ITEM 1. Business; and ITEM 2.
ITEM 3. Legal Proceedings
We are, from time to time, involved in various legal proceedings and claims arising in the ordinary course of business. We believe that the ultimate disposition of these matters will not have a material adverse effect on our consolidated financial condition, results of operations or liquidity.
In June 2000, a former employee of Sportmart brought two class action complaints in California against us, alleging various wage and hour claims in violation of the California Labor Code, California Business and Professional Code section 17200 and other related matters. One complaint alleges that we classified some of our managers in our California stores as exempt from overtime pay when they would have been classified as non-exempt and paid overtime. The second complaint alleges that we failed to pay hourly employees in its California stores for all hours worked. In March 2001, a third class action complaint was filed in the same court in California alleging the same wage and hour violations regarding classification of certain managers as exempt from overtime pay. In July 2001, a fourth complaint was filed alleging that store managers should also not be classified as employees exempt from overtime pay. All the complaints seek compensatory damages, punitive damages and penalties. The amount of damages sought is unspecified. We have entered into a settlement agreement relating to the first two complaints that were filed, which has received preliminary approval by the court. With the settlement of the first two complaints, the named plaintiffs in the third and fourth actions will be included in the settlement class although they may opt to proceed with their lawsuits on an individual basis. We recorded an estimated liability totaling $1.5 million, including attorney fees and expenses, in the year ended January 31, 2004.
In June 2003, Financo, Inc., a financial advisory firm, filed a complaint against us in the Delaware Court of Chancery alleging that we owed Financo $2,000,000 for services provided to us in connection with the merger negotiations with TSA. No written contract existed between Financo and us. We reached a settlement with Financo and paid a total of $500,000, including attorney fees and expenses, during the year ended January 31, 2004.
TSA Stores is one of thirty-three named defendants, including firearms manufacturers, distributors and retailers, in City of Chicago and County of Cook v. Beretta U.S.A. Corp. et al., Circuit Court of Cook County, Illinois. This suit was served on TSA Stores in November 1998. The original complaint was based on legal theories of public nuisance and negligent entrustment of firearms and alleged that the defendants created a public nuisance by distributing, marketing and selling firearms in the portion of Cook County outside Chicago knowing or recklessly disregarding that these guns would be illegally transferred and used in Chicago to commit crimes. The complaint sought damages allocated among the defendants exceeding $433 million to compensate the City of Chicago and Cook County for their alleged costs resulting from the alleged public nuisance. The complaint also sought punitive damages and injunctive relief imposing additional regulations on the methods the defendants use to distribute, market and sell firearms in Cook County. In February 2000, the Court dismissed the complaint's negligent entrustment count. The plaintiffs filed an amended complaint with the Court's permission in March 2000, which contained both the public nuisance and negligent entrustment counts. In September 2000, the Court granted the motions of the defendants to dismiss the amended complaint,
in its entirety, with prejudice. In October 2000, the plaintiffs appealed the dismissal of their public nuisance claim to the Appellate Court of Illinois, First Judicial District. On November 4, 2002, the Appellate Court reversed the dismissal of the public nuisance claim and remanded the case to the trial court for further proceedings. On November 25, 2002, TSA Stores filed a petition for rehearing with the Appellate Court, which was denied on March 7, 2003. On March 27, 2003, TSA Stores joined in a petition by the other defendants for leave to appeal to the Illinois Supreme Court the Appellate Court's decision reversing the trial court's dismissal of the public nuisance claim, which was granted on April 8, 2003. The Illinois Supreme Court heard oral arguments by the parties on September 10, 2003 and has yet to render a decision. We are currently unable to predict the outcome of this case.
ITEM 4.
ITEM 4. Submission of Matters to a Vote of Security Holders
No matters were put to a vote of security holders during the fourth quarter of fiscal 2003.
PART II
ITEM 5.
ITEM 5. Market Price of Common Stock and Related Stockholder Matters
Our common stock trades on the New York Stock Exchange under the symbol "TSA." Prior to August 4, 2003, our common stock traded on the NASDAQ National Market under the symbol "GRTS." As of March 26, 2004, there were 2,557 holders of record. The number of holders of our common stock does not include beneficial owners whose shares are held in the name of banks, brokers, nominees or other fiduciaries. The table below sets forth the reported high and low closing prices on the NASDAQ National Market and New York Stock Exchange during fiscal 2003 and 2002:
We have never declared or paid any dividends on our common stock. We plan to retain earnings to finance future growth and have no current plans to pay cash dividends. The payment of any future cash dividends will be at the sole discretion of our board of directors and will depend upon, among other things, future earnings, capital requirements, and our general financial condition. Our ability to declare or pay dividends on our common stock and to repurchase shares of our common stock is limited to $16 million per year under our revolving line of credit.
See Item 12 of this annual report for information on securities authorized for issuance under equity compensation plans.
ITEM 6.
ITEM 6. Selected Consolidated Financial Data
The selected consolidated financial data presented below under the caption "Statement of Income Data" for each of the fiscal years in the three-year period ended January 31, 2004, and the "Balance Sheet Data" as of January 31, 2004 and February 1, 2003 are derived from our audited consolidated financial statements included in this Form 10-K. This data should be read in conjunction with our consolidated financial statements, the accompanying notes and Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations." The "Statement of Income Data" for each of the fiscal years in the two-year period ended February 3, 2001, and the "Balance Sheet Data" as of February 2, 2002, February 3, 2001, and January 29, 2000 are derived from audited consolidated financial statements not included in this Form 10-K.
