
statements, inventories are valued at the lower of average cost or market.
Cost is determined using the weighted-average method. Markdown allowances
received from vendors are recorded as a reduction of inventory cost and
therefore as a reduction of cost of goods sold in the period in which the
related merchandise is sold. In addition, inventories include an allocation of
buying and distribution costs to prepare product for the stores. This
inventory valuation method requires certain management estimates and judgments,
including estimates of merchandise markdowns, which could significantly affect
gross margin. Management estimates the markdown reserve based on several
factors, including but not limited to, merchandise quantities, historical
markdown percentages, aged seasonal merchandise and future merchandise plans.
If future demand or merchandise markdowns are less favorable than those
projected by management, additional inventory adjustments may be required. On
a monthly basis, management estimates shrink based on historical shrink rates.
These estimates are compared to actual results as inventory counts are taken
and reconciled to the general ledger. Gadzooks has not experienced significant
fluctuations in historical shrink rates. Long-lived Asset Impairment.As discussed in Note 3 of the consolidated
financial statements, management periodically reviews its long-lived assets for
impairment and records a provision whenever events or circumstances indicate
that the net book value of the asset may not be recoverable. Impairment is
determined based on several factors, including but not limited to, current year
operating loss or cash flow loss combined with a history and forecast of
operating or cash flow losses, significant negative industry or economic trends
and a current expectation, that more likely than not, the asset will be
disposed of significantly before the end of its previously estimated useful
life. If management determines that an impairment exists, an impairment loss
is recognized if the sum of the expected future cash flows (undiscounted and
before interest) from the use of the assets is less than the net book value of
the assets. The amount of the impairment loss is measured as the difference
between the net book value of the assets and the estimated fair market value of
the related assets. 20




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Deferred Tax Assets.Due to our operating losses and continuing same
store sales declines since the conversion to an all-female concept, we
recognized a valuation allowance of approximately $25.0 million to reduce our
deferred tax assets and tax benefits generated during fiscal 2003. The Company
does not anticipate recording any tax benefit associated with operating losses
in the foreseeable future. At January 31, 2004, the Company had tax
receivables totaling $5.3 million, representing the amount of the current year
estimated operating loss that can be carried back to prior years taxable
income to obtain a tax refund. Accrued Expenses.On a monthly basis, certain expenses are estimated in
an effort to reflect these expenses in the proper period. Gadzooks most
material estimates relate to self-insurance reserves, store level operating
expenses and bonuses. The self-insurance reserves for medical and workers
compensation claims are recorded based on historical claim levels adjusted for
changes in the employee base. If the historical claims used to calculate these
estimates are not reflective of actual results, additional expenses may be
incurred up to the point that the Companys stop loss insurance begins. The
Company is self-insured for property claims at the store level. Property
claims at the store level are estimated and recognized as incurred. Accrued
store level operating expenses are estimated based on current activity and
historical results. Bonuses are based on performance and projected performance
for the remainder of the bonus period. If actual results are significantly
different from Gadzooks expectations, an adjustment to expenses may be
required. Store
Closures.Reserves for store closures, related to leases without
early termination provisions, represent calculations of the present
value of the remaining lease obligation, reduced by estimated
sub-tenant income, plus other estimated contractual obligations as
stated in the lease. For leases with early termination provisions,
the liability for costs to terminate a lease before the end of its
term is recognized when the Company terminates the lease in
accordance with the contract terms. Expenses associated with the
establishment of these reserves are reflected in general and
administrative expense. Operating expenses reflect the future lease
obligation or lease termination payments, less any remaining accrual
for straight-line average rent. Store fixtures are transferred at
historical cost to other store locations, written off or written down
to their net realizable value and sold. Results of Operations The following table sets forth for the periods indicated certain selected
statement of operations data expressed as a percentage of net sales and certain
store data: Fiscal Year2003
    
    2002
    
    2001Net sales
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %Cost of goods sold, including buying,
distribution and occupancy costs
    
    
    88.1
    
    
    
    75.1
    
    
    
    74.6Gross profit
    
    
    11.9
    
    
    
    24.9
    
    
    
    25.4Selling, general and administrative expenses
    
    
    31.6
    
    
    
    23.7
    
    
    
    22.2Long-lived asset impairments
    
    
    3.5
    
    
    
    1.8
    
    
    
    0.2Operating income (loss)
    
    
    (23.2
    )
    
    
    (0.6
    )
    
    
    3.0Interest income (expense), net
    
    
    (0.3
    )
    
    
    
    
    
    
    0.1Income (loss) before income taxes
    
    
    (23.5
    )
    
    
    (0.6
    )
    
    
    3.1Provision (benefit) for income taxes
    
    
    0.5
    
    
    
    (0.2
    )
    
    
    1.2Net income (loss)
    
    
    (24.0
    )%
    
    
    (0.4
    )%
    
    
    1.9
    %Number of stores open at end of period
    
    
    410
    
    
    
    439
    
    
    
    431
 Fiscal Year.The Companys fiscal year is the 52- or 53-week period that
ends on the Saturday nearest January 31. Fiscal 2003 was the 52-week period
ending January 31, 2004. Fiscal 2003 Compared to Fiscal 2002 Net sales decreased approximately $67.0 million, or 20.6 percent, to
$258.5 million during fiscal 2003 from $325.5 million during fiscal 2002. The
total Company sales decrease was due to a comparable store sales decrease of
$60.6 million and a sales decrease of $8.3 million due to closed stores,
partially offset by $1.9 million of sales for the two new stores opened during
fiscal 2003 and for those stores not yet included in the comparable store sales
base. Comparable store sales decreased 19.3 percent for 21




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fiscal 2003. The
decrease in comparable store sales is attributed to the conversion to an
all-female assortment and the Companys failure to build its share of the
junior apparel and accessory market as quickly as planned. The average dollar
sale
decreased by 8.9 percent for the year, and the number of transactions per
average store declined by 10.1 percent. A store becomes comparable after it
has been open for 14 full fiscal months. Gross profit decreased approximately $50.5 million to $30.7 million during
fiscal 2003 from $81.2 million in fiscal 2002. As a percentage of net sales,
gross profit decreased 13.0 percent to 11.9 percent from 24.9 percent in fiscal
2002. Merchandise margin as a percentage of sales was 8.5 percent lower than
the prior year. This decrease is attributable to increased markdown activity
during the period, as a result of the Companys liquidation of all its mens
merchandise in the first half of the year, lower of cost or market adjustments
recorded at year-end in relation to stores slated to close in the first quarter
of fiscal 2004 of $3.0 million, markdowns taken to liquidate inventories in the
31 stores that closed in fiscal 2003 and significant promotional activity in
the second half of the year initiated to stimulate sales and accelerate the
Companys market share growth. Occupancy costs as a percentage of sales
increased 4.0 percent, and buying and distribution costs as a percentage of
sales increased by 0.7 percent. Of the increase in store occupancy costs as a
percentage of sales, 3.6 percent was due to negative sales leverage, and the
rest was the result of an increase in occupancy costs per average square foot
due to the higher costs associated with new stores and remodels as well as
higher depreciation expense associated with store refurbishments and
accelerated depreciation of fixtures disposed of in the conversion to an
all-female merchandise assortment. The increase in buying and distribution
costs as a percentage of sales was primarily due to the negative leverage
effect of the comparable store sales decrease. Selling, general and administrative, or SG&A expenses, increased
approximately $4.4 million to $81.7 million in fiscal 2003 from $77.3 million
in fiscal 2002. The aggregate increase in SG&A is primarily attributable to
costs of $3.0 million associated with the liquidation of the mens merchandise,
lease termination costs of $3.4 million and additional advertising and
marketing expenses of $2.0 million related to the all-girls transition offset
in part by a reduction in payroll costs of $3.2 million, and a reduction in
inventory service costs of $528,000. As a percentage of net sales, SG&A
increased 7.9 percent to 31.6 percent from 23.7 percent in fiscal 2002. The
increase in the SG&A percentage is primarily the result of the negative
leverage effect of the comparable store sales decrease, costs associated with
the liquidation of the mens merchandise, lease termination costs and the
increase in advertising and marketing costs related to the transition. The Company recorded $828,000 in net interest expense during fiscal 2003
compared to $74,000 in net interest income in fiscal 2002. The change is due
primarily to an increase in the costs associated with the Companys credit
facility, an increase in amounts borrowed under the facility and interest on
the notes issued in the latter part of the third quarter, and to a lesser
extent, increased letter of credit activity and lower average cash balances. The Company recorded a provision for income taxes of $1.1 million in
fiscal 2003 compared to a $675,000 tax benefit in fiscal 2002. Due to
operating losses and continuing same store sales declines since the conversion
to an all-female concept, the Company recorded a valuation allowance of
approximately $25.0 million to reduce our deferred tax assets and tax benefits
generated during fiscal 2003. The Company does not anticipate recording any
tax benefit associated with operating losses in the foreseeable future. At
January 31, 2004, the Company had tax receivables totaling $5.3 million,
representing the amount of the current year estimated operating loss that can
be carried back to prior years taxable income to obtain a tax refund. Long-lived Asset Impairments.As indicated in Note 3 of the consolidated
financial statements, the Company has experienced significant operating losses
and continuing same store sales declines since the conversion to an all-female
concept. The Company also filed for bankruptcy in fiscal 2004 and as a result,
liquidated and closed 158 stores in the first quarter of fiscal 2004.
Consequently, the Company performed an impairment analysis on all of its stores
during fiscal 2003 and recorded a non-cash impairment charge of $9.0 million to
reflect fixtures and leasehold improvements at their respective estimated fair
value. The Company is currently considering the closure of approximately 15 to
20 additional under-performing stores in fiscal 2004. If management determines
that it is unlikely that a stores expected future operating results will be
sufficient to meet the Companys financial objectives, management will consider
remedial actions up to and including closing the store. If management approves
a plan for closing a store or stores, the Company will recognize the liability
for the costs associated with the plan as the liabilities are incurred. Costs
to close a store can vary greatly based on the remaining life of a lease,
buyout options with landlords and severance costs. 22




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Fiscal 2002 Compared to Fiscal 2001 Net sales increased approximately $11.7 million, or 3.7 percent, to $325.5
million during fiscal 2002 from $313.8 million during fiscal 2001. Net sales
for the 11 new stores opened during fiscal 2002 and for those not yet
qualifying as comparable stores accounted for $22.0 million of total sales.
These sales were primarily offset by a comparable store sales decrease of $10.3
million, or 3.4 percent, in fiscal 2002. Sales per average store by category
compared to the prior year were as follows: shoes  increased 2.3 percent;
mens apparel  decreased 5.4 percent; accessories  decreased 6.8 percent and
junior apparel was flat to fiscal 2001. The decrease in comparable store sales
is attributed to increased competition and a difficult retail environment. The
average dollar sale increased by 3.1 percent for the year, and the number of
transactions per average store declined by 6.3 percent. A store becomes
comparable after it has been open for 14 full fiscal months. Gross profit increased approximately $1.4 million to $81.2 million during
fiscal 2002 from $79.8 million in fiscal 2001. As a percentage of net sales,
gross profit decreased 0.5 percent to 24.9 percent from 25.4 percent in fiscal
2001. Merchandise margin as a percentage of sales was 0.8 percent higher than
the prior year. This increase is primarily attributable to improved inventory
shrinkage results as well as higher merchandise margins resulting from a shift
in the merchandise mix to increased levels of private-label merchandise.
Offsetting the improvement in merchandise margin was a 1.3 percent increase in
occupancy costs as a percentage of sales. Of the increase in store occupancy
costs as a percentage of sales, 0.6 percent was due to negative sales leverage,
and the rest was the result of a 4.0 percent increase in occupancy costs per
average square foot due to the higher costs associated with new stores and
remodels as well as higher depreciation expense associated with store
refurbishments. Buying and distribution costs as a percentage of sales were
essentially flat to fiscal 2001. Selling, general and administrative, or SG&A expenses, increased
approximately $7.5 million to $77.3 million in fiscal 2002 from $69.8 million
in fiscal 2001. The aggregate increase in SG&A is primarily attributable to
additional store expenses as a result of the Companys expanded store base
during the past fiscal year and an increase in administrative costs to support
the larger store base. As a percentage of net sales, SG&A increased 1.5
percent to 23.7 percent from 22.2 percent in fiscal 2001. The increase in the
SG&A percentage is primarily the result of the negative leverage effect of the
comparable store sales decrease, an increase in store payroll expense,
increased advertising and visual marketing costs, accelerated depreciation and
the write-off of certain project costs related to an abandoned information
systems project. The Companys net interest income decreased $220,000 to $74,000 in 2002
from $294,000 in fiscal 2001, due to both lower average cash balances and lower
interest rates in fiscal 2002. The Companys effective tax rate decreased to 35.0 percent in fiscal 2002
from 38.3 percent in fiscal 2001. This decrease is primarily due to a change
in mix of contribution to income from different states in fiscal 2002 as
compared to fiscal 2001. Long-lived Asset Impairments.As indicated in Note 3 of the consolidated
financial statements, during fiscal 2002, the Company recorded a non-cash
impairment charge of $5,870,000 to reflect fixtures and leasehold improvements
at their respective estimated fair value in a total of 71 under-performing
stores. The Company closed 26 of these stores in fiscal 2003. The total
impairment charge is expected to reduce depreciation expense by approximately
$978,000 annually over the average remaining useful lives of these assets
(approximately 6.1 years). Management will continue to monitor these stores
along with its regular review of the performance of all the Companys stores.
If management determines that it is unlikely that a stores expected future
operating results will be sufficient to meet the Companys financial
objectives, management will consider remedial actions up to and including
closing the store. If management approves a plan for closing a store or
stores, the Company will recognize the liability for the costs associated with
the plan as the liabilities are incurred. Costs to close a store can vary
greatly based on the remaining life of a lease, buyout options with landlords
and severance costs. Quarterly Results and Seasonality The Companys quarterly results of operations may fluctuate materially
depending on, among other things, net sales contributed by new stores,
increases or decreases in comparable store sales and changes in the Companys
merchandise mix. In fiscal 2004 particularly, the Companys quarterly results
are also likely to fluctuate significantly due to the liquidation of the 158
stores during the first quarter of fiscal 2004. The Companys business is also subject to seasonal influences, with higher
sales during the Christmas holiday, back-to-school, and spring break seasons.
The Christmas holiday season remains the Companys single most important
selling season. 23