Fiscal 2003 began on February 2, 2003 and ended on January 31, 2004 and included 52 weeks of operations. Fiscal 2002 began on February 3, 2002 and ended on February 1, 2003 and included 52 weeks of operations. Fiscal 2001 began on February 4, 2001 and ended on February 2, 2002 and included 52 weeks of operations. Fiscal 2000 began on January 30, 2000 and ended on February 3, 2001 and included 53 weeks of operations. Fiscal 1999 began on January 31, 1999 and ended on January 29, 2000 and included 52 weeks of operations.
The results for fiscal year 2003 are not comparable to the other periods presented, due to the inclusion of Sports Authority results of operations since August 4, 2003, the date of merger. The results
for fiscal year 2001 are not comparable to the prior periods presented, due to the inclusion of Oshman's results of operations since June 7, 2001, the date of acquisition. The results for fiscal year 2000, although it includes a fifty-third week of operations, and fiscal year 1999 are considered comparable to each other.
(1)Amount includes the effect of $26.7 million, net of tax, or $1.37 per diluted share, of merger integration costs associated with the TSA merger; non-recurring interest income of $1.3 million, net of tax, or $0.07 per diluted share, and a non-recurring tax benefit of $1.7 million, or $0.09 per diluted share, both related to the settlement of a tax dispute involving our former parent; and a non-recurring expense of $0.9 million, net of tax, or $0.05 per diluted share, including attorneys' fees and expenses, related to the settlement of wage and hour class action lawsuits in California.
(2)We issued 12.4 million shares in connection with the TSA merger, which was completed on August 4, 2003.
(3)Amount includes the effect of $7.6 million, net of tax, or $0.74 per diluted share of merger integration costs associated with the acquisition of Oshman's.
(4)We acquired Oshman's on June 7, 2001. This transaction involved the issuance of 3.4 million shares of our common stock.
(5)Amount includes the effect of a one-time tax benefit of $13.5 million, or $1.75 per diluted share, associated with the reversal of tax asset valuation allowances.
(6)Includes 205 Sports Authority stores acquired in the TSA merger on August 4, 2003.
(7)Includes 11 Sports Authority stores closing and one Gart store closing as a result of the merger integration process.
(8)Includes 58 Oshman's stores acquired on June 7, 2001.
(9)Includes four Oshman's stores closed after the acquisition on June 7, 2001.
(10)New stores enter the comparable store sales base at the beginning of their 14th full month of operation. The Oshman's stores were included in the comparable store sales base beginning August 2, 2002, the beginning of the 14th full month of operations from the acquisition date. The Sports Authority stores that met the criteria above were included in the comparable store sales base beginning August 4, 2003, the merger date.
ITEM 7.
ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis should be read in conjunction with "Selected Consolidated Financial Data" and our consolidated financial statements and accompanying notes included elsewhere in this report. This discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. The actual results may differ materially from those anticipated in these forward-looking statements as a result of a number of factors.
Overview
On August 4, 2003, a wholly-owned subsidiary of Gart Sports Company completed a merger with The Sports Authority, Inc. In connection with the merger, Gart Sports Company was renamed The Sports Authority, Inc. The references made to the entities herein refer to The Sports Authority, Inc. (formerly Gart Sports Company which includes "Sports Authority" or "Company" or "we" or "our" or "us") and its subsidiaries. "TSA" refers to TSA Stores Inc. (formerly known as The Sports Authority, Inc.). The merger was accounted for under the purchase method of accounting with Gart Sports Company as the acquirer, and accordingly, the results of operations for fiscal 2003 include the results of TSA since the date of the merger. Prior year results, as well as results for the first 26 weeks of the 52 weeks ended January 31, 2004, reflect the former Gart Sports Company on a stand-alone basis.
At the closing of the TSA merger, we became the nation's largest publicly traded full-line sporting goods retailer, with a presence in most major markets across the United States. At January 31, 2004, we operated 384 stores in 45 states under the Sports Authority, Gart Sports, Oshman's and Sportmart brand names. We also have a licensing agreement with Mega Sports to operate stores in Japan under the Sports Authority name. We believe that our geographic dispersion will benefit top-line sales due to sales of licensed apparel in a broader number of professional team markets, and balancing of seasonal and weather fluctuations, among other factors. In 2003, our efforts were focused on integrating the systems, processes and cultures of the two organizations, while ensuring the continuous flow of merchandise to our stores to maintain top-line sales. Comparable store sales for the post-merger 26 weeks ended January 31, 2004 were slightly positive, a favorable indication that sales volumes were maintained during the merger integration process. We also expect the TSA merger to provide us with synergistic benefits in gross margin as a result of reduced inventory costs and increased vendor entitlements. Additionally, we expect to realize significant cost savings from eliminating redundant back office functions.
In 2004, our focus will be on increasing sales through a number of initiatives, including: improving in-stock positions and rationalizing our merchandise assortment across the chain; growing the ski and snowboard business in the northeastern Sports Authority stores; remodeling a significant number of Sports Authority stores to create a more appealing, customer-friendly environment; realigning stores among the six distribution centers to reduce in-transit time; remodeling the Sports Authority distribution centers and improving information systems to increase product flow-through and data integrity; and continued new store development, with 23 new stores and two relocations planned for the year. In addition, we expect that the closure of a number of underperforming or overlapping Sports Authority stores will enhance our profitability, as negative contributors are eliminated from operating results. We identified 27 Sports Authority stores for closure as part of the merger integration process, of which eleven were closed and two relocated as of January 31, 2004. We expect to close the remaining stores identified for closure within the next 12 to 15 months. The implementation of these initiatives will require significant capital expenditures, which we estimate will approximate $85 million in fiscal 2004, and working capital to fund closed store lease obligations. We believe that our operating cash flows and the availability under our $600 million revolving credit facility provide the liquidity required for these initiatives.
Given the economic characteristics of our store formats, the similar nature of the products sold, the type of customer and method of distribution, our operations are aggregated in one reportable segment as defined by Statement of Financial Accounting Standards No. 131, "Disclosure About Segments of an Enterprise and Related Information."
Results of Operations
The following table sets forth for the periods indicated, certain income and expense items expressed as a percentage of net sales and the number of stores open at the end of each period (dollars rounded to millions):
We consider cost of goods sold to include the direct cost of merchandise, plus certain costs associated with procurement, warehousing, handling and distribution. In addition to the full cost of inventory, cost of goods sold includes related occupancy costs and amortization and depreciation of leasehold improvements and rental equipment.
Operating expenses include controllable and non-controllable store expenses (except occupancy), non-store expenses and depreciation and amortization not associated with cost of goods sold.
Fiscal 2003 as compared to Fiscal 2002
Net Sales. Net sales increased $709.2 million, or 67.5%, to $1,760.4 million in fiscal 2003, compared to $1,051.2 million in fiscal 2002. The sales increase reflects the inclusion of $697.0 million in sales from TSA stores from August 4, 2003, the merger date, versus results for Gart Sports on a stand-alone basis in fiscal 2002. Additionally, non-comparable sales for Gart on a stand-alone basis increased $28.3 million, net, reflecting an increase from store openings in fiscal 2002 and fiscal 2003 of $45.6 million, offset by a decrease of $17.3 million, primarily from store closings. Comparable store sales in fiscal 2003, which includes TSA stores since August 4, 2003, decreased 0.7%, primarily due to a first quarter decline of 8.8% for Gart on a stand-alone basis. The first quarter was impacted by a comparison to increased sales from the Salt Lake City Winter Olympics in 2002 and a decrease in sales due to a major snowstorm in the Denver area in 2003, among other factors. Sales performance improved thereafter, with relatively flat comparable store sales in the second and fourth quarters, and a 1.7% increase in the third quarter. Focusing on results for the Company following the TSA merger, comparable store sales increased $9.9 million or 0.8% for the last half of the 2003 fiscal year. The
increase resulted from a positive performance in the team sports, hunting and camping categories, and by strong sales in the ski, snowboard and snow apparel categories in Sports Authority locations in the northeast. The northeast stores benefited from an expanded product offering in these categories, as the broader assortment available in Gart stores was introduced into Sports Authority cold-weather markets. In aggregate, these factors produced a $15.9 million or 8.0% increase in comparable store sales. Partially offsetting these gains were declines in the fitness equipment, trends/gifts and skate categories aggregating $12.7 million or 7.1% decrease in comp store sales.
Gross Profit. Gross profit for fiscal 2003 was $485.7 million, or 27.6% of net sales, as compared to $274.9 million, or 26.2% of net sales, for fiscal 2002. The increase as a percent of net sales reflected improved merchandise margins for the combined companies as a result of lower inventory costs. Gart Sports results also improved on a stand-alone basis over the prior year, with an increase in merchandise margins of 0.5% of net sales. The increase reflects a somewhat less promotional selling environment in fiscal 2003 than in the prior year combined with reduced inventory costs, which produced improvements in merchandise margin rates in a number of categories. These categories include fitness equipment, snowboards, hunting and camping, which produced a combined increase in merchandise margin rates of 90 basis points. In addition, the application of EITF Consensus No. 02-16, "Accounting by a Customer (Including a Reseller) for Certain Consideration Received from a Vendor" ("EITF 02-16") resulted in the recharacterization of $3.0 million of vendor allowances, from a reduction of advertising expense to a reduction of the cost of inventory purchased, of which $2.1 million, or 0.1% of net sales, was recognized in cost of goods sold in fiscal 2003.
Operating Expenses. Operating expenses in fiscal 2003 were $409.5 million, or 23.3% of net sales, compared to $229.0 million, or 21.8% of net sales, for fiscal 2002. The increase in operating expense dollars primarily reflects the store operating costs associated with 205 TSA stores acquired on August 4, 2003. Operating expenses also increased as a percent of sales due to the following factors:
(i)TSA Stores' overall operating expenses historically trended higher than Gart's. TSA Stores' selling, general and administrative expenses were 26.0%, 25.5% and 24.6% of net sales in 2002, 2001 an 2000, compared to Gart's operating expenses of 21.8% of net sales for each of fiscal 2002 and 2001, and 21.9% of net sales for fiscal 2000. The implementation of consistent operating procedures for the combined company is an ongoing process that we expect to have completed by the end of fiscal 2004;
(ii)The higher level of general and administrative costs as a result of the TSA merger, including insurance costs, which increased $2.8 million, and corporate office rent, which increased $1.7 million due to additional leased office space to accommodate our larger corporate offices;
(iii)The recharacterization of $3.0 million, or 0.2% of net sales, of cooperative advertising monies from a reduction of advertising expense to a reduction of inventory costs as required by EITF 02-16; and
(iv)Establishing a reserve for the settlement of wage and hour class action lawsuits in California totaling $1.5 million, including attorney fees and expenses, recorded in the first quarter of 2003.
Merger Integration Costs. Merger integration costs for fiscal 2003 were $43.8 million, or 2.5% of net sales, and were related to the TSA merger. Integration costs include only non-recurring, incremental costs arising as a direct result of integrating the two companies following the merger. For fiscal 2003, these costs consisted of $17.7 million of duplicative payroll, benefits and retention payments, $8.4 million of severance costs, $6.7 million of consulting fees, $6.0 million of expense related to winding up the operations of the TSA corporate office in Ft. Lauderdale and closing a Gart store in an overlapping market, $3.0 million for relocation and travel, and $2.0 million of advertising related to rebranding and announcing the combined company.