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##### Table of Contents



The Company believes, however, that the significance of the
back-to-school season (which affects operating results in the
second and third quarters) and the spring break season (which affects
operating results in the first quarter) reduces somewhat the Companys
dependence on the Christmas holiday selling season. The following table sets forth certain statement of operations and
operating data for each of the Companys last eight fiscal quarters. The
following quarterly data was derived from unaudited financial statements of the
Company, which in the opinion of management of the Company, contain all
adjustments (consisting only of normal recurring adjustments) necessary for
fair presentation thereof. Results for any quarter are not necessarily
indicative of results that may be achieved for a full fiscal year. Fiscal 2003
    
    Fiscal 2002($ in thousands, except operating
    
    First
    
    Second
    
    Third
    
    Fourth
    
    First
    
    Second
    
    Third
    
    Fourthdata and per share amounts)
    
    Quarter
    
    Quarter
    
    Quarter
    
    Quarter
    
    Quarter
    
    Quarter
    
    Quarter
    
    QuarterStatement of operations data:Net sales
    
    $
    70,741
    
    
    $
    68,474
    
    
    $
    49,190
    
    
    $
    70,101
    
    
    $
    78,275
    
    
    $
    76,697
    
    
    $
    73,734
    
    
    $
    96,814Gross profit (2)
    
    
    13,274
    
    
    
    9,660
    
    
    
    5,443
    
    
    
    2,280
    
    
    
    21,606
    
    
    
    19,328
    
    
    
    16,949
    
    
    
    23,316Operating income (loss)
(1) (2)
    
    
    (6,754
    )
    
    
    (12,749
    )
    
    
    (13,240
    )
    
    
    (27,262
    )
    
    
    2,821
    
    
    
    166
    
    
    
    (1,411
    )
    
    
    (3,584
    )Net income (loss) (1) (2)
    
    
    (4,143
    )
    
    
    (7,862
    )
    
    
    (22,107
    )
    
    
    (27,865
    )
    
    
    1,757
    
    
    
    115
    
    
    
    (856
    )
    
    
    (2,274
    )Net income (loss) per
share (1) (2)Basic
    
    $
    (0.45
    )
    
    $
    (0.86
    )
    
    $
    (2.42
    )
    
    $
    (3.05
    )
    
    $
    0.19
    
    
    $
    0.01
    
    
    $
    (0.09
    )
    
    $
    (0.25
    )Diluted
    
    $
    (0.45
    )
    
    $
    (0.86
    )
    
    $
    (2.42
    )
    
    $
    (3.05
    )
    
    $
    0.19
    
    
    $
    0.01
    
    
    $
    (0.09
    )
    
    $
    (0.25
    )Average shares outstandingBasic
    
    
    9,147
    
    
    
    9,127
    
    
    
    9,132
    
    
    
    9,140
    
    
    
    9,095
    
    
    
    9,135
    
    
    
    9,132
    
    
    
    9,140Diluted
    
    
    9,147
    
    
    
    9,127
    
    
    
    9,132
    
    
    
    9,140
    
    
    
    9,350
    
    
    
    9,274
    
    
    
    9,132
    
    
    
    9,140Selected operating data:Stores open at end of period
    
    
    430
    
    
    
    427
    
    
    
    414
    
    
    
    410
    
    
    
    437
    
    
    
    439
    
    
    
    441
    
    
    
    439
  (1)
    
    Includes a charge for long-lived asset impairments of $8,974,000 during
the fourth quarter of 2003 and a charge for long-lived asset impairments
of $5,870,000 during the fourth quarter of 2002.  (2)
    
    Includes a charge of $3,046,000 for the write-down of inventory to its
estimated net realizable value during the fourth quarter of 2003, related to the
158 stores that were closed in fiscal 2004. Liquidity and Capital Resources As a result of significant operating losses incurred in fiscal 2003, a
considerable and rapid reduction in available trade credit and the inability to
secure additional financing, the Company filed for bankruptcy protection under
Chapter 11 of the United States Bankruptcy Code in February 2004. Management
continues to operate the Company as debtor-in-possession. The cost to
terminate leases on stores identified for closure could be as much as $15.0
million, but the Company believes the ultimate liability could be much less
than that amount. Management believes it will be necessary to raise additional
capital to liquidate and/or restructure the Companys pre-petition obligations,
to satisfy the Companys lease termination liabilities arising from the
rejection of store leases and to adequately capitalize the business. The
Company has engaged an investment banker to assist it in determining and
satisfying its capital needs. At this time it is not possible to predict the
exact amount or nature of such new capital. In addition, there can be no
guarantee that additional capital will be available to the Company, or that
such capital will be available on terms favorable to the Company. Raising
additional capital could result in the significant dilution of current equity
interests, but it is not possible to predict the extent of such potential
dilution at this time. General.During the last three fiscal years, the Companys primary uses
of cash have been to finance new store openings, store remodels, and
information system enhancements and to purchase merchandise inventories. Cash Flows.During fiscal 2003, 2002 and 2001, cash flows from (used by)
operating activities were ($34.4) million, $14.9 million and $7.4 million,
respectively. Cash flow from operations before working capital changes
decreased to ($36.1) million in fiscal 2003 from $11.5 million in the prior
year primarily due to the decline in operating results discussed above. Working capital components provided $1.7 million in fiscal 2003. Cash
provided was primarily the result of lower average store inventory levels
($15.6 million) offset in part by a decrease in accounts payable ($12.0
million). Working capital components provided $3.4 million in fiscal 2002. Cash
provided was primarily the result of lower average store inventory levels ($7.5
million), offset in part by an increase in other assets ($4.5 million)
consisting primarily of prepaid monthly store rent, which is due to a timing
difference in rent payments. 24




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##### Table of Contents



Cash used in investing activities approximated $9.0 million, $9.7 million
and $14.0 million for fiscal 2003, 2002 and 2001,
respectively. The Company spent $9.1 million on capital expenditures during fiscal 2003,
the primary components of which were $2.1 million to open one new Gadzooks
store, open one new Orchid store, remodel three Gadzooks stores, refurbish 26
Gadzooks stores and purchase other assets for open stores, $6.7 million to
update the fixtures of all the Gadzooks stores to support the transition to an
all-female merchandise assortment and $337,000 used for corporate purposes,
such as the reconfiguration of the distribution center and computer hardware
replacements. The Company received $122,000 in net proceeds for disposed
assets related to the all-female transition. The Company spent $9.7 million on capital expenditures during fiscal 2002,
the primary components of which were $1.9 million to open 11 new stores and
remodel one Gadzooks store, $2.2 million to refurbish 91 existing Gadzooks
stores, $3.6 million to update the look of all the Gadzooks stores and $2.0
million to purchase and/or upgrade information systems and for other corporate
purposes. The Company opened one, 11 and 56 new Gadzooks stores in fiscal
2003, 2002 and 2001, respectively, and one and four new Orchid stores in fiscal
2003 and 2001, respectively. Net cash flow provided by financing activities totaled $24.4 million,
$679,000 and $1.2 million for fiscal 2003, 2002 and 2001, respectively.
Primary sources of financing in fiscal 2003 include a net line of credit
advance of $11.3 million and net proceeds from issuance of long-term debt of
$13.1 million. The Company received $460,000 from the exercise of employee
stock options in fiscal 2002. There were no employee stock options exercised
in fiscal 2003. The Company received $155,000 and $219,000 for sales of
treasury stock in fiscal 2003 and fiscal 2002, respectively, and purchased
$102,000 in treasury stock in fiscal 2003. As described more fully in Notes 7 and 8 to the consolidated financial
statements as of January 31, 2004 our contractual obligations were as follows: Payment Due by PeriodLess than
    
    1-3
    
    3-5
    
    More thanContractual Obligations
    
    Total
    
    1 year
    
    years
    
    years
    
    5 yearsCredit Agreement
    
    
    11,271,628
    
    
    
    11,271,628Long-term debt obligations
    
    
    14,000,000
    
    
    
    14,000,000Operating lease obligations
    
    
    139,642,393
    
    
    
    27,011,760
    
    
    
    48,241,858
    
    
    
    33,908,414
    
    
    
    30,480,361Purchase Obligations
    
    
    18,929,000
    
    
    
    18,929,000Total
    
    
    183,843,021
    
    
    
    71,212,388
    
    
    
    48,241,858
    
    
    
    33,908,414
    
    
    
    30,480,361
 Long-term Debt and Credit Agreement.On October 9, 2003, the Company
issued $14,000,000 of 5% Convertible Subordinated Notes (Notes) due October
9, 2008 with interest payable semi-annually commencing April 1, 2004. The
Notes, as well as unpaid accrued interest, are convertible at any time at the
option of the holder into common stock at a conversion price of $5.00 per
share. However, the investors are contractually prohibited from converting
Notes into shares of common stock without receiving prior shareholder approval
if such issuance of common stock would exceed 20 percent of the Companys
outstanding shares of common stock or result in the ownership by any one
shareholder of greater than 20 percent of the Companys outstanding shares of
common stock. The Company has recorded a beneficial conversion discount of
$1,372,000 as a credit to additional paid-in capital based on the difference
between the fair value and the conversion price (calculated as the intrinsic
value) as of October 9, 2003. The discount will be amortized over a three-year
period using the effective interest method. At the option of the Company, the
Notes, as well as unpaid accrued interest, may be converted into shares of
common stock at any time after April 9, 2005 if the closing price of the
Companys common stock is greater than $6.00 for 20 trading days during a 30
consecutive trading day period. At any time after October 9, 2006, the Company
has the right to prepay the Notes and the holders have the right to put the
Notes back to the Company at the face value of the Notes, plus unpaid accrued
interest. As of January 31, 2004, the Notes, and unpaid accrued interest, were
convertible into 2,842,778 shares of common stock with a fair value of
$2,842,778. As a result of the bankruptcy filing on February 3, 2004, all of
the Notes, as well as the unpaid accrued interest, became due and payable for a
total of $14,213,889. 25




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On April 11, 2003, the Company and Wells Fargo Retail Finance LLC (Wells
Fargo) entered into a three-year $30 million revolving credit agreement (the
Facility), which is secured by an exclusive and first priority, perfected
interest in all assets of
the Company. The credit agreement also provides for the issuance of
letters of credit that are used in connection with merchandise purchases.
Outstanding letters of credit issued by the bank reduce amounts otherwise
available for borrowing under the revolving line of credit. On October 31, 2003, the Company and Wells Fargo entered into an amendment
of the three-year $30 million revolving line of credit agreement. The
covenants imposed by the amendment require minimum levels of earnings before
interest, taxes, depreciation and amortization (EBITDA), minimum accounts
payable balances and a capital infusion of not less than $7.5 million. The
EBITDA and accounts payable balance covenants become effective only in the
event of a measurement event as defined by the amendment. At January 31, 2004,
the Company was in default under the Facility. As of January 31, 2004,
amounts available to borrow under the amended credit line are limited as
described above, by the outstanding line balance of $11.3 million and by
outstanding letters of credit of $10.7 million. The weighted average interest
rate for the year ended January 31, 2004 on these borrowings was 5.0 percent. Included in the foregoing amounts are significant pre-petition
obligations. Under the Bankruptcy Code, actions to collect pre-petition
indebtedness are stayed and other contractual obligations against Gadzooks may
not be enforced. Therefore, the commitments shown above may not reflect actual
cash outlays in the future period. On February 3, 2004, the Company and Wells Fargo entered into a one-year
$30 million debtor-in-possession loan and security agreement (the DIP
Facility), which is secured by a super-priority administrative expense claim
and a super-priority lien, on all assets of the Company. As a
pre-condition to obtaining the DIP financing, the Company paid in
full its existing credit facility of $11.3 million subsequent to
the bankruptcy filing. The Companys
borrowings under the agreement are limited to the lesser of 68% of eligible
inventory (as defined by the DIP Facility) or 85% of the appraised inventory
liquidation value of eligible inventory plus 85% of eligible credit card
accounts receivable less certain financial reserves specified by Wells Fargo.
As of May 1, 2004, amounts available to borrow under the DIP Facility, limited
as described above and by outstanding letters of credit of $3.0 million,
totaled $11.7 million. The DIP Facility also provides for the issuance of
letters of credit that are generally used in connection with merchandise
purchases and securing obligations of the Company. Outstanding letters of
credit issued by the bank reduce amounts otherwise available for borrowing
under the revolving line of credit. The DIP Facility subjects the Company to
certain weekly and monthly financial covenants. Covenants on sales and
disbursements are tested weekly on a cumulative basis. Inventory and gross
margin percentage covenants are tested monthly (non-cumulative), and covenants
on earnings before interest, taxes, depreciation and amortization are tested
monthly on a cumulative basis. Amounts borrowed under the revolving line will
bear interest at 1.00% above Wells Fargos prime rate, and amounts outstanding
under letters of credit will bear interest at 2.00%. The DIP Facility also
contains an unused line fee of 0.375%. The DIP Facility was amended (the First
DIP Amendment) on February 25, 2004 to allow the Company to include 75% of
federal income tax refunds receivable in the borrowing base in certain
situations and to modify the inventory advance rate. Pursuant to the First DIP
Amendment, the inventory component of the borrowing base calculation is now
calculated as the lesser of 75% of eligible inventory or 85% of the appraised
inventory liquidation value of eligible inventory. Employee Retention and Incentive Plan.The Company has received approval
from the U.S. Bankruptcy Court for an employee retention and incentive plan.
The plan is comprised of three primary components including a retention bonus,
a performance incentive and a severance program. Under the terms of the plan,
the retention bonus component would be due to eligible employees on the sooner
of the effective date of confirmation by the Court of a plan of reorganization
or plan of liquidation, sixty days after the Company or the employees business
unit is sold or the date of the employees termination without cause by the
Company. The maximum payout for the retention bonus component is an aggregate
of $1.1 million. The performance incentive component is payable to eligible
employees if the Company meets or exceeds certain financial milestones from the
Companys fiscal 2004 business plan for the following three periods, each to be
evaluated independently: February through April, May through August and
September through January. The target incentive payments will be made for each
period that the Companys actual performance in that period at least exceeds
the operating benchmark by the amount to be paid. The total target incentive
payout for fiscal 2004, if earned by all eligible employees for all periods,
would approximate $0.6 million. The plan also provides for potential additional
end-of-year incentive payments if the Company exceeds its annual financial
goals by specified amounts. The plan also includes a severance component
payable in the event of an eligible employees termination without cause on or
before the effective date of confirmation by the Court of a plan of
reorganization or plan of liquidation or sixty days after the Company or the
employees business unit is sold. The plan provides that any employee eligible
for a severance payment is also eligible for a retention payment. The
severance payout portion of the plan 26




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##### Table of Contents



will terminate upon the effective date of
a plan of reorganization or liquidation. The maximum payout for severance is an
aggregate $1.2 million. Factoring.We believe that the majority of our merchandise vendors either
enter into factoring arrangements whereby
factors purchase the vendors invoices, or enter into agreements with
factors to insure the payment of their invoices. This financing mechanism
allows Gadzooks vendors to receive payment in a shorter period of time.
Certain of these factors have modified the terms of agreements with some of
Gadzooks vendors and have accelerated the due dates for payments by us,
required us to provide standby letters of credit or refused to approve
shipments altogether. We believe that these factors may continue to materially
and adversely modify our payment terms until our results of operations improve.
Further material modifications by factors could materially adversely affect
our ability to obtain new inventory, meet our cash requirements and maintain
necessary liquidity going forward. Store Closings.During fiscal 2003, the Company closed 31 stores that had
been identified as under-performing. The total costs incurred as a result of
store closings and lease termination agreements totaled $3.4 million for fiscal
2003, of which $719,600 was still accrued at January 31, 2004. The Company has
already closed 158 stores in fiscal 2004 and is currently considering the
closure of approximately 15 to 20 additional under-performing stores. Closing
costs relating to the remaining stores will be accrued during fiscal 2004 when
incurred. No assurance can be given however, that the 15 to 20 stores will be
closed during fiscal 2004 or that additional stores will not be closed during
fiscal 2004. Capital Expenditures.The Company anticipates capital expenditures of
$250,000 to $450,000 in fiscal 2004 to update the fixtures of existing stores,
as needed, to support the merchandise assortment. During fiscal 2003, the
Company had capital expenditures of $9.1 million, of which $2.1 million was
used to open one new Gadzooks store, one new Orchid store, remodel three
Gadzooks stores, refurbish 26 Gadzooks stores and purchase other assets for
open stores. Additionally, $6.7 million was spent to update the fixtures of
all Gadzooks stores to support the transition to an all-female merchandise
assortment. The remaining $337,000 was used primarily for corporate purposes,
such as the reconfiguration of the distribution center and computer hardware
replacements. New Accounting Pronouncements In April 2003, the Financial Accounting Standards Board (FASB) issued
SFAS No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging
Activities (SFAS No. 149). This statement amends and clarifies the
accounting for derivative instruments and hedging activities under SFAS No.
133, Accounting for Derivative Instruments and Hedging Activities. We
adopted SFAS No. 149 effective January 31, 2004. There was no impact to the
Company upon the adoption of SFAS No. 149. In May 2003, the FASB issued SFAS No. 150, Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity
(SFAS No. 150). SFAS No. 150 requires certain financial instruments with
characteristics of both liabilities and equity to be classified as liabilities.
We adopted SFAS No. 150 effective January 31, 2004. We did not have any
financial instruments that were classified as equity prior to the adoption of
SFAS No. 150 that were required to be reclassified to liabilities. In December 2003, the Emerging Issues Task Force (EITF) issued EITF
Issue No. 03-10, Application of EITF Issue No. 02-16, Accounting by a
Customer (Including a Reseller) for Certain Consideration Received from a
Vendor, by Resellers to Sales Incentives Offered to Consumers by
Manufacturers (EITF 03-10). According to EITF 03-10, manufacturers coupons
that meet certain criteria should be recorded gross-basis as revenue, and are
not subject to the guidance in EITF 02-16. There was no impact to the Company
upon the adoption of EITF 03-10. In December 2003 the FASB issued SFAS No. 132 (revised 2003), Employers
Disclosures about Pensions and Other Postretirement Benefits (SFAS
No.132(R)). SFAS No. 132(R) revises the annual and interim disclosure
requirements about pension and other postretirement benefits. We have complied
with the new disclosure requirements that were effective for fiscal years
ending after December 15, 2003 in this Annual Report on Form 10-K. Additional
disclosure required for interim reporting and fiscal years beginning after June
15, 2004 will be disclosed when required. 27




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##### Table of Contents



Inflation The Company does not believe that inflation has had a material effect on
net sales or results of operations. The Company has generally been able to
pass on increased costs through increases in selling prices. Special Note Regarding Forward-Looking Statements Our disclosure and analysis in this Annual Report, including the preceding
Managements Discussion and Analysis of Financial Condition and Results of
Operations and information incorporated by reference, includes forward-looking
statements within the meaning of Section 27A of the Securities Act of 1933, as
amended, or the Securities Act, Section 21E of the Securities Exchange Act of
1934, as amended, or the Exchange Act, and the Private Securities Litigation
Reform Act of 1995, that are subject to risks and uncertainties.
Forward-looking statements give our current expectations and projections
relating to the financial condition, results of operations, plans, objectives,
future performance and business of Gadzooks. You can identify these statements
by the fact that they do not relate strictly to historical or current facts.
These statements may include words such as anticipate, estimate, expect,
project, intend, plan, predict, will, believe and other words and
terms of similar meaning in connection with any discussion of the timing or
nature of future operating or financial performance or other events. All
statements other than statements of historical facts included in, or
incorporated into, this report that address activities, events or developments
that we expect, believe or anticipate will or may occur in the future are
forward-looking statements and include, among other things, statements relating
to: General Factors  
    
    general economic conditions,
    
    weather conditions, including those which affect buying patterns of our customers,
    
    changes in consumer spending and our ability to
anticipate buying patterns and implement appropriate
inventory strategies,
    
    competitive pressures and other third party actions,
    
    ability to timely acquire desired goods and/or fulfill labor needs at planned costs,
    
    our ability to successfully implement business
strategies and otherwise execute planned changes in various
aspects of the business,
    
    regulatory and legal developments,
    
    our ability to attract, motivate and/or retain key executives and associates,
    
    our ability to attract and retain customers,
    
    other factors affecting business beyond our control, Bankruptcy Related Factors  
    
    our ability to continue as a going concern,
    
    our ability to operate pursuant to the terms of the DIP Facility,
    
    our ability to obtain Bankruptcy Court approval
with respect to motions in the Chapter 11 proceeding
prosecuted by it from time to time,
    
    our ability to develop, prosecute, confirm and
consummate a plan of reorganization with respect to the
Chapter 11 case,
    
    risks associated with third parties seeking and
obtaining court approval to terminate or shorten the
exclusivity period that we have to propose and confirm a plan
of reorganization, for the appointment of a Chapter 11
trustee or to convert the case to a Chapter 7 case,
    
    our ability to obtain and maintain normal terms with vendors, factors and service providers,
    
    our ability to maintain contracts that are critical to our operations,
    
    the potential adverse impact of the Chapter 11 case on our liquidity or results of operations, and
    
    our ability to fund and execute our business plan. Similarly, these and other factors, including the terms of any
reorganization plan ultimately confirmed, can affect the value of our various
pre-petition liabilities and common stock. No assurance can be given as to what
values, if any, will be ascribed in the bankruptcy proceedings to each of these
constituencies. A plan of reorganization could result in holders of Gadzooks
common stock receiving no value for their interests. Because of such
possibilities, the value of the common stock is highly 28




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##### Table of Contents



speculative.
Accordingly, we urge that appropriate caution be exercised with respect to
existing and future investments in any of
these liabilities and/or securities. These forward-looking statements are based on our expectations and beliefs
concerning future events affecting us and are subject to uncertainties and
factors relating to our operations and business environment, all of which are
difficult to predict and many of which are beyond our control. Although we
believe that the expectations reflected in our forward-looking statements are
reasonable, we do not know whether our expectations will prove correct. Any or
all of our forward-looking statements in this report may turn out to be wrong.
They can be affected by inaccurate assumptions we might make or by known or
unknown risks and uncertainties. Many factors mentioned in our discussion in
this report, including the risks outlined under Risk Factors will be
important in determining future results. Actual future results may vary
materially from those reflected in our forward-looking statements. Because of
these factors, we caution that investors should not place undue reliance on any
of our forward-looking statements. Further, any forward-looking statement
speaks only as of the date on which it is made, and except as required by law
we undertake no obligation to update any forward-looking statement to reflect
events or circumstances after the date on which it is made or to reflect the
occurrence of anticipated or unanticipated events or circumstances. 
 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. The Company does not engage in trading market risk sensitive instruments
and does not purchase as investments, as hedges, or for purposes other than
trading instruments that are likely to expose the Company to market risk,
whether it be from interest rate, foreign currency exchange, commodity price or
equity price risk. The Company has issued no debt instruments, entered into no
forward or futures contracts, purchased no options and entered into no swaps. The Companys primary market risk exposure is that of interest rate risk.
A change in LIBOR or the Prime Rate as set by Wells Fargo would affect the rate
at which the Company could borrow funds under its DIP Facility. 29




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##### Table of Contents



ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. Gadzooks, Inc.
Index to Consolidated Financial Statements PageAudited Consolidated Financial Statements:Report of Independent Auditors
    
    31Consolidated Balance Sheets at January 31, 2004 and February 1, 2003
    
    32Consolidated Statements of Operations for the Years Ended
January 31, 2004, February 1, 2003 and February 2, 2002
    
    33Consolidated Statements of Shareholders Equity for the Years Ended
January 31, 2004, February 1, 2003 and February 2, 2002
    
    34Consolidated Statements of Cash Flows for the Years Ended
January 31, 2004, February 1, 2003 and February 2, 2002
    
    35Notes to Consolidated Financial Statements
    
    36 - 48
 30




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##### Table of Contents



Report of Independent Auditors To the Board of Directors and Shareholders of Gadzooks, Inc. In our opinion, the accompanying consolidated balance sheets and the
related consolidated statements of operations, of shareholders equity and of
cash flows present fairly, in all material respects, the financial position of
Gadzooks, Inc. and its subsidiaries at January 31, 2004 and February 1, 2003,
and the results of their operations and their cash flows for each of the three
years in the period ended January 31, 2004 in conformity with accounting
principles generally accepted in the United States of America. 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 of these statements in accordance with
auditing standards generally accepted in the United States of America, which
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, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion. The accompanying consolidated financial statements have been prepared
assuming that the Company will continue as a going concern. As discussed in
Note 1 to the consolidated financial statements, on February 3, 2004, the
Company voluntarily filed for protection under Chapter 11 of the United States
Bankruptcy Code, which raises substantial doubt about the Companys ability to
continue as a going concern. Managements intentions with respect to this
matter are also described in Note 1. The accompanying consolidated financial
statements do not include any adjustments that might result from the outcome of
this uncertainty. /s/ PricewaterhouseCoopers, LLP 
 Dallas, Texas
May 5, 2004 31




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Gadzooks, Inc. 
 Consolidated Balance Sheets
 Fiscal Year EndedJanuary 31,
    
    February 1,2004
    
    2003AssetsCurrent assets:Cash and cash equivalents
    
    $
    1,831,678
    
    
    $
    20,769,129Accounts receivable
    
    
    1,206,732
    
    
    
    1,321,012Income tax receivable
    
    
    5,343,086
    
    
    
    Inventory
    
    
    40,627,194
    
    
    
    56,191,529Other current assets
    
    
    1,517,155
    
    
    
    7,136,81850,525,845
    
    
    
    85,418,488Leaseholds, fixtures and equipment, net
    
    
    24,903,651
    
    
    
    34,823,910Deferred tax assets
    
    
    
    
    
    
    4,884,784Debt issue costs
    
    
    790,262
    
    
    
    25,693,913
    
    
    
    39,708,694$
    76,219,758
    
    
    $
    125,127,182Liabilities and Shareholders EquityCurrent liabilities:Line of credit
    
    $
    11,271,628
    
    
    $
    Accounts payable
    
    
    14,958,145
    
    
    
    26,952,651Accrued payroll and benefits
    
    
    2,807,558
    
    
    
    4,117,311Other current liabilities
    
    
    4,740,681
    
    
    
    3,498,424Income taxes payable
    
    
    
    
    
    
    77,274Convertible subordinated notes
    
    
    12,751,971
    
    
    
    46,529,983
    
    
    
    34,645,660Accrued rent
    
    
    3,884,290
    
    
    
    4,124,012Commitments and contingencies (Notes 1 and 8)Shareholders equity:Preferred stock, $1.00 par value, 1,000,000 shares authorized, none
issued
    
    
    
    
    
    
    Common stock, $.01 par value, 25,000,000 shares authorized, 9,159,671
and 9,159,671 shares issued and 9,147,024 and 9,144,758
shares outstanding, respectively
    
    
    91,597
    
    
    
    91,597Additional paid-in capital
    
    
    46,272,413
    
    
    
    44,942,081Retained earnings (deficit)
    
    
    (20,527,033
    )
    
    
    41,450,347Treasury stock, at cost, 12,647 and 14,913 shares, respectively
    
    
    (31,492
    )
    
    
    (126,515
    )25,805,485
    
    
    
    86,357,510$
    76,219,758
    
    
    $
    125,127,182
 The accompanying notes are an integral part of these consolidated financial statements. 32




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##### Table of Contents



Gadzooks, Inc. 
 Consolidated Statements of Operations
 Fiscal Year EndedJanuary 31,
    
    February 1,
    
    February 2,2004
    
    2003
    
    2002Net sales
    
    $
    258,505,934
    
    
    $
    325,520,820
    
    
    $
    313,822,954Costs and expenses:Cost of goods sold, including buying,
distribution and
occupancy costs
    
    
    227,849,465
    
    
    
    244,320,456
    
    
    
    234,054,103Selling, general and administrative expenses
    
    
    81,687,527
    
    
    
    77,337,503
    
    
    
    69,758,047Long-lived asset impairments
    
    
    8,974,086
    
    
    
    5,869,901
    
    
    
    563,081318,511,078
    
    
    
    327,527,860
    
    
    
    304,375,231Operating income (loss)
    
    
    (60,005,144
    )
    
    
    (2,007,040
    )
    
    
    9,447,723Interest expense
    
    
    903,654
    
    
    
    75,864
    
    
    
    138,201Interest income
    
    
    75,670
    
    
    
    149,586
    
    
    
    432,603Income (loss) before income taxes
    
    
    (60,833,128
    )
    
    
    (1,933,318
    )
    
    
    9,742,125Provision (benefit) for income taxes
    
    
    1,144,252
    
    
    
    (675,756
    )
    
    
    3,733,434Net income (loss)
    
    $
    (61,977,380
    )
    
    $
    (1,257,562
    )
    
    $
    6,008,691Net income (loss) per shareBasic
    
    $
    (6.78
    )
    
    $
    (0.14
    )
    
    $
    0.66Diluted
    
    $
    (6.78
    )
    
    $
    (0.14
    )
    
    $
    0.65Average shares outstandingBasic
    
    
    9,136,355
    
    
    