Operating Income. As a result of the factors described above, operating income for fiscal 2003 was $32.9 million, or 1.9% of net sales, compared to $45.9 million, or 4.4% of net sales, in fiscal 2002.
Interest Expense. Interest expense for fiscal 2003 increased to $12.3 million, or 0.7% of net sales, from $9.2 million, or 0.9% of net sales, in the prior year. The increase in interest expense is related to the assumption of TSA Stores' debt upon completion of the merger and to financing of merger and integration costs.
Other Income. Other income was $3.5 million for fiscal 2003 compared to $1.1 million for fiscal 2002. The increase is primarily attributable to interest income associated with the settlement of the Rite Aid tax dispute totaling $2.1 million.
Income Taxes. Our income tax expense for fiscal 2003 was $7.7 million compared to $14.6 million in fiscal 2002. Tax expense for fiscal 2003 was offset by a tax benefit of $1.7 million recorded as a result of the settlement with our former parent regarding an IRS examination of our 1992 and 1993 consolidated federal income tax returns. Excluding this one-time benefit, the Company's estimated tax rate was approximately 39% for both fiscal 2003 and fiscal 2002.
Fiscal 2002 as compared to Fiscal 2001
Net Sales. Net sales increased $115.5 million, or 12.3%, to $1,051.2 million in fiscal 2002 compared to $935.7 million in fiscal 2001. Sales in fiscal 2001 include Oshman's results after the June 7, 2001 acquisition date compared to a full year of results for the combined company in fiscal 2002, resulting in an increase of fiscal 2002 net sales of approximately $92.0 million or 8.8%. New stores contributed approximately $23.5 million in net sales, or 2.2%, for fiscal 2002. Comparable store sales in fiscal 2002, which included the Oshman's stores from August 4, 2002, were flat, reflecting several offsetting factors throughout the year. In the first quarter of 2002, comparable store sales were strong due to a strong late ski season in our cold-weather markets, sales of merchandise related to the Winter Olympics in Salt Lake City and increased exercise equipment promotions. The second quarter reflected a general decline in business, and a significant decline in the camping and hunting departments due to drought and forest fire activity in the Rocky Mountain Region and the western United States. Third quarter 2002 sales increases were driven by licensed apparel sales as teams in our markets were involved in the Major League Baseball World Series and playoffs. However, these increases were offset by a soft selling environment in the fourth quarter of 2002, combined with a mild winter, which impacted our outdoor apparel sales.
Gross Profit. Gross profit for fiscal 2002 was $274.9 million, or 26.2% of net sales, as compared to $239.4 million, or 25.6% of net sales, for fiscal 2001. The increase as a percent of sales is due to a number of factors including: a less promotional strategy taken during the year; synergies realized from the Oshman's acquisition; systems investments, allowing us to better manage in-stock positions; and the addition of key personnel in the buying organization, particularly in the softlines department. Due to the nature of these items, they cannot be independently quantified.
Operating Expenses. Operating expenses in fiscal 2002 were $229.0 million, or 21.8% of net sales, compared to $204.4 million, or 21.8% of net sales, for fiscal 2001. Fiscal 2002 reflects a full year of operating expenses related to the Oshman's stores, while fiscal 2001 includes only results after the June 7, 2001, the acquisition date. As a percentage of sales, operating expenses were flat year over year, due to a continued focus on controlling costs.
Merger Integration Costs. Merger integration costs were $12.5 million, or 1.4% of net sales, for fiscal 2001 and related to the Oshman's acquisition. These costs include $3.6 million of duplicative or retention payroll and benefits, $3.0 million of advertising related to rebranding and announcing the combined company, $1.5 million for outside consulting services related to the integration, $2.3 million
of costs associated with consolidating and relocating the corporate offices, and the balance principally for other corporate office costs, travel and employee relocation and other personnel costs. We incurred no further merger integration costs related to the Oshman's acquisition since the fourth quarter of fiscal 2001.
Operating Income. As a result of the factors described above, operating income for fiscal 2002 was $45.9 million or 4.4% of net sales compared to $22.5 million or 2.4% of net sales in fiscal 2001. Fiscal 2002 operating income increased $10.9 million, or 0.7% of sales, when compared to fiscal 2001 operating income excluding integration costs of $35.0 million or 3.7% of sales.
Interest Expense. Interest expense for fiscal 2002 decreased to $9.2 million, or 0.9% of net sales, from $11.0 million, or 1.2% of net sales, in the prior year. The decrease in interest expenses is related to lower effective borrowing rates on amounts borrowed in 2002, resulting in approximately $2.7 million in interest savings, a settlement with the IRS in the third quarter of 2002 reducing interest expense by $0.7 million, and an increase to interest expense of $1.6 million due to an overall higher average debt balance, resulting from a decrease in the average debt as a result of the net proceeds from the May 2002 common stock offering, offset by the increased average debt due to the acquisition of Oshman's on June 7, 2001 and the shares repurchased under the 2002 common share repurchase program.
Other Income. Other income was $1.1 million for fiscal 2002 compared to $2.1 million for fiscal 2001. The decrease is primarily attributable to non-recurring items recorded in fiscal 2001, including $0.7 million of income related to a consulting services agreement, $0.3 million of income recognized on the sales of marketable securities, and a one-time gain of $0.2 million on the sale of certain assets that were held in Edmonton, Alberta, Canada. These items were offset primarily by increased sales tax handling income in the current year of approximately $0.2 million, due to increased sales volume as a result of the acquisition of Oshman's.