    9,125,627
    
    
    
    9,039,912Diluted
    
    
    9,136,355
    
    
    
    9,125,627
    
    
    
    9,303,926
 The accompanying notes are an integral part of these consolidated financial statements. 33




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##### Table of Contents



Gadzooks, Inc. 
 Consolidated Statements of Shareholders Equity
 Common Stock
    
    AdditionalPaid in
    
    RetainedEarnings
    
    Treasury StockShares
    
    Capital
    
    Capital
    
    (Deficit)
    
    Shares
    
    Capital
    
    TotalBalance, February 3, 2001
    
    
    8,969,825
    
    
    $
    89,698
    
    
    $
    43,042,615
    
    
    $
    36,699,218
    
    
    
    52,797
    
    
    $
    (443,588
    )
    
    $
    79,387,943Stock issued under option
plans
    
    
    147,412
    
    
    
    1,474
    
    
    
    966,255
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    967,729Sale of treasury stock
    
    
    
    
    
    
    
    
    
    
    95,156
    
    
    
    
    
    
    
    (13,734
    )
    
    
    112,311
    
    
    
    207,467Tax benefit from exercise
of stock options
    
    
    
    
    
    
    
    
    
    
    280,912
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    280,912Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    6,008,691
    
    
    
    
    
    
    
    
    
    
    
    6,008,691Balance, February 2, 2002
    
    
    9,117,237
    
    
    
    91,172
    
    
    
    44,384,938
    
    
    
    42,707,909
    
    
    
    39,063
    
    
    
    (331,277
    )
    
    
    86,852,742Stock issued under option
plans
    
    
    42,434
    
    
    
    425
    
    
    
    459,646
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    460,071Sale of treasury stock
    
    
    
    
    
    
    
    
    
    
    14,543
    
    
    
    
    
    
    
    (24,150
    )
    
    
    204,762
    
    
    
    219,305Tax benefit from exercise
of stock options
    
    
    
    
    
    
    
    
    
    
    82,954
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    82,954Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,257,562
    )
    
    
    
    
    
    
    
    
    
    
    (1,257,562
    )Balance, February 1, 2003
    
    
    9,159,671
    
    
    
    91,597
    
    
    
    44,942,081
    
    
    
    41,450,347
    
    
    
    14,913
    
    
    
    (126,515
    )
    
    
    86,357,510Purchase of treasury stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    40,800
    
    
    
    (101,596
    )
    
    
    (101,596
    )Sale of treasury stock
    
    
    
    
    
    
    
    
    
    
    (41,668
    )
    
    
    
    
    
    
    (43,066
    )
    
    
    196,619
    
    
    
    154,951Convertible subordinated
note beneficial
conversion discount
    
    
    
    
    
    
    
    
    
    
    1,372,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,372,000Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (61,977,380
    )
    
    
    
    
    
    
    
    
    
    
    (61,977,380
    )Balance, January 31, 2004
    
    
    9,159,671
    
    
    $
    91,597
    
    
    $
    46,272,413
    
    
    $
    (20,527,033
    )
    
    
    12,647
    
    
    $
    (31,492
    )
    
    $
    25,805,485
 The accompanying notes are an integral part of these consolidated financial statements. 34




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##### Table of Contents



Gadzooks, Inc. 
 Consolidated Statements of Cash Flows
 Fiscal Year EndedJanuary 31,
    
    February 1,
    
    February 2,2004
    
    2003
    
    2002Cash flows from operating activities:Net income (loss)
    
    $
    (61,977,380
    )
    
    $
    (1,257,562
    )
    
    $
    6,008,691Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:Impairment of long-lived assets
    
    
    8,974,086
    
    
    
    5,869,901
    
    
    
    563,081Loss on disposal of assets
    
    
    59,832
    
    
    
    545,134
    
    
    
    140,319Depreciation and amortization
    
    
    10,098,762
    
    
    
    9,458,252
    
    
    
    8,344,301Deferred income taxes
    
    
    6,771,033
    
    
    
    (3,080,593
    )
    
    
    (1,220,830
    )Changes in operating assets and liabilities:Accounts receivable
    
    
    114,280
    
    
    
    361,100
    
    
    
    1,443,883Income tax receivable/payable
    
    
    (5,420,360
    )
    
    
    (1,573,001
    )
    
    
    (1,526,689
    )Inventory
    
    
    15,564,335
    
    
    
    7,467,977
    
    
    
    (7,718,038
    )Other assets
    
    
    3,733,412
    
    
    
    (4,479,729
    )
    
    
    175,513Accounts payable
    
    
    (11,994,506
    )
    
    
    (138,899
    )
    
    
    1,858,127Accrued payroll and benefits
    
    
    (1,309,753
    )
    
    
    1,322,383
    
    
    
    (1,446,931
    )Other liabilities
    
    
    1,002,536
    
    
    
    414,323
    
    
    
    818,493Net cash provided by (used in) operating activities
    
    
    (34,383,723
    )
    
    
    14,909,286
    
    
    
    7,439,920Cash flows from investing activities:Capital expenditures
    
    
    (9,123,574
    )
    
    
    (9,687,906
    )
    
    
    (14,274,965
    )Purchase of short-term investments
    
    
    
    
    
    
    (5,957,176
    )
    
    
    Proceeds from redemption of short-term investments
    
    
    
    
    
    
    5,957,176
    
    
    
    Proceeds from the sale of leaseholds,
fixtures and equipment
    
    
    121,882
    
    
    
    
    
    
    
    243,854Net cash used in investing activities
    
    
    (9,001,692
    )
    
    
    (9,687,906
    )
    
    
    (14,031,111
    )Cash flows from financing activities:Proceeds from line of credit
    
    
    124,871,208
    
    
    
    
    
    
    
    Repayment of line of credit
    
    
    (113,599,580
    )
    
    
    
    
    
    
    Proceeds from issuance of convertible
subordinated debt
    
    
    14,000,000
    
    
    
    
    
    
    
    Debt issue costs
    
    
    (877,019
    )
    
    
    
    
    
    
    Issuance of common stock under options plans
    
    
    
    
    
    
    460,071
    
    
    
    967,729Purchase of treasury stock
    
    
    (101,596
    )
    
    
    
    
    
    
    Sale of treasury stock under employee benefit plans
    
    
    154,951
    
    
    
    219,305
    
    
    
    207,467Net cash provided by financing activities
    
    
    24,447,964
    
    
    
    679,376
    
    
    
    1,175,196Net increase (decrease) in cash and cash equivalents
    
    
    (18,937,451
    )
    
    
    5,900,756
    
    
    
    (5,415,995
    )Cash and cash equivalents at beginning of year
    
    
    20,769,129
    
    
    
    14,868,373
    
    
    
    20,284,368Cash and cash equivalents at end of year
    
    $
    1,831,678
    
    
    $
    20,769,129
    
    
    $
    14,868,373Cash paid (received) during the year for:Interest
    
    $
    455,842
    
    
    $
    115,671
    
    
    $
    135,257Income taxes
    
    
    (535,785
    )
    
    
    4,306,230
    
    
    
    6,482,779
 The accompanying notes are an integral part of these consolidated financial statements. 35




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##### Table of Contents



Gadzooks, Inc. 
 Notes to Consolidated Financial Statements
  1.
    
    Organization and Nature of the Company Gadzooks, Inc. (Gadzooks or the Company) is a mall-based, specialty
retailer of casual apparel and related accessories for young women principally
between the ages of 16 and 22. In the second half of fiscal 2001, the Company
began testing a new retail concept with the opening of four Orchid stores. The
Orchid concept catered to the innerwear and sleepwear needs of females between
the ages of 14 and 22. At January 31, 2004, the Company had 410 company-owned
stores in metropolitan and middle markets in 41 states, of which 406 were
Gadzooks stores and four were Orchid stores. During the first quarter of
fiscal 2004, the Company closed 158 stores. As of May 1, 2004, the Company
operated 252 stores. The Companys fiscal year ends on the Saturday nearest January 31. All
references in these financial statements to fiscal years are to the calendar
year in which the fiscal year begins. Fiscal years 2003, 2002 and 2001
represent the 52-week periods ended January 31, 2004, February 1, 2003 and
February 2, 2002, respectively. Subsequent Event  Voluntary Bankruptcy Filing On February 3, 2004, Gadzooks, Inc. (the Debtor) filed a voluntary
petition for reorganization (the Filing) under Chapter 11 of the United
States Bankruptcy Code (Chapter 11) in the United States Bankruptcy Court for
the Northern District of Dallas (the Court) and was assigned case number
04-31486-hdh11. As a debtor-in-possession, the Company is authorized to
continue operating as an ongoing business, but may not engage in transactions
outside the ordinary course of business without the approval of the Court,
after notice and an opportunity for a hearing. At first day hearings held on February 3 and 4, 2004, the Court entered
orders granting authority to the Company to, among other things, pay
pre-petition and post-petition employee wages, salaries, benefits and other
employee obligations, to pay vendors and other providers in the ordinary course
for goods and services received from January 24, 2004, and to honor customer
service programs, including returns, store credits and gift cards. On February
3, 2004, the Court also gave interim approval for a debtor-in-possession
revolving credit facility referred to as the DIP Facility with Wells Fargo
Retail Finance, LLC in the aggregate amount of $30 million for the payment of
permitted pre-petition claims, working capital needs, letters of credit and
other general corporate purposes. On February 25, 2004, the Court gave final
approval on the DIP Facility underwritten by Wells Fargo Retail Finance, LLC.
A description of the DIP Facility appears in Note 7. Background of Filing  In January 2003, the Company announced its decision
to convert the Gadzooks stores to an all-female merchandise assortment early in
the second half of fiscal 2003. The Company anticipated an operating loss
during the transition phase in fiscal 2003, with expectations of returning to
profitability in fiscal 2004. However, as a result of a rapid decline in
liquidity resulting from below-plan sales and earnings performance in the
second half of fiscal 2003, an erosion of supplier confidence, intense
competition and unsuccessful sales and marketing initiatives, the Company filed
a voluntary petition for reorganization under Chapter 11 of the Bankruptcy Code
in the Bankruptcy Court, on February 3, 2004. Under Chapter 11, the Company
expects to continue to operate its business as debtor-in-possession under court
protection from its creditors and claimants, while using the Chapter 11 process
to complete the reorganization of its core business around approximately 250
stores that were chosen to strengthen its market share in the junior apparel
business. Consequence of Filing  As a consequence of the Chapter 11 filing, all
pending claims against the Company are stayed and no party may take any action
to realize its pre-petition claims except pursuant to an order of the
Bankruptcy Court. It is the Companys intention to address all of its
pre-petition claims in a plan of reorganization to be voted upon by creditors
and equity holders and approved by the Court. Restructuring Activities  Since filing for bankruptcy protection,
management has been actively engaged in restructuring the Companys operations.
With the assistance of an independent consulting firm specializing in
restructuring operations, management analyzed all of the Companys stores based
on a number of factors including, but not limited to, historical sales results,
expected future sales results, occupancy cost, and mix of juniors versus mens
business to identify the optimal set of stores to retain and operate.
Management continues to evaluate the operating results of all the Companys
stores. The cost to terminate leases on stores identified for closure could be
as much as $15.0 million, but the Company believes the ultimate liability could
be much less than that amount. The Company is currently operating
approximately 250 stores, but there can be no guarantee that additional stores
will not be closed, or that stores already closed will not be reopened with an
improved 36




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##### Table of Contents



occupancy structure. Management retained an independent real estate
consulting firm to assist the Company in achieving the most cost effective
strategy for exiting stores targeted for closure. The real estate consultant
has also assisted management in its efforts to negotiate reduced rents for
certain properties. Those real estate initiatives are ongoing. Management also
thoroughly evaluated its merchandising activities in an effort to improve the
Companys sales, merchandise margin and inventory turnover metrics. Under the
supervision of a new President and Chief Merchandising Officer (assumed the
position in February 2004), the Companys merchandising group has implemented a
number of new strategies including, but not limited to, the following:  
    
    an increased emphasis on establishing leadership positions in the mall in certain product categories,
    
    the accelerated identification and liquidation of slow-moving items,
    
    an increased emphasis on popular brands,
    
    more appropriate utilization of the Companys private brands,
    
    an increased emphasis on offering products that customers are inclined to purchase for immediate use (buy now, wear now),
    
    the maintenance of more appropriate inventory mix metrics (e.g., tops to bottoms ratio),
    
    maintaining lower inventory levels to promote faster inventory turns and a more desirable shopping experience in the stores and
    
    providing for more frequent changes to store visuals and merchandise presentations. Management has also significantly reduced the Companys fixed cost
structure primarily by eliminating approximately 65 field management and
corporate positions in fiscal 2004 and, accordingly, the Company will recognize
any severance related expenses in fiscal 2004. Management expects that the
cost reductions the Company has implemented will result in significant
annualized expense savings. Management believes it will be necessary to raise
additional capital to liquidate and/or restructure the Companys pre-petition
obligations, to satisfy the Companys lease termination liabilities arising
from the rejection of store leases and to adequately capitalize the business.
The Company has engaged an investment banker to assist it in determining and
satisfying its capital needs. At this time it is not possible to predict the
exact amount or nature of such new capital. In addition, there can be no
guarantee that additional capital will be available to the Company, or that
such capital will be available on terms favorable to the Company. Raising
additional capital could result in the significant dilution of current equity
interests, but it is not possible to predict the extent of such potential
dilution at this time. Generally, under the provisions of the Bankruptcy Code, holders of equity
interests may not participate under a plan of reorganization unless the claims
of creditors are satisfied in full under the plan or unless creditors accept a
reorganization plan that permits holders of equity interests to participate.
Although the Company expects to file a reorganization plan that provides for
emergence from bankruptcy in the second half of 2004, there can be no assurance
that a reorganization plan will be proposed by the Company or confirmed by the
Court, or that any such plan will be consummated. As such, it is currently
impossible to predict with any degree of certainty how the plan will treat
pre-petition claims and the impact the Chapter 11 filing and any reorganization
plan may have on shares of common stock of Gadzooks. The accompanying Consolidated Financial Statements have been prepared on a
going concern basis, which contemplates continuity of operations, realization
of assets and liquidation of liabilities in the ordinary course of business.
The filing of Chapter 11 raises substantial doubt about the Companys ability
to continue as a going concern. Further, a plan of reorganization could
materially change the amounts and classifications reported in the consolidated
financial statements, which do not give effect to any adjustments to the
carrying value or the classification of assets or liabilities that might be
necessary as a consequence of a plan of reorganization. All of the Companys pre-petition debt is now in default due to the
Chapter 11 filing. Accordingly, the accompanying Consolidated Balance Sheet as
of January 31, 2004 reflects the classification of the Companys pre-petition
debt as current. Accounting Impact  Beginning in the first quarter of fiscal 2004, the
Company will be required to follow Statement of Position 90-7 (SOP 90-7),
Financial Reporting by Entities in Reorganization under the Bankruptcy Code.
Pursuant to SOP 90-7, the Companys pre-petition liabilities that are subject
to compromise will be reported separately on the balance sheet at an estimate
of the amount that will ultimately be allowed by the Bankruptcy Court. SOP
90-7 also requires separate reporting of certain expenses, realized gains and
losses, and provisions for losses related to the Chapter 11 filing as
reorganization items. In January 2004, the Company entered into an agreement with a consulting
firm to help with the complete liquidation of its inventory in 37
under-performing stores. All amounts paid or payable to the firm pursuant to
the contract are contingent upon the firms ability to meet certain minimum
levels of sales performance. During the fourth quarter of fiscal 2003, the
Company recognized approximately $133,000 owed to the firm (or paid to the
firm) based on sales through year-end as selling, general 37




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##### Table of Contents



and administrative expense pursuant to the contract. In addition, during
the fourth quarter of fiscal 2003, the Company recognized $546,000 in cost of
sales in order to write-down inventory to its estimated net realizable value at
the applicable stores that had not been liquidated as of year-end. Six of
these stores were closed during fiscal 2003 and the remaining stores were
closed during the first quarter of fiscal 2004. During the first quarter of
fiscal 2004, the Company performed one of the following on all of the store
closures: 1) exercised early termination provision of the lease, 2) closed the
store due to a lease expiration or 3) rejected the lease. In February 2004, the Company entered into an agreement with a consulting
firm to help with the complete liquidation of its inventory in 127
under-performing stores. Under the terms of the agreement, the Company was
guaranteed a certain percentage of the aggregate retail price of the
merchandise as determined by the contract and was reimbursed for store level
operating expenses of the respective stores for the term of the liquidation. A
total of $2.5 million was recorded as cost of goods sold through a write-down
of the respective inventory to its estimated realizable value during the fourth
quarter of fiscal 2003, pursuant to this agreement. All of these stores were
closed during the first quarter of fiscal 2004. The Company and liquidation
firm are negotiating the final settlements and amounts owed pursuant to the
contract. During the first quarter of fiscal 2004, the Company performed one
of the following on all but three of the store closures: 1) exercised early
termination provision of the lease, 2) closed the store due to a lease
expiration or 3) rejected the lease.  2.
    
    Summary of Significant Accounting Policies Principles of Consolidation. In June 2000, the Company completed a
corporate restructuring. The consolidated financial statements include the
accounts of Gadzooks, Inc. and its wholly owned affiliates, Gadzooks Holding
Company and Gadzooks Management, L.P. All significant inter-company accounts
and transactions have been eliminated in consolidation. Effective December 31,
2002, the Company again restructured, whereby Gadzooks Management, L.P. and
Gadzooks Holding Company were merged into Gadzooks, Inc. Use of Estimates.The preparation of the financial statements in
conformity with accounting principles generally accepted in the United States
of America requires management to make certain estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at January 31, 2004, and February 1, 2003 and
the reported amounts of revenues and expenses during each of the three years in
the period ended January 31, 2004. On an ongoing basis, management evaluates
such estimates including sales return rates, inventory reserves, impairment of
long-lived assets, income taxes and accrued expenses. The Company bases its
estimates on historical experience and on various other assumptions that the
Company believes to be reasonable under the circumstances, the results of which
form the basis for making judgments about the carrying value of assets and
liabilities that are not readily apparent from other sources. The
self-insurance reserves for medical and workers compensation claims are
recorded based on historical claim levels adjusted for growth in the employee
base. If the historical claims used to calculate these estimates are not
reflective of actual results, additional expenses may be incurred up to the
point that the Companys stop loss insurance begins. The Company is
self-insured for property and casualty claims at the store level. Property and
casualty claims at the store level are estimated and recognized as incurred.
Actual results could differ from these estimates. Cash and Cash Equivalents.Cash and cash equivalents include cash on hand
and marketable securities with original maturities of three months or less. Inventory.Inventory is valued at the lower of average cost or market.
Cost is determined using the weighted-average method. Markdown allowances
received from vendors are recorded as a reduction of inventory cost and
therefore as a reduction of cost of goods sold in the period in which the
related merchandise is sold. In addition, inventories include an allocation of
buying and distribution costs to prepare product for the stores less an
estimate for shrink, which is based on historical shrink rates and adjusted to
actual levels based on physical inventory results. Leaseholds, Fixtures and Equipment.Leaseholds, fixtures and equipment
are stated at cost. Depreciation of fixtures and equipment is based upon the
estimated useful lives of the assets, generally from five to ten years,
computed on the straight-line method. Amortization of leasehold improvements
is computed on the straight-line method over estimated useful lives or lease
terms, if shorter. The Company reviews its long-lived assets for impairment
whenever events or changes in circumstances indicate the respective net
carrying amounts may not be recoverable. An impairment loss is recognized if
the sum of the expected future cash flows (undiscounted and before interest)
from the use of the assets is less than the net book value of the assets. The
amount of the impairment loss is measured as the difference between the net
book value of the assets and the estimated fair value of the related assets.
Fair value is determined using a traditional present value method, which
requires 38




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estimated future cash flows to be discounted using an interest rate
commensurate with the associated risk. Impairment review of long-lived assets
is performed at the store level. Accrued Expenses.On a monthly basis, certain expenses are estimated in
an effort to reflect these expenses in the proper period. Gadzooks most
material estimates relate to self-insurance reserves, store level operating
expenses and bonuses. The self-insurance reserves for medical and workers
compensation claims are recorded based on historical claim levels adjusted for
changes in the employee base. If the historical claims used to calculate these
estimates are not reflective of actual results, additional expenses may be
incurred up to the point that the Companys stop loss insurance begins. The
Company is self-insured for property claims at the store level. Property
claims at the store level are estimated and recognized as incurred. Accrued
store level operating expenses are estimated based on current activity and
historical results. Bonuses are based on performance and projected performance
for the remainder of the bonus period. If actual results are significantly
different from Gadzooks expectations, an adjustment to expenses may be
required. Revenue Recognition.Retail merchandise sales are recognized at the point
of sale less sales returns and employee discounts. Management records a
provision for estimated sales returns based on historical return rates. If
sales return rates increase, an additional allowance may be required. Advertising.Advertising costs are expensed when incurred. Advertising
costs were $3,913,678, $2,063,563 and $1,270,772 for fiscal years 2003, 2002
and 2001, respectively. Store
Closures.Reserves for store closures, related to leases without
early termination provisions, represent calculations of the present
value of the remaining lease obligation, reduced by estimated
sub-tenant income, plus other estimated contractual obligations as
stated in the lease. For leases with early termination provisions,
the liability for costs to terminate a lease before the end of its
term is recognized when the Company terminates the lease in
accordance with the contract terms. Expenses associated with the
establishment of these reserves are reflected in general and
administrative expense. Operating expenses reflect the future lease
obligation or lease termination payments, less any remaining accrual
for straight-line average rent. Store fixtures are transferred at
historical cost to other store locations, written off or written down
to their net realizable value and sold. Store Pre-Opening Costs.Costs incurred with the setup of a new store
prior to its opening for business are expensed as incurred. Income Taxes.Deferred income taxes are provided on the liability method.
Under this method, deferred tax assets and liabilities are recognized based on
differences between the financial statement and the tax basis of assets and
liabilities using presently enacted tax rates. The Company reviews its deferred
tax assets for ultimate realization and will record a valuation allowance to
reduce the deferred tax asset if it is more likely than not that some portion,
or all, of these deferred tax assets will not be realized. Earnings (Loss) per Share.Basic earnings (loss) per share are computed
by dividing net income (loss) by the weighted average number of shares
outstanding during each period. Diluted earnings (loss) per share are computed
by dividing net income (loss) by the weighted average number of shares
outstanding during each period after giving effect to dilutive potential common
shares resulting from outstanding stock options as well as from common shares
that would result from the conversion of the convertible notes. Fair Value of Financial Instruments.Cash and cash equivalents, accounts
receivable, trade accounts payable, credit facility and accrued liabilities are
reflected in our financial statements at cost, which approximates fair value
due to the short maturity of these instruments. The fair value of our
convertible subordinated notes is discussed in Note 7  Convertible
Subordinated Notes and Credit Agreement. Stock Option Plans.The Company has adopted the disclosure-only
provisions of Statement of Financial Accounting Standards (SFAS) No. 123,
Accounting for Stock-Based Compensation. In accordance with the provisions of
SFAS 123, the Company applies Accounting Principles Board (APB) Opinion No.
25, Accounting for Stock Issued to Employees, and related interpretations in
accounting for the plans and, accordingly, does not recognize compensation
expense for stock option plans because the Company issues options at exercise
prices equal to the market value at date of grant. 39




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The following table shows Gadzooks net income (loss) for the years ended
January 31, 2004, February 1, 2003, and February 2, 2002 had compensation
expense for Gadzooks stock option plans applicable to the Companys employees
been determined based upon the fair value at the grant date for awards
consistent with the methodology prescribed by SFAS 123 (these pro forma effects
may not be representative of expense in future periods since the estimated fair
value of stock options on the date of grant is amortized to expense over the
vesting period, and additional options may be granted or cancelled in future
years): Fiscal2003
    
    2002
    
    2001Pro forma net income (loss):Reported net income (loss)
    
    $
    (61,977,380
    )
    
    $
    (1,257,562
    )
    
    $
    6,008,691Less: Total stock-based
employee compensation
expense determined under
fair value based methods
for all awards, net of
related tax effects
    
    
    (1,983,441
    )
    
    
    (1,917,963
    )
    
    
    (2,617,644
    )Pro forma net income (loss)
    
    $
    (63,960,821
    )
    
    $
    (3,175,525
    )
    
    $
    3,391,047Net income (loss) per share:Basic
    
    $
    (6.78
    )
    
    $
    (0.14
    )
    
    $
    0.66Basic  pro forma
    
    $
    (7.00
    )
    
    $
    (0.35
    )
    
    $
    0.38Diluted
    
    $
    (6.78
    )
    
    $
    (0.14
    )
    
    $
    0.65Diluted  pro forma
    
    $
    (7.00
    )
    
    $
    (0.35
    )
    
    $
    0.36
 New Accounting Pronouncements.In April 2003, the Financial Accounting
Standards Board (FASB) issued SFAS No. 149, Amendment of Statement 133 on
Derivative Instruments and Hedging Activities (SFAS No. 149). This
statement amends and clarifies the accounting for derivative instruments and
hedging activities under SFAS No. 133, Accounting for Derivative Instruments
and Hedging Activities. We adopted SFAS No. 149 effective January 31, 2004.
There was no impact to the Company upon the adoption of SFAS No. 149. In May 2003, the FASB issued SFAS No. 150, Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity
(SFAS No. 150). SFAS No. 150 requires certain financial instruments with
characteristics of both liabilities and equity to be classified as liabilities.
We adopted SFAS No. 150 effective January 31, 2004. We did not have any
financial instruments that were classified as equity prior to the adoption of
SFAS No. 150 that were required to be reclassified to liabilities. In December 2003, the Emerging Issues Task Force (EITF) issued EITF
Issue No. 03-10, Application of EITF Issue No. 02-16, Accounting by a
Customer (Including a Reseller) for Certain Consideration Received from a
Vendor, by Resellers to Sales Incentives Offered to Consumers by
Manufacturers (EITF 03-10). According to EITF 03-10, manufacturers coupons
that meet certain criteria should be recorded on a gross-basis as revenue, and
are not subject to the guidance in EITF 02-16. There was no impact to the
Company upon the adoption of EITF 03-10. In December 2003 the FASB issued SFAS No. 132 (revised 2003), Employers
Disclosures about Pensions and Other Postretirement Benefits (SFAS No.
132(R)). SFAS No. 132(R) revises the annual and interim disclosure
requirements about pension and other postretirement benefits. There was no
impact to the Company upon the adoption of SFAS No. 132.  3.
    
    Impairment of Long-lived Assets In accordance with SFAS No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets, which requires that long-lived assets held
and used or to be disposed of by an entity be reviewed for impairment
whenever events or circumstances indicate that the net book value of the
asset may not be recoverable. The Company has experienced significant
operating losses and continuing same store sales declines since the
conversion to an all-female concept. As discussed in Note 1, the Company
also filed for bankruptcy in fiscal 2004 and as a result, liquidated and
closed 158 stores in the first quarter of fiscal 2004. Consequently, the
Company performed an impairment analysis on all of its stores during fiscal
2003 and recorded a non-cash impairment charge of $8,974,000 to reflect
fixtures and leasehold improvements at their respective estimated fair value. 40




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During fiscal 2002, the Company recorded a non-cash impairment charge of
$5,870,000 to reflect fixtures and leasehold improvements at their respective
estimated fair value in a total of 71 under-performing stores. If management determines that it is unlikely that a store with negative
cash flows will increase its sales volume to a level that would allow the
store to generate positive cash flow, management will consider remedial
actions up to and including closing the store. If management initiates the
closing of a store or stores, the Company will recognize a provision for
store closing costs during the quarter in which the liability is incurred. During the second quarter of 2002, the Company abandoned its point of sale
software implementation project after learning that the software provider would
offer a new point of sale software product in 2003 and would discontinue sales
of the current software. As a result of the abandonment of the project,
certain costs related to the original project were written off. The total
impact of the write-off was a $310,000 loss on disposal during the second
quarter of fiscal 2002. In the first quarter of fiscal 2002, the Company hired a consulting firm
to review the current store base and provide recommendations on ways to update
the look of more mature stores and enhance visual merchandising in all stores.
The store update and visual enhancement program developed in conjunction with
the consulting firm was finalized during the second quarter and was implemented
primarily during the second and third quarters of 2002 in an attempt to
increase the visual appeal, flow and shopability of all stores. The program
includes the removal of certain leasehold improvements and fixtures prior to
the end of their estimated useful life. As a result, the Company recognized
accelerated depreciation and loss on disposal of assets related to the project
of approximately $365,000 and $61,000 in the second and third quarters of
fiscal 2002, respectively. In accordance with SFAS No. 121, Accounting for the Impairment of
Long-Lived Assets to be Disposed of, which requires that long-lived assets
held and used by an entity be reviewed for impairment whenever events or
circumstances indicate that the net book value of the asset may not be
recoverable, the Company recorded a non-cash impairment charge of $563,000 in
fiscal 2001 to reflect fixtures and leasehold improvements at their respective
estimated fair value in a total of six under-performing stores.  4.
    