Income Taxes. Our income tax expense for fiscal 2002 was $14.6 million compared to $5.3 million in fiscal 2001. Our effective tax rate for fiscal 2002 was 38.7% compared to 39.0% in fiscal 2001, reflecting changes in certain permanent tax differences as compared to fiscal 2001.
Liquidity and Capital Resources
Our primary capital requirements are for inventory and other seasonal working capital needs, capital improvements, including investments in store remodeling, store fixtures and ongoing infrastructure improvements, and pre-opening expenses to support our expansion plans.
Cash Flow Analysis
Cash provided by operating activities increased $25.1 million in fiscal 2003 compared to fiscal 2002. The increase is primarily due to a higher level of accounts payable financing in fiscal 2003, only partially offset by an increase in inventories, producing a net $39.4 million improvement in operating cash flows year over year. Additionally, net income adjusted to exclude depreciation and amortization increased by $8.1 million over fiscal 2002. These increases in operating cash flows were partially offset by an increase in accounts receivable of $13.0 million due to increased vendor entitlement receivables. In fiscal 2002, the increase in cash provided by operations compared to fiscal 2001 is due to an increase in net income adjusted to exclude depreciation and amortization.
Cash used in investing activities increased $79.1 million in fiscal 2003 compared to fiscal 2002. The change reflects an increase in capital expenditures in fiscal 2003 of $41.7 million, combined with TSA merger costs (net of cash acquired) of $42.8 million offset by the receipt of $5.1 million on the sale-leaseback of a TSA store site. Additionally, we entered into a second sale-leaseback transaction of a TSA store site in January 2004, while the proceeds of $10.9 million were received on the first business day of fiscal 2004. Total capital expenditures were $67.6 million in fiscal 2003, and included: $24.2 million for expanding and remodeling the corporate office and improvements and upgrades to our information and POS systems; $20.9 million for the development of 17 new or relocated stores, and for stores planned to be opened in early fiscal 2004; and $20.2 million for refurbishment, remodel and general capital improvements of existing stores. Cash used in investing activities declined $38.6 million in fiscal 2002 versus 2001, reflecting non-recurring acquisition costs in fiscal 2001 of $49.9 million related to the Oshman's acquisition.
Cash provided by financing activities, which typically consists principally of net borrowings or payments under our revolving credit facility, increased $73.2 million in fiscal 2003 compared to fiscal 2002. The increase reflects additional borrowings required to finance TSA merger costs and the higher level of capital expenditures in fiscal 2003 not otherwise financed by operating cash flows. Proceeds from stock option exercises were $9.9 million in fiscal 2003 compared to $2.7 million in fiscal 2002, consistent with the increase in stock option exercises due to acceleration of vesting of TSA options as a result of the merger. In fiscal 2002, cash flows from financing activities other than stock option exercises were relatively neutral as proceeds from our secondary common stock offering were used to pay down long-term debt. By comparison, financing cash flows of $55.8 million in fiscal 2001 reflected the higher level of borrowings required to finance the Oshman's acquisition.
Working capital was $378.9 million as of January 31, 2004 compared to $171.8 million as of February 1, 2003, an increase of $207.1 million. The increase is due principally to an increase in inventories net of accounts payable of $169.5 million year over year, reflecting additional stores acquired in the TSA merger. Additionally, current deferred income taxes increased $80.0 million, reflecting tax assets generated in connection with the TSA merger and tax assets acquired from the former Sports Authority.
Our liquidity and capital needs have principally been met by operating cash flows and by borrowings under a revolving credit facility with CIT/Business Credit, Inc. ("CIT"), as agent.
Upon consummation of the merger, we entered into a new credit financing agreement (the "Credit Agreement") with CIT, as agent, that allows us to borrow up to $600,000,000, limited to an amount equal to 70% of eligible inventory or 85% of the appraised net orderly liquidation value of eligible inventory (as defined in the agreement). We are also entitled to seasonal increases in the inventory advance rate for up to 120 days during any calendar year as designated by us for the lesser of 80% of eligible inventory or 90% of appraised net orderly liquidation value. Borrowings are secured by substantially all present and future accounts (as defined in the Credit Agreement), inventories, trade receivables, equipment, documents of title and intangible assets. The borrowings mature, absent an occurrence of default under the agreement, on August 4, 2007. The Credit Agreement contains certain covenants, including financial covenants that require us to maintain a specified minimum level earnings
before interest, taxes, depreciation and amortization to interest ratios if we do not have at least $50 million available for borrowing in the first year, $60 million in the second year and $75 million thereafter. In addition, the Credit Agreement restricts, among other things, our ability to incur additional debt, to merge, consolidate or sell assets, to make loans or advances to others, to guaranty obligations of others, to pledge our assets, to make certain investments, and to engage in transactions with affiliates. Our ability to declare or pay dividends on our common stock and to repurchase our common stock is limited to $16 million per year under the Credit Agreement. We are in compliance with all covenants under the Credit Agreement. In connection with the Credit Agreement, we pledged all of the outstanding common stock of our subsidiaries, including TSA Stores, Inc. our principal operating retail subsidiary, as collateral for the Credit Agreement. Interest is payable monthly at Chase Manhattan Bank's prime rate plus a margin rate ranging from 0% to 0.50% or, at our option, at Chase Manhattan Bank's LIBOR rate plus a margin rate ranging from 1.50% to 2.50%. At January 31, 2004, there was $317.3 million outstanding under the Credit Agreement and $139.5 million was available for borrowing.