    Inventory Liquidation Costs In April 2003, the Company entered into an agreement with a consulting
firm to help with the complete liquidation of its mens inventory. Under the
terms of the agreement, the Company reimbursed the firm for certain operating
costs and paid the firm a portion of the sales proceeds based on certain
specified levels of sales performance as defined in the contract. All amounts
paid to the firm or accrued under the contract were contingent upon the firms
ability to meet certain minimum levels of sales performance. A total of $3.0
million was recorded as selling, general and administrative expenses during the
first half of fiscal 2003 pursuant to this agreement. In addition, during 2004, the Company entered into two agreements with
consulting firms to help in the complete liquidation of its inventory in a
total of 164 stores. Additional details surrounding the agreements as well as
the financial statement impact respective to the agreements are discussed in
Note 1  Subsequent Event  Bankruptcy Filing.  5.
    
    Leaseholds, Fixtures and Equipment Leaseholds, fixtures and equipment are summarized as follows: January 31,
    
    February 1,2004
    
    2003Leasehold improvements
    
    $
    38,862,122
    
    
    $
    42,857,260Fixtures
    
    
    32,945,731
    
    
    
    32,962,62271,807,853
    
    
    
    75,819,882Less accumulated depreciation
    
    
    (46,904,202
    )
    
    
    (40,995,972
    )$
    24,903,651
    
    
    $
    34,823,910
 41




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##### Table of Contents



6.
    
    Store Closing Costs During fiscal 2003, the Company closed 31 stores that had been identified
as under-performing. The total costs incurred as a result of store closings
and lease termination agreements totaled $3.4 million for fiscal 2003, of which
$719,600 was still accrued at January 31, 2004. These costs, primarily
composed of lease termination costs, are included in selling, general and
administrative expenses. Store closure costs associated with the 158 stores
that were closed in fiscal 2004 will be expensed as incurred in fiscal 2004. Included in the foregoing amount are significant pre-petition obligations.
Under the Bankruptcy Code, actions to collect pre-petition indebtedness are
stayed and other contractual obligations against Gadzooks may not be enforced.
Therefore, the commitments shown above may not reflect actual cash outlays in
the future period.  7.
    
    Convertible Subordinated Notes and Credit Agreement On October 9, 2003, the Company issued $14,000,000 of 5% Convertible
Subordinated Notes (Notes) due October 9, 2008 with interest payable
semi-annually commencing April 1, 2004. The Notes, as well as unpaid accrued
interest, are convertible at any time at the option of the holder into common
stock at a conversion price of $5.00 per share. However, the investors are
contractually prohibited from converting Notes into shares of common stock
without receiving prior shareholder approval if such issuance of common stock
would exceed 20 percent of the Companys outstanding shares of common stock or
result in the ownership by any one shareholder of greater than 20 percent of
the Companys outstanding shares of common stock. The Company has recorded a
beneficial conversion discount of $1,372,000 as a credit to additional paid-in
capital based on the difference between the fair value and the conversion price
(calculated as the intrinsic value) as of October 9, 2003. The discount will
be amortized over a three-year period using the effective interest method. At
the option of the Company, the Notes, as well as unpaid accrued interest, may
be converted into shares of common stock at any time after April 9, 2005 if the
closing price of the Companys common stock is greater than $6.00 for 20
trading days during a 30 consecutive trading day period. At any time after
October 9, 2006, the Company has the right to prepay the Notes and the holders
have the right to put the Notes back to the Company at the face value of the
Notes, plus unpaid accrued interest. Included in the foregoing amounts are
significant pre-petition obligations. As of January 31, 2004, the Notes and
unpaid accrued interest were convertible into 2,842,778 shares of common stock
with a fair value of $2,842,778. As a result of the Bankruptcy Filing on
February 3, 2004, all of the Notes, as well as the unpaid accrued interest,
became due and payable for a total of $14,213,889. The estimated fair value of
the convertible subordinated notes at January 31, 2004 was $8.3 million plus
accrued interest. The estimated fair market value was based on a subsequent
sale of a portion of the notes within a few days after January 31, 2004. On April 11, 2003, the Company and Wells Fargo Retail Finance LLC (Wells
Fargo) entered into a three-year $30 million revolving credit agreement (the
Facility), which is secured by an exclusive and first priority, perfected
interest in all assets of the Company. The credit agreement also provides for
the issuance of letters of credit that are used in connection with merchandise
purchases. Outstanding letters of credit issued by the bank reduce amounts
otherwise available for borrowing under the revolving line of credit. On October 31, 2003, the Company and Wells Fargo entered into an amendment
of the three-year $30 million revolving line of credit agreement. The
covenants imposed by the amendment require minimum levels of earnings before
interest, taxes, depreciation and amortization (EBITDA), minimum accounts
payable balances and a capital infusion of not less than $7.5 million. The
EBITDA and accounts payable balance covenants become effective only in the
event of a measurement event as defined by the amendment. At January 31, 2004,
the Company was in default under the Facility. As of January 31, 2004,
amounts available to borrow under the amended credit line, are limited as
described above, by the outstanding line balance of $11.3 million and by
outstanding letters of credit of $10.7 million. The weighted average interest
rate for the year ended January 31, 2004 on these borrowings was 5.0 percent. All of the Companys pre-petition debt is now in default due to the
Chapter 11 filing. Accordingly, the accompanying Consolidated Balance Sheet as
of January 31, 2004 reflects the classification of the Companys pre-petition
debt as current. Included in the foregoing amounts are significant pre-petition
obligations. Under the Bankruptcy Code, actions to collect pre-petition
indebtedness are stayed and other contractual obligations against Gadzooks may
not be enforced. Therefore, the commitments shown above may not reflect actual
cash outlays in the future period. 42




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On February 3, 2004, the Company and Wells Fargo entered into a one-year
$30 million debtor-in-possession loan and security agreement (the DIP
Facility), which is secured by a super-priority administrative expense claim
and a super-priority lien, on all assets of the Company. As a pre-condition to
obtaining the DIP financing, the Company paid in full its existing credit
facility of $11.3 million subsequent to the bankruptcy filing. Under the order
entered by the court granting the DIP financing, Well Fargos claim was
converted over time from a pre-petition to a post-petition debt. The Companys
borrowings under the agreement are limited to the lesser of 68% of eligible
inventory (as defined by the DIP Facility) or 85% of the appraised inventory
liquidation value of eligible inventory plus 85% of eligible credit card
accounts receivable less certain financial reserves specified by Wells Fargo.
The DIP Facility also provides for the issuance of letters of credit that are
generally used in connection with merchandise purchases and securing
obligations of the Company. Outstanding letters of credit issued by the bank
reduce amounts otherwise available for borrowing under the revolving line of
credit. The DIP Facility subjects the Company to certain weekly and monthly
financial covenants. Covenants on sales and disbursements are tested weekly on
a cumulative basis. Inventory and gross margin percentage covenants are tested
monthly (non-cumulative), and covenants on earnings before interest, taxes,
depreciation and amortization are tested monthly on a cumulative basis. Amounts
borrowed under the revolving line will bear interest at 1.00% above Wells
Fargos prime rate, and amounts outstanding under letters of credit will bear
interest at 2.00%. The DIP Facility also contains an unused line fee of 0.375%.
The DIP Facility was amended (the First DIP Amendment) on February 25, 2004
to allow the Company to include 75% of federal income tax refunds receivable in
the borrowing base in certain situations and to modify the inventory advance
rate. Pursuant to the First DIP Amendment, the inventory component of the
borrowing base calculation is now calculated as the lesser of 75% of eligible
inventory or 85% of the appraised inventory liquidation value of eligible
inventory.  8.
    
    Commitments and Contingencies Operating Leases.The Company leases store, office, and warehouse space
under non-cancelable leases with terms that generally range from five to ten
years. Most of the store leases provide for additional rentals based on a
percentage of store sales and specify rental increases over the term of the
lease. Total rent expense under these operating leases was $29,381,112,
$30,976,603 and $28,029,808, for fiscal years 2003, 2002 and 2001,
respectively. Included in these total rent figures are $73,000, $567,000 and
$735,000 of contingent rent for fiscal years 2003, 2002 and 2001, respectively.
Accrued rent of $3,884,290 as of January 31, 2004 and $4,124,012 as of
February 1, 2003 has been provided to account for rent expenses on a
straight-line basis. Future minimum lease payments under non-cancelable
operating leases as of January 31, 2004 are as follows: Fiscal year2004
    
    
    27,011,7602005
    
    
    25,416,2692006
    
    
    22,825,5892007
    
    
    18,766,5922008
    
    
    15,141,822Thereafter
    
    
    30,480,361Total minimum lease payment
    
    $
    139,642,393
 Under the Bankruptcy Code we may assume or reject executory contracts,
including lease obligations. Therefore, the commitments shown above may not
reflect actual cash outlays in the future periods. See Note 1, Subsequent Event
- Voluntary Bankruptcy Filing. Employee Retention and Incentive Plan.The Company has received approval
from the U.S. Bankruptcy Court for an employee retention and incentive plan.
The plan is comprised of three primary components including a retention bonus,
a performance incentive and a severance program. Under the terms of the
plan, the retention bonus component would be due to eligible employees on the
sooner of the effective date of confirmation by the Court of a plan of
reorganization or plan of liquidation, sixty days after the Company or the
employees business unit is sold or the date of the employees termination
without cause by the Company. The maximum payout for the retention bonus
component is an aggregate of $1.1 million. The performance incentive component
is payable to eligible employees if the Company meets or exceeds certain
financial milestones from the Companys fiscal 2004 business plan for the
following three periods, each to be evaluated independently: February through
April, May through August and September through January. The target incentive
payments will be made for each period that the Companys actual performance in
that period at least exceeds the operating benchmark by the amount to be paid.
The total target incentive payout for fiscal 2004, if earned by all eligible
employees for all periods, would approximate $0.6 43




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##### Table of Contents



million. The plan also provides for potential additional end-of-year
incentive payments if the Company exceeds its annual financial goals by
specified amounts. The plan also includes a severance component payable in the
event of an eligible employees termination without cause on or before the
effective date of confirmation by the Court of a plan of reorganization or plan
of liquidation or sixty days after the Company or the employees business unit
is sold. The plan provides that any employee eligible for a severance payment
is also eligible for a retention payment. The severance payout portion of the
plan will terminate upon the effective date of a plan of reorganization or
liquidation. The maximum payout for severance is an aggregate of $1.2 million. Litigation.In the ordinary course of business, the Company is
periodically a party to lawsuits. The Company does not believe that any
resulting liability from existing legal proceedings, individually or in the
aggregate, will have a material adverse effect on its operations or financial
condition. However, there can be no assurances that future costs will not be
material to operating results and liquidity. During the third quarter of
fiscal 2001, the Company favorably settled a lawsuit against another mall
tenant, which resulted in a gain of approximately $740,000.  9.
    
    Income Taxes The provision (benefit) for federal and state income taxes consists of the
following: Fiscal2003
    
    2002
    
    2001Current tax provision/(benefit)
    
    $
    (5,626,781
    )
    
    $
    2,404,837
    
    
    $
    4,954,264Deferred tax provision/(benefit)
    
    
    6,771,033
    
    
    
    (3,080,593
    )
    
    
    (1,220,830
    )$
    1,144,252
    
    
    $
    (675,756
    )
    
    $
    3,733,434
 The following table reconciles the provision for income taxes to the
amount computed by applying the U.S. statutory federal tax rate of 34% to
pre-tax income (loss): Fiscal2003
    
    2002
    
    2001Tax provision (benefit) at the federal corporate rate
    
    $
    (20,683,264
    )
    
    $
    (657,328
    )
    
    $
    3,312,323State income taxes, net of related federal benefit
    
    
    (2,924,924
    )
    
    
    (52,021
    )
    
    
    433,458Increase (decrease) in valuation allowance
    
    
    24,980,951
    
    
    
    
    
    
    
    Tax exempt interest
    
    
    
    
    
    
    (3,011
    )
    
    
    (38,134
    )Other, net
    
    
    (228,511
    )
    
    
    36,604
    
    
    
    25,787Provision (benefit) for income taxes
    
    $
    1,144,252
    
    
    $
    (675,756
    )
    
    $
    3,733,434
 44




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##### Table of Contents



Deferred tax assets (liabilities) are comprised of the following: January 31,
    
    February 1,2004
    
    2003Deferred tax assets:Accruals not currently deductible
    
    $
    8,729,648
    
    
    $
    5,556,801Depreciation
    
    
    1,007,693
    
    
    
    1,214,232Other
    
    
    59,326
    
    
    
    Net operating loss carry forward and
alternative minimum tax credit
    
    
    15,184,284
    
    
    
    Total deferred tax assets
    
    
    24,980,951
    
    
    
    6,771,033Deferred tax liabilities:
    
    
    
    
    
    
    Valuation allowance
    
    
    (24,980,951
    )
    
    
    Total
    
    
    
    
    
    
    6,771,033Current deferred tax assets/(liabilities)
    
    
    2,859,731
    
    
    
    1,886,249Valuation allowance
    
    
    (2,859,731
    )
    
    
    Noncurrent deferred tax assets/(liabilities)
    
    
    22,121,220
    
    
    
    4,884,784Valuation allowance
    
    
    (22,121,220
    )
    
    
    $
    
    
    
    $
    6,771,033
 At January 31, 2004, the Company had tax receivables totaling $5.3 million
representing the amount of the current year estimated operating loss that can
be carried back to prior years taxable income. At January 31, 2004, the
Company had net operating loss (NOL) carry forwards totaling approximately
$34,751,000 that may be used to offset future taxable income through fiscal
2023 subject to certain limitations, if applicable. Realization of benefits
associated with the Companys deferred tax assets (including the NOL carry
forward) is dependent upon generating sufficient future taxable income and
utilization of the NOLs prior to their expiration being careful to take into
consideration any limitations that are applicable. As a result of significant
operating losses and continuing same store sales declines since the conversion
to an all-female concept, management has reviewed its deferred tax assets for
ultimate realization and believes that it is more likely than not that some
portion, if not all, of the deferred tax assets will not be realized, and that
the NOL (or a portion thereof) may expire unused. Accordingly, during fiscal
2003 the Company established a valuation allowance against the NOL and the
other deferred tax assets. The early disposition of certain qualified stock options and the exercise
of certain nonqualified stock options in fiscal 2002 and 2001 resulted in
income tax benefits to the Company of $82,954 and $280,912 respectively, which
was credited to additional paid-in capital. There were no exercises of stock
options in fiscal 2003. The income tax benefit is the tax effect of the
difference between the market price on the date of exercise and the option
price.  10.
    