Capital expenditures are projected to be approximately $85 million in fiscal 2004, primarily for the opening of approximately 23 new stores and relocation of two stores, remodeling of approximately 70 stores, principally Sports Authority stores; completion of a new distribution center in Fontana, California, and refurbishment of the existing Sports Authority distribution centers, and information systems upgrades and enhancements and ongoing Sports Authority systems integration. We lease the majority of our store locations and intend to continue to finance our new store construction with long-term operating leases. Based upon recent store openings, newly constructed superstores require a cash investment of approximately $1.6 million for a 42,000 square foot store and approximately $1.3 million for a 32,000 square foot store. The level of capital improvements will be affected by the mix of new construction versus renovation of existing retail space.
We believe that cash generated from operations, combined with funds available under the revolving credit facility, will be sufficient to fund projected capital expenditures, future common share purchases, if any, and other working capital requirements for the foreseeable future. We intend to utilize the revolving credit facility to meet seasonal fluctuations in cash flow requirements.
Contractual obligations and commercial commitments
To facilitate an understanding of our contractual obligations and commercial commitments, the following data is provided (dollars in thousands):
(1)We have routine commitments under merchandise inventory purchase orders, which vary in amount from month to month depending on seasonality and other factors. Such purchase orders are cancelable by us without payment. In addition, we have entered into employment agreements with each of our executive officers. Payments under these employment agreements are dependent on these executives providing future services and certain payments are required to be made upon termination of employment by us without cause, as defined in the employment agreements. These items have not been included in the amounts in the above table. Interest Rate and Foreign Currency Risk Management
We entered into an interest rate swap agreement on June 28, 2001, expiring on June 30, 2004, and entered into a second interest rate swap agreement on December 11, 2002, expiring on May 31, 2005, to minimize the risks and costs associated with our financing activities. Under the swap agreements, we pay fixed rate interest and receive variable LIBOR interest rate payments periodically over the life of the agreements. The total notional amounts under the interest rate swaps are $60 million, which do not represent the exposure due to credit loss.
Our interest rate swaps are designated as cash flow hedges and are considered highly effective, as defined by FASB Statement No. 133. Net settlements on the swap agreements are recorded as interest expense. At January 31, 2004, the fair value of the swap agreements was a loss of $759,000, net of the related tax benefit. The unrealized loss from these interest rate swaps is included in other comprehensive income and is a component of stockholders' equity.
Our exposure to foreign currency risk is not material.
Seasonality and Inflation
The following table sets forth our unaudited consolidated quarterly results of operations for each of the quarters in fiscal 2003 and 2002. This information is unaudited, but is prepared on the same basis as the annual financial information and, in the opinion of management, reflects all adjustments (consisting only of normal recurring adjustments) necessary for a fair presentation of the information for the periods presented. The results of operations for any quarter are not necessarily indicative of the results for any future period.
The results for the last two quarters of fiscal year 2003 are not comparable to the other periods presented due to the inclusion of The Sports Authority results of operations, after August 4, 2003, the date of merger.
(1)Amounts reflect the results of Gart Sports on a stand-alone basis for these periods.
(2)Amounts include the results of the former Sports Authority, Inc. from August 4, 2004, the date of merger. The fourth quarter has historically been our strongest quarter. We believe that two primary factors contribute to this seasonality: first, sales of cold weather sporting goods and ski and snowboard merchandise during the fourth quarter are generally strong in anticipation of the ski and snowboard season; and second, holiday sales contribute significantly to our operating results. As a result of these factors, inventory levels, which gradually increase beginning in April, generally reach their peak in November and then decline to their lowest level following the December holiday season. Any decrease in sales for the fourth quarter, whether due to a slow holiday selling season, poor snowfall in ski areas near our markets or otherwise, could have a material adverse effect on our business, financial condition and operating results for the entire fiscal year.
Although our operations are influenced by general economic conditions, we do not believe that inflation has a material impact on our results of operations. We believe that we are generally able to pass along inflationary increases in costs to our customers.
Critical Accounting Policies
Management's Discussion and Analysis of Financial Condition and Results of Operations discusses the results of operations and financial condition as reflected in our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of financial statements in conformity with accounting principles generally accepted in the United States 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 date of the financial statements and reported amounts of revenues and expenses during the reporting period. On an ongoing basis, management evaluates its estimates and judgments, including those related to inventory valuation, accounts receivable, the recoverability of long-lived assets including intangible assets, store closing reserves, income taxes, self insured reserves and the estimates used to apply the purchase method of accounting to our mergers and acquisitions. Management bases its estimates and judgments on its historical experience and other relevant factors, which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. See Note 2 to the consolidated financial statements for a complete listing of our significant accounting policies.
Valuation of Inventory
We value our inventory at the lower of last-in, first-out ("LIFO") cost or market. Cost is determined using the average cost of items purchased and applying the dollar value LIFO inventory method. Our dollar value LIFO pools are computed using the Inventory Price Index Computation ("IPIC") method. LIFO cost of our inventories is then compared to estimated market value. This assessment of estimated market value is based on the quality and age of merchandise, the rate of sale of merchandise, the quantities on hand, and our assessment of the market conditions. Estimates and judgments are required in the determination of the market value of our inventory and future events, such as changes in customer merchandise preferences or unseasonable weather patterns, could impact the market value of our inventory.
Inventory shrinkage is accrued as a percentage of merchandise sales based on historical inventory shrinkage trends. We perform physical inventories at stores and distribution centers throughout the year. The reserve for inventory shrinkage represents an estimate for inventory shrinkage for each location since the last physical inventory date through the reporting date. These estimates are impacted by internal and external factors and may vary from actual results.
Vendor Allowances
We receive certain allowances from our vendors, which include rebates and cooperative advertising funds. These amounts are negotiated with vendors typically on an annual basis and are, at times, dependent on projected purchase volumes and advertising plans. The amounts are subject to changes in market conditions or marketing strategies of our vendors, and changes in our product purchases. We record an estimate of earned allowances based on the latest information available with respect to purchase volumes, advertising plans and status of our negotiation with vendors. We received $39.0 million, $28.2 million and $22.9 million in vendor allowances for fiscal years 2003, 2002 and 2001, respectively. Of those amounts, $32.8 million, $28.2 million, and $22.9 million, in fiscal years 2003, 2002 and 2001, respectively, were vendor allowances for advertising costs and were recorded as a reduction of advertising expense, while any remainder was recorded as a reduction of the cost of inventory purchased.
Impairment of Assets
We review long-lived tangible and intangible assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be fully recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell. Future events could cause management to conclude that impairment indicators exist and that the value of long-lived tangible and intangible assets is impaired.
Store Closing Reserves
Prior to December 31, 2002 and the adoption of SFAS No. 146, "Accounting for Costs associated with Exit or Disposal Activities" ("SFAS No. 146"), we recorded a provision for store closing costs when the decision was made by management to close a store. In accordance with SFAS No. 146, for store closing activities initiated after December 31, 2002, the related liability is recorded at fair value when a liability is incurred rather than when the decision to close a store is made. This will change the timing of recognition for certain exit costs, so that certain exit costs will be recognized over the period in which the exit activities occur. We also record store exit reserves arising from our various mergers and acquisitions pursuant to SFAS No. 141, "Business Combinations" and EITF Issue No. 95-3, "Recognition of Liabilities in Connection with a Purchase Business Combination" ("EITF 95-3"). Under EITF 95-3, the costs of a plan to exit an activity of the acquired company are recognized as liabilities assumed in the business combination. As such, reserves are recorded in purchase accounting for the net present value of projected costs to be incurred after the store closing date. The costs incurred in connection with store closings primarily consist of post-closing future net lease obligations, utilities, property taxes, and employee costs directly related to the store closing.
Deferred Taxes
Deferred tax assets and liabilities are recognized based on differences between the financial statement carrying amount and the tax bases of assets and liabilities. Deferred tax assets are reviewed for recoverability based on projections of future operating results, which dictate our ability to realize the tax assets. We record a valuation allowance to reduce the carrying value of our deferred tax assets when this amount exceeds the amount more likely than not to be realized. As of January 31, 2004, we had no valuation allowance on our deferred tax assets.
Self Insured Reserves
We are self-insured for our workers' compensation, general liability and employee medical plans up to a self-insured retention amount. We record a reserve for the estimated cost of both reported and incurred but not reported ("IBNR") claims. The estimate of our current claim obligation requires significant judgment and is based on specific loss estimates for reported claims, and on loss triangulation estimates of future claims payments, including IBNR's. Reserves are regularly evaluated for adequacy based on the most current available information, including historical claims experience and expected future claims costs.
Acquisitions and Mergers Accounting
Our acquisitions and mergers are accounted for under the purchase method of accounting. Accordingly, the total costs of such transactions are allocated to the tangible and intangible assets acquired and liabilities assumed based on their respective fair values. The determination of fair values involves the use of estimates and assumptions, which are subject to adjustment in the future. While we believe that the historical experience and other factors considered provide a meaningful basis for the accounting policies applied in the preparation of the consolidated financial statements, we cannot guarantee that our estimates and assumptions will be accurate, and will not require adjustment in future periods.
Impact of Recent Accounting Pronouncements
In April 2003, the FASB issued Statement No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities". This Statement amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities under Statement No. 133, "Accounting for Derivative Instruments
and Hedging Activities". The provisions of this Statement are effective for us for all derivatives and hedging activity entered into after June 30, 2003. The adoption of this Statement had no impact on our overall financial position and results of operations.
In May 2003, the FASB issued Statement No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity". This Statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. The provisions of this Statement are effective for these financial instruments with our fiscal year beginning February 1, 2004. We expect that the adoption of this Statement will have no material impact on our overall financial position and results of operations.
In November 2002, the EITF of the FASB issued consensus No. 02-16, "Accounting by a Customer (Including a Reseller) for Certain Consideration Received from a Vendor" ("EITF 02-16"). EITF 02-16 addresses how a reseller of a vendor's products should account for cash consideration received from the vendor and addresses two Issues. On Issue 1, the Task Force reached a consensus that cash consideration received from a vendor is presumed to be a reduction of cost of sales when recognized in the reseller's income statement. This presumption is overcome when the consideration is a reimbursement for specific, incremental, identifiable costs incurred by the reseller to sell the vendor's products, in which case the cash consideration should be characterized as a reduction of that cost when recognized in the reseller's income statement. Additionally, the Task Force concluded on Issue 2 that a refund or a rebate of a specified amount of cash consideration payable only if the reseller completes a specified level of purchases should be recognized as a reduction of cost of sales based on a systematic and rational allocation of the cash consideration offered to each of the underlying transactions that results in progress by the reseller toward earning the refund or rebate, provided the amounts are probable and reasonably estimable. In its January 2003 meeting, the Task Force amended the transition guidance relative to adoption of EITF 02-16 to require that the consensus on Issue 1 be applied to new arrangements, including modifications of existing arrangements, entered into after December 31, 2002. Issue 2 remains applicable to arrangements entered into after November 21, 2002.