    Employee Benefit Plans Effective January 1, 1995, the Company established the Gadzooks, Inc.
Employees Savings Plan (the 401(k) Plan). The 401(k) Plan is open to
substantially all employees who have been employed at least one year and who
work at least 1,000 hours per year. Under the 401(k) Plan, a participant may
contribute up to 15% of pre-tax earnings, with the Company matching 50% of the
employees contribution up to 5% of earnings. Employee and Company
contributions are paid to a corporate trustee and invested in various mutual
funds or the Companys common stock at the discretion of the participant.
Company contributions made to participants accounts become 100% vested on the
fifth anniversary of the employees employment. For the years ended January 31,
2004, February 1, 2003 and February 2, 2002, the Company contributed $210,998,
$204,555 and $213,362, respectively, in matching contributions to the 401(k)
Plan. During fiscal 2002, 1,883 shares of the Companys treasury stock were
sold to the 401(k) plan at the closing price for the respective pay period.
There were no shares of the Companys treasury stock sold to the
401(k) plan in
fiscal 2003. On June 18, 1998, the shareholders approved the Gadzooks, Inc. Employee
Stock Purchase Plan (ESPP). The ESPP allows eligible employees the right to
purchase common stock on a monthly basis at 85% of the closing market price of
the shares on the last business day of the respective calendar month. The
aggregate number of shares that may be offered under the ESPP was increased
from 60,000 to 110,000 in fiscal 2000. During fiscal 2003, 2002 and 2001,
43,066, 22,267, and 13,482 shares, respectively, of the Companys common stock
were sold to employees pursuant to the plan. The Company may 45




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##### Table of Contents



purchase shares of common stock from time to time on the open market to
provide shares for sale pursuant to the ESPP. All contributions to the ESPP
were suspended effective January 1, 2004.  11.
    
    Stock Option Plans The Company has three incentive and nonstatutory stock option plans. The
Employee Plan for employees and consultants was adopted in February 1992; the
Key Employee Plan for key employees was adopted in September 1994; and the
Nonemployee Director Plan for the Companys outside directors was adopted in
August 1995. Under these plans, options are granted to purchase common stock
at a price no less than fair market value at the grant date. For options
granted prior to the initial public offering, the Board of Directors considered
various factors in determining fair market value including, among other things,
the rights and preferences of holders of other securities issued by the
Company, the financial position and results of operations of the Company, and
the liquidity of the Companys common stock. Subsequent to the initial public
offering, all shares have been granted at the closing price of the Companys
common stock traded on The Nasdaq Stock Market on the date of grant. Options
have vesting periods of generally two to five years from date of grant and may
be exercised at any time once they become vested, but not more than 10 years
from the date of grant. During fiscal 2000, the Employee Plan was amended to adjust the maximum
aggregate number of shares that may be optioned and sold under the plan to
2,100,000 shares. During fiscal 2003, the Nonemployee Director Plan was
amended to adjust the maximum aggregate number of shares that may be optioned
and sold from 100,000 to 200,000 shares. The maximum aggregate number of
shares that may be optioned and sold under the Key Employee Plan is 272,651
shares. The following table includes option information for the Employee Plan, Key
Employee Plan and Nonemployee Director Plan: Fiscal 2003
    
    Fiscal 2002
    
    Fiscal 2001Weighted
    
    
    
    
    
    Weighted
    
    
    
    
    
    WeightedAverage
    
    
    
    
    
    Average
    
    
    
    
    
    AverageExercise
    
    
    
    
    
    Exercise
    
    
    
    
    
    ExerciseShares
    
    Price
    
    Shares
    
    Price
    
    Shares
    
    PriceOutstanding at beginning of year
    
    
    1,352,101
    
    
    $
    12.98
    
    
    
    1,234,274
    
    
    $
    13.21
    
    
    
    1,117,511
    
    
    $
    10.64Granted
    
    
    333,841
    
    
    
    3.62
    
    
    
    290,420
    
    
    
    13.11
    
    
    
    308,039
    
    
    
    20.04Exercised
    
    
    
    
    
    
    
    
    
    
    (42,434
    )
    
    
    10.84
    
    
    
    (142,036
    )
    
    
    6.41Canceled
    
    
    (135,958
    )
    
    
    11.31
    
    
    
    (130,159
    )
    
    
    16.06
    
    
    
    (49,240
    )
    
    
    17.37Expired
    
    
    (952
    )
    
    $
    0.32
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Outstanding at end of year
    
    
    1,549,032
    
    
    $
    11.12
    
    
    
    1,352,101
    
    
    $
    12.98
    
    
    
    1,234,274
    
    
    $
    13.21Available for grant at end of year
    
    
    143,706
    
    
    
    
    
    
    
    240,637
    
    
    
    
    
    
    
    400,898
 The following table summarizes information about stock options outstanding
at January 31, 2004: Options Outstanding
    
    Options ExercisableWeightedAverage
    
    Weighted
    
    
    
    
    
    WeightedNumber
    
    Remaining
    
    Average
    
    Number
    
    AverageRange of
    
    Outstanding
    
    Contractual
    
    Exercise
    
    Outstanding
    
    ExerciseExercise Prices
    
    at 1-31-04
    
    Life
    
    Price
    
    at 1-31-04
    
    Price$
    1.05 - $  5.75
    
    
    
    283,318
    
    
    9 years
    
    $
    3.03
    
    
    
    24,853
    
    
    $
    3.475.78 -     9.00
    
    
    
    344,263
    
    
    6 years
    
    
    6.96
    
    
    
    241,563
    
    
    
    7.179.06 -   12.38
    
    
    
    411,932
    
    
    5 years
    
    
    11.50
    
    
    
    355,492
    
    
    
    11.4912.44 -   15.80
    
    
    
    250,129
    
    
    8 years
    
    
    15.26
    
    
    
    75,971
    
    
    
    14.9916.00 -   28.13
    
    
    
    259,390
    
    
    7 years
    
    
    20.89
    
    
    
    141,473
    
    
    
    20.79$
    1.05 -  $28.13
    
    
    
    1,549,032
    
    
    
    
    
    
    
    
    
    
    
    839,352
 46




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##### Table of Contents



The fair value of each option grant is estimated as of the date of grant
using the Black-Scholes Multiple Option pricing model with the following
weighted-average assumptions used for grants: Fiscal2003
    
    2002
    
    2001Expected volatility
    
    
    193%
    
    
    
    205%
    
    
    
    207%Risk-free interest rate
    
    
    2.3%
    
    
    
    4.0%
    
    
    
    4.4%Expected lives
    
    
    3.7 years
    
    
    
    4.4 years
    
    
    
    4.4 yearsDividend yield
    
    
    0%
    
    
    
    0%
    
    
    
    0%
 The weighted average fair value of options granted was $3.28, $12.55 and
$19.22 per share for fiscal 2003, 2002 and 2001, respectively.  12.
    
    Earnings Per Share The following table outlines the Companys calculation of weighted average
shares outstanding: Fiscal2003
    
    2002
    
    2001Weighted average common shares outstanding (basic)
    
    
    9,136,355
    
    
    
    9,125,627
    
    
    
    9,039,912Effect of dilutive options
    
    
    
    
    
    
    
    
    
    
    264,014Weighted average common and dilutive potential
shares outstanding (diluted)
    
    
    9,136,355
    
    
    
    9,125,627
    
    
    
    9,303,926
 The treasury stock method is used to determine dilutive potential common
shares outstanding related to stock options. Options which, based on their
exercise price, would be antidilutive are not considered in the treasury stock
method calculation. The options excluded from the earnings per share
calculation due to their antidilutive nature totaled 1,549,032, 1,352,101 and
225,057 in fiscal 2003, 2002 and 2001, respectively. The Company had $14.0
million in convertible debt, plus unpaid accrued interest outstanding for the
year ended January 31, 2004, which was convertible into 2,842,778 shares of
common stock (see Note 7). These shares have been excluded from the earnings
per share calculation for fiscal 2003 due to their anti-dilutive effect under
the if-converted method.  13.
    
    Retirement Agreement Effective August 28, 2002, the Company entered into an executive
retirement agreement with Gerald R. Szczepanski, Chairman of the Board and
Chief Executive Officer, pursuant to which Mr. Szczepanski or his estate shall
be eligible to receive certain benefits on termination of his employment with
Gadzooks as a result of either death, termination without cause (solely with
respect to the benefits described in (iv) and (v)) or retirement. Upon such
termination (i) Gadzooks will continue to provide Mr. Szczepanski (and his
spouse, if applicable) medical, dental and life insurance coverage, (ii)
Gadzooks will enter into a consulting relationship with Mr. Szczepanski for 24
months whereby Mr. Szczepanski will receive a consulting fee of $300,000 per
year to facilitate an orderly transition to Mr. Szczepanskis successor; (iii)
Mr. Szczepanski will receive his pro rata bonus for the fiscal year in which he
retires; (iv) all of Mr. Szczepanskis stock options will become vested in
full; and (v) all of Mr. Szczepanskis stock options with an exercise price
equal to or greater than $9.00 will be amended to include a term equal to the
lesser of (a) three years from such termination or (b) the original expiration
date of such stock options. In addition, Mr. Szczepanski agrees that upon
termination of his employment with Gadzooks, he will not disclose any
confidential information relating to Gadzooks and he will not solicit,
interfere or compete with Gadzooks, its business, its clients or its customers
for a period of two years. Pursuant to the agreement, Mr. Szczepanski is fully vested in the
postretirement insurance benefits available under the executive retirement
agreement. Accordingly, during the third quarter of fiscal 2002, the Company
recognized $115,000 as selling, general and administrative expense, which
represents the estimated present value of the future health insurance benefits
payable pursuant to the contract. 47




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##### Table of Contents



14.
    
    Shareholder Rights Plan On September 3, 1998, the Company declared a dividend of one Preferred
Share Purchase Right (Right) on each outstanding share of Gadzooks, Inc.
common stock. The dividend distribution was made on September 15, 1998 to
shareholders of record on that date. The Shareholder Rights Plan was amended
on October 7, 2003 and again on October 23, 2003 to amend the definition of
Acquiring Person in connection with the sale of the convertible subordinated
notes in October 2003. The Rights become exercisable if a person or group
acquires 20 percent or more of the Companys common stock or announces its
intent to do so. Each Right will entitle shareholders to buy one
one-thousandth of a new series of junior participating preferred stock at an
exercise price of $110. When the Rights become exercisable, the holder of each
Right (other than the acquiring person or members of such group) is entitled
(1) to purchase, at the Rights then current exercise price, a number of the
acquiring companys common shares having a market value of twice such price;
(2) to purchase, at the Rights then current exercise price, a number of the
Companys common shares having a market value of twice such price; or (3) at
the option of the Company, to exchange the Rights (other than Rights owned by
such person or group), in whole or in part, at an exchange ratio of one share
of common stock (or one-thousandth of a share of the new series of junior
participating preferred stock) per Right. The Rights may be redeemed for one
cent each by the Company at any time prior to acquisition by a person (or
group) of beneficial ownership of 20 percent or more of the Companys common
stock. The Rights will expire on September 15, 2008. 48




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##### Table of Contents



ITEM 9.
    
    CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE. None. 
  ITEM 9A. CONTROLS AND PROCEDURES Gadzooks management, with the participation of its Chairman of the Board
and Chief Executive Officer (its principal executive officer) and its Chief
Financial Officer (our principal financial officer) has concluded, based on
their evaluation as of the end of the period covered by this report, that its
disclosure controls and procedures are effective to ensure that information
required to be disclosed by Gadzooks and its reports filed or submitted by it
under the Securities Exchange Act of 1934, as amended, is recorded, processed,
summarized and reported within the time periods specified in the SECs rules
and forms, and include controls and procedures designed to ensure that
information required to be disclosed by Gadzooks in such reports is accumulated
and communicated to its management, including its principal executive officer
and financial officer, as appropriate to allow timely decisions regarding
required disclosure. There were no changes in our internal controls during the fourth quarter
of 2003 that have materially affected or are reasonably likely to materially
affect its internal controls over financial reporting. 
 PART III 
  ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. Information with respect to Item 10 is incorporated by reference from the
registrants definitive proxy statement to be filed with the Commission not
later than 120 days after the end of the registrants fiscal year. 
  ITEM 11. EXECUTIVE COMPENSATION. Information with respect to Item 11 is incorporated by reference from the
registrants definitive proxy statement to be filed with the Commission not
later than 120 days after the end of the registrants fiscal year. 
  ITEM 12.
    
    SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS. Information with respect to Item 12 is incorporated by reference from the
registrants definitive proxy statement to be filed with the Commission not
later than 120 days after the end of the registrants fiscal year. 
  ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. Information with respect to Item 13 is incorporated by reference from the
registrants definitive proxy statement to be filed with the Commission not
later than 120 days after the end of the registrants fiscal year. 
  ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES Information with respect to Item 14 is incorporated by reference from the
registrants definitive proxy statement to be filed with the Commission not
later than 120 days after the end of the registrants fiscal year. 49




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##### Table of Contents



PART IV 
 ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K  (a)
    1.
    The financial statements of the Company filed as part of this report on
Form 10-K are listed in the Index to Consolidated Financial Statements
under Part II, Item 8 of this Form 10-K, on page 24.2.
    Financial statement schedules are omitted because they are not
applicable or the required information is shown in the financial
statements or notes thereto.3.
    Exhibits included or incorporated herein:See Index to Exhibits.(b)
    
    Reports on Form 8-K:  On November 18, 2003, Gadzooks, Inc., a Texas corporation, issued a press
release announcing its financial and operating results for the third quarter
ended November 1, 2003.On February 3, 2004, Gadzooks, Inc. issued a press release announcing that it
had filed a voluntary petition under Chapter 11 of the United States Bankruptcy
Code. 50




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##### Table of Contents



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. GADZOOKS, INC.Date: May 14, 2004
    
    
    
    By
    /s/ Gerald R. SzczepanskiGerald R. SzczepanskiChairman of the Board and Chief Executive Officer
 Each person whose signature appears below hereby authorizes Gerald R.
Szczepanski and James A. Motley, or either of them, as attorneys-in-fact to
sign on his behalf, individually, and in each capacity stated below and to file
all amendments and/or supplements to the Annual Report on Form 10-K. 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. Signature
    
    Title
    
    Date/s/ Gerald R. Szczepanski
              Gerald R. Szczepanski
    
    Chairman of the Board and
Chief Executive Officer
(Principal Executive Officer)
    
    May 14, 2004/s/ James A. Motley
              James A. Motley
    
    Vice President, Chief Financial
Officer and Secretary (Principal
Financial and Accounting
Officer)
    
    May 14, 2004/s/ William C. Bousquette
              William C. Bousquette
    
    Director
    
    May 14, 2004/s/ Carolyn Greer Gigli
              Carolyn Greer Gigli
    
    Director, President and
Chief Merchandising Officer
    
    May 14, 2004/s/ G. Michael Machens
              G. Michael Machens
    
    Director
    
    May 14, 2004/s/ Robert E.M. Nourse
              Robert E.M. Nourse
    
    Director
    
    May 14, 2004/s/ Ron G. Stegall
              Ron G. Stegall
    
    Director
    
    May 14, 2004/s/ Lawrence H. Titus, Jr.
              Lawrence H. Titus, Jr.
    