We receive certain allowances from our vendors, which include rebates and cooperative advertising funds. These amounts are negotiated with vendors typically on an annual basis and are, at times, dependent on projected purchase volumes and advertising plans. The amounts are subject to changes in market conditions or marketing strategies of our vendors, and changes in our product purchases. We record an estimate of earned allowances based on the latest information available with respect to purchase volumes, advertising plans and status of our negotiation with vendors. We have historically treated certain vendor entitlements as a reduction of inventory costs, while cooperative advertising reimbursements have been reflected as a reduction of selling, general, and administrative expense. The impact of EITF 02-16 for fiscal 2002 was immaterial and for fiscal 2003 was a recharacterization of $3.0 million from reduction of advertising expense to reduction of cost of inventory purchased. The net impact of EITF 02-16 for fiscal 2003 was a reduction of net income of $0.5 million, or $0.03 per diluted share.
Risks and Uncertainties
Integration of The Sports Authority, Inc. (formerly known as Gart Sports Company) and TSA Stores, Inc. (formerly known as The Sports Authority, Inc.) may be difficult and expensive to achieve.
On August 4, 2003, we completed the merger of equals contemplated by the Agreement and Plan of Merger, dated as of February 19, 2003, among Gart Sports Company, Gold Acquisition Corp. and The Sports Authority, Inc. Pursuant to the merger agreement, we changed our name from Gart Sports Company to The Sports Authority, Inc. and the company formerly known as The Sports Authority, Inc. changed its name to TSA Stores, Inc.
The merger involves the integration of companies that have previously operated independently. The integration will be a complex, time consuming and expensive process and may materially harm our business if not completed in a timely and efficient manner. We may not be able to integrate the operations of the companies without encountering difficulties, including possible unanticipated costs, failure to retain key employees, the diversion of management's attention or failure to integrate our information systems. Due to the location of the combined company's headquarters in Colorado, a significant number of the members of the management team of TSA Stores have not remained with the combined company. As a result, we may lose some historical knowledge of the operations and business of TSA Stores. Additionally, we may not realize the increased revenues and cost savings that the pre-merger companies expected to achieve as a result of the merger or that would justify the investment made.
If the benefits of the merger do not exceed the costs associated with the merger, including any dilution to the stockholders resulting from the issuance of shares in connection with the merger, our financial results, including earnings per share, could be adversely affected.
Intense competition in the sporting goods industry could limit our growth and reduce our profitability.
The sporting goods retail market is highly fragmented and intensely competitive. Our current and prospective competitors include many large companies that have substantially greater market presence, name recognition, financial, marketing and other resources than we do. We compete directly or indirectly with the following categories of companies:
•full-line sporting goods retailers;
•traditional sporting goods stores and chains;
•specialty sporting goods retailers and pro shops;
•mass merchandisers, warehouse clubs, discount stores and department stores; and
•catalog and internet-based sporting goods retailers.
Increased competition in markets in which we have stores, the adoption by competitors of innovative store formats, pricing strategies and retail sale methods, the entry of new competitors in our markets or the expansion of operations by existing competitors in our markets could cause us to lose market share, limit our growth and reduce our profitability.
If we are unable to predict or react to changes in consumer demand, our sales may decline and we may be required to take significant markdowns in inventory.
Our success depends on our ability to anticipate and respond in a timely manner to changing consumer demand and preferences regarding sporting goods. Our products must appeal to a broad range of consumers whose preferences cannot be predicted with certainty and are subject to change. Additionally, we often make commitments to purchase products from our vendors several months in advance of the proposed delivery. If we misjudge the market for our merchandise, we may lose sales or we may overstock unpopular products, which may require us to take significant inventory markdowns. In either case, our revenues and profit margins could significantly decline and our business and financial results may suffer.
We sell products that expose us to a greater risk of product liability and infringement claims, and our insurance may not be sufficient to cover damages related to those claims. Additionally, we face claims in Illinois relating to the sale of handguns before 1999.
We may be subject to lawsuits resulting from injuries associated with the use of sporting goods equipment that we sell or rent. Among other things, we sell long guns, handguns and air pistols, which are products that are associated with an increased risk of injury and related lawsuits. We may incur losses relating to these claims or the defense of these claims. We may also incur losses due to lawsuits relating to our performance of background checks on firearm purchasers as mandated by state and federal law or the improper use of firearms sold by us, including lawsuits by municipalities or other organizations attempting to recover costs from firearm manufacturers and retailers relating to the misuse of firearms. In addition, in the future there may be increased federal, state or local regulation, including taxation, of the sale of firearms in our current markets as well as future markets in which we may operate. Commencement of these lawsuits against us or the establishment of new regulations could reduce our sales and decrease our profitability. There is a risk that claims or liabilities will exceed our insurance coverage.
TSA Stores is one of thirty-three named defendants, including firearms manufacturers, distributors and retailers, in City of Chicago and County of Cook v. Beretta U.S.A. Corp. et al., Circuit Court of Cook County, Illinois. This suit was served on TSA Stores in November 1998. The original complaint was based on legal theories of public nuisance and negligent entrustment of firearms and alleged that the defendants created a public nuisance by distributing, marketing and selling firearms in the portion of Cook County outside Chicago knowing or recklessly disregarding that these guns would be illegally transferred and used in Chicago to commit crimes. The complaint sought damages allocated among the defendants exceeding $433 million to compensate the City of Chicago and Cook County for their alleged costs resulting from the alleged public nuisance. The complaint also sought punitive damages and injunctive relief imposing additional regulations on the methods the defendants use to distribute, market and sell firearms in Cook County. In February 2000, the Court dismissed the complaint's negligent entrustment count. The plaintiffs filed an amended complaint with the Court's permission in March 2000, which contained both the public nuisance and negligent entrustment counts. In September 2000, the Court