    Director
    
    May 14, 2004
 51




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##### Table of Contents



INDEX TO EXHIBITS ExhibitNo.
    
    
    
    Description of Documents3.1
    
    
    
    Third Restated Articles of Incorporation of the Company
(filed as Exhibit 4.1 to the Companys Form S-8 (No.
33-98038) filed with the Commission on October 12, 1995 and
incorporated herein by reference).3.2
    
    
    
    Amended and Restated Bylaws of the Company (filed as
Exhibit 4.2 to the Companys Form S-8 (No. 33-98038) filed
with the Commission on October 12, 1995 and incorporated
herein by reference).3.3
    
    
    
    First Amendment to the Amended and Restated Bylaws of the
Company (filed as Exhibit 3.3 of the Companys Quarterly
Report on Form 10-Q for the quarter ended August 2, 1997
filed with the Commission on September 16, 1997 and
incorporated herein by reference).4.1
    
    
    
    Specimen Certificate for shares of Common Stock, $.01 par
value, of the Company (filed as Exhibit 4.1 to the
Companys Amendment No. 2 to Form S-1 (No. 33-95090) filed
with the Commission on September 8, 1995 and incorporated
herein by reference).4.2
    
    
    
    Rights Agreement dated as of September 3, 1998 between the
Company and Mellon Investor Services, L.L.C. (filed as
Exhibit 1 to the Companys Form 8-A filed with the
Commission on September 4, 1998 and incorporated herein by
reference).4.3
    
    
    
    First Amendment to Rights Agreement dated as of October 7,
2003 between the Company and Mellon Investor Services,
L.L.C. (filed as Exhibit 2 to the Companys Form 8-A/A
filed with the Commission on October 17, 2003 and
incorporated herein by reference).4.4
    
    
    
    Second Amendment to the Rights Agreement dated as of
October 23, 2003 between the Company and Mellon Investor
Services, L.L.C. (filed as Exhibit 3 to the Companys Form
8-A/A filed with the Commission on October 31, 2003 and
incorporated herein by reference).4.5
    
    
    
    Form of 5% Convertible Subordinated Note due October 9,
2008 (filed as Exhibit 4.1 to the Companys Form 8-K filed
with the Commission on October 14, 2003 and incorporated
herein by reference).4.6
    
    
    
    Form of Note Purchase Agreement dated on or about October
7, 2003 by and between certain investors and the Company
(filed as Exhibit 99.2 to the Companys Form 8-K filed with
the Commission on October 14, 2003 and incorporated herein
by reference).10.1
    
    
    
    Purchase Agreement dated as of January 31, 1992 among the
Company, Gerald R. Szczepanski, Lawrence H. Titus, Jr. and
the Investors listed therein (filed as Exhibit 10.1 to the
Companys Form S-1 (No. 33-95090) filed with the
Commission on July 28, 1995 and incorporated herein by
reference).10.2
    
    
    
    Purchase Agreement dated as of May 26, 1994 among the
Company, Gerald R. Szczepanski, Lawrence H. Titus, Jr. and
the Investors listed therein (filed as Exhibit 10.2 to the
Companys Form S-1 (No. 33-95090) filed with the
Commission on July 28, 1995 and incorporated herein by
reference).10.3
    
    
    
    Form of Indemnification Agreement with a schedule of
director signatories (filed as Exhibit 10.5 to the
Companys Form S-1 (No. 33-95090) filed with the Commission
on July 28, 1995 and incorporated herein by reference).
 52




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##### Table of Contents



10.4
    
    
    
    Employment Agreement dated January 31, 1992 between the
Company and Gerald R. Szczepanski, as continued by letter
agreement (filed as Exhibit 10.6 to the Companys Form S-1
(No. 33-95090) filed with the Commission on July 28, 1995
and incorporated herein by reference).10.5
    
    
    
    1992 Incentive and Nonstatutory Stock Option Plan dated
February 26, 1992, and Amendments No. 1 through 3 thereto
(filed as Exhibit 10.8 to the Companys Form S-1 (No.
33-95090) filed with the Commission on July 28, 1995 and
incorporated herein by reference).10.6
    
    
    
    1994 Incentive and Nonstatutory Stock Option Plan for Key
Employees dated September 30, 1994 (filed as Exhibit 10.9
to the Companys Form S-1 (No. 33-95090) filed with the
Commission on July 28, 1995 and incorporated herein by
reference).10.7
    
    
    
    1995 Non-Employee Director Stock Option Plan (filed as
Exhibit 10.10 to the Companys Form S-1 (No.
333-00196) filed with the Commission on January 9, 1996 and
incorporated herein by reference).10.8
    
    
    
    Gadzooks, Inc. Employees Savings Plan, as amended and
revised (filed as Exhibit 4.5 to the Companys Form S-8
(No. 333-68205) filed with the Commission on December 1,
1998 and incorporated herein by reference).10.9
    
    
    
    Severance Protection Agreement dated September 1, 1998
between the Company and Gerald R. Szczepanski
(filed as Exhibit 10.24 to the Companys Quarterly Report
on Form 10-Q filed with the Commission on December 15, 1998
and incorporated herein by reference).10.10
    
    
    
    Amendment No. 4 to the Gadzooks, Inc. 1992 Incentive and
Nonstatutory Stock Option Plan (filed as Exhibit 10.14 to
the Companys Amendment No. 3 to Form S-1 (No. 33-95090)
filed with the Commission on September 27, 1995 and
incorporated herein by reference).10.11
    
    
    
    Amendment No. 5 to the Gadzooks, Inc. 1992 Incentive and
Nonstatutory Stock Option Plan dated September 12, 1996
(filed as Exhibit 10.13 to the Companys 1996 Annual Report
on Form 10-K filed with the Commission on April 23, 1997
and incorporated herein by reference).10.12
    
    
    
    Amendment No. 1 to the 1994 Incentive and Nonstatutory
Stock Option Plan for Key Employees dated September 12,
1996 (filed as Exhibit 10.14 to the Companys 1996 Annual
Report on Form 10-K filed with the Commission on
April 23, 1997 and incorporated herein by reference).10.13
    
    
    
    Gadzooks, Inc. Employee Stock Purchase Plan (filed as
Exhibit 4.5 to the Companys Form S-8 (No. 333-50639) filed
with the Commission on April 21, 1998 and incorporated
herein by reference).10.14
    
    
    
    Lease Agreement between Gadzooks, Inc. (Lessee) and CB
Midway International, LTD. (Lessor) dated August 23, 1996
(filed as Exhibit 10.17 to the Companys 1997 Annual Report
on Form 10-K filed with the Commission on April 27, 1998
and incorporated herein by reference).10.15
    
    
    
    Gadzooks, Inc. 401(k) Plan and Profit Sharing Plan Adoption
Agreement (filed as Exhibit 10.18 to the Companys
Quarterly Report on Form 10-Q filed with the Commission on
June 9, 1998, and incorporated herein by reference).10.16
    
    
    
    Amendment No. 6 to the Gadzooks, Inc. 1992 Incentive and
Non-Statutory Stock Option Plan dated June 18, 1998 (filed
as Exhibit 4.8 to the Companys Form S-8 (No. 333-60869)
filed with the Commission on August 7, 1998 and
incorporated herein by reference).10.17
    
    
    
    Amendment No. 1 to the Gadzooks, Inc. 1995 Non-Employee
Director Stock Option Plan dated June 18, 1998 (filed as
Exhibit 4.10 to the Companys Form S-8 (No. 333-60869)
filed with the Commission on August 7, 1998 and
incorporated herein by reference).
 53




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##### Table of Contents



10.18
    
    
    
    Amendment No. 7 to the Gadzooks, Inc. 1992 Incentive and
Nonstatutory Stock Option Plan dated as of March 30, 2000
(filed as Exhibit 4.9 to the Companys Form S-8 (No.
333-48350) filed with the Commission on October 20, 2000
and incorporated herein by reference).10.19
    
    
    
    Amendment No. 8 to the Gadzooks, Inc. 1992 Incentive and
Nonstatutory Stock Option Plan dated as of March 30, 2000
(filed as Exhibit 4.10 to the Companys Form S-8 (No.
333-48350) filed with the Commission on October 20, 2000
and incorporated herein by reference).10.20
    
    
    
    Amendment No. 1 to the Gadzooks, Inc. Employee Stock
Purchase Plan dated as of March 30, 2000
(filed as Exhibit 4.10 to the Companys Form S-8 (No.
333-48350) filed with the Commission on October 20, 2000
and incorporated herein by reference).10.21
    
    
    
    Executive Retirement Agreement between Gadzooks Management,
L.P. and Gerald R. Szczepanski dated July 31, 2001 (filed
as Exhibit 10.29 to the Companys Quarterly Report on Form
10-Q filed with the Commission on September 18, 2001 and
incorporated herein by reference).10.22
    
    
    
    First Amendment to the Severance Protection Agreement
between Gadzooks Management, L.P. and Gerald R. Szczepanski
dated June 1, 2001 (filed as Exhibit 10.28 to the Companys
Quarterly Report on Form 10-Q filed with the Commission on
December 18, 2001 and incorporated herein by reference).10.23
    
    
    
    Severance Protection Agreement between Gadzooks Management,
L.P. and Paula Y. Masters dated July 1, 2001 (filed as
Exhibit 10.29 to the Companys Quarterly Report on Form
10-Q filed with the Commission on December 18, 2001 and
incorporated herein by reference).10.24
    
    
    
    Severance Protection Agreement between Gadzooks Management,
L.P. and William S. Kotch, III dated July 1, 2001 (filed as
Exhibit 10.31 to the Companys Quarterly Report on Form
10-Q filed with the Commission on December 18, 2001 and
incorporated herein by reference).10.25
    
    
    
    First Amended and Restated Credit Agreement between the
Company and Wells Fargo Bank (Texas), National Association
dated June 1, 2002 (filed as Exhibit 10.1 to the Companys
Quarterly Report on Form 10-Q filed with the Commission on
June 14, 2002 and incorporated herein by reference).10.26
    
    
    
    Amendment No. 1 to the Executive Retirement Agreement
between Gadzooks Management, L.P. and Gerald R. Szczepanski
dated August 28, 2002 (filed as Exhibit 10.2 to the
Companys Quarterly Report on Form 10-Q filed with the
Commission on September 10, 2002 and incorporated herein by
reference).10.27
    
    
    
    Amendment No. 1 to the First Amended and Restated Credit
Agreement and Waiver of Defaults between the Company and
Wells Fargo Bank (Texas) National Association dated
November 11, 2002 (filed as Exhibit 10.3 to the Companys
Quarterly Report on form 10-Q filed with the Commission on
December 13, 2002 and incorporated herein by reference).10.28
    
    
    
    Continuing Security Agreement  Rights to Payment and
Inventory between the Company and Wells Fargo Bank (Texas)
National Association dated as of November 8, 2002, (filed
as Exhibit 10.4 to the Companys Quarterly Report on form
10-Q filed with the Commission on December 13, 2002 and
incorporated herein by reference).10.29
    
    
    
    Security Agreement  Equipment Inventory between the
Company and Wells Fargo Bank (Texas) National Association
dated as of November 8, 2002 (filed as Exhibit 10.5 to the
Companys Quarterly Report on form 10-Q filed with the
Commission on December 13, 2002 and incorporated herein by
reference).
 54




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##### Table of Contents



10.30
    
    
    
    Committed, Senior, Secured Revolving Line of Credit
Agreement between the Company and Wells Fargo Retail
Finance, LLC dated as of April 11, 2003 (filed as Exhibit
10.38 to the Companys Quarterly Report on form 10Q filed
with the Commission on December 15, 2003 and incorporated
herein by reference).10.31
    
    
    
    Trademark and Trademark Applications Security Agreement
between the Company and Wells Fargo Retail Finance, LLC
dated as of April 11, 2003 (filed as Exhibit 10.39 to the
Companys Quarterly Report on form 10Q filed with the
Commission on December 15, 2003 and incorporated herein by
reference).10.32
    
    
    
    Second Amendment to Loan and Security Agreement dated
October 9, 2003 by and between the Company and Wells Fargo
Retail Finance, LLC (filed as Exhibit 99.3 to the Companys
Form 8-K filed with the Commission on October 14, 2003 and
incorporated herein by reference).10.33*
    
    
    
    Debtor-In-Possession Loan and Security Agreement dated February 3,
2004 between the Company and Wells Fargo Retail Finance, LLC.10.34*
    
    
    
    Debtor-In-Possession Revolving Credit Note dated February 4, 2004
between the Company and Wells Fargo Retail Finance, LLC.10.35*
    
    
    
    First Amendment to Loan and Security Agreement dated February 25,
2004 between the Company and Wells Fargo Retail Finance, LLC.10.36*
    
    
    
    Employee Retention and Incentive Plan.10.37*
    
    
    
    Employment Letter between the Company and Carolyn Greer dated April 29, 2004.21
    
    
    
    List of Subsidiaries (filed as Exhibit 21 to the Companys 2000 Annual Report on Form 10-K filed with the
Commission on April 30, 2001 and incorporated herein by reference).23*
    
    
    
    Consent of PricewaterhouseCoopers LLP.24*
    
    
    
    Power of Attorney (included on signature page of this report).31.1*
    
    
    
    Certification pursuant to Section 302 of the Sarbanes-Oxley Act of Chief Executive Officer.31.2*
    
    
    
    Certification pursuant to Section 302 of the Sarbanes-Oxley Act of Chief Financial Officer.32.1*
    
    
    
    Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002 of Chief Executive Officer.32.2*
    
    
    
    Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002 of Chief Financial Officer.
   *
    
    Filed herewith (unless otherwise indicated, exhibits are previously filed). 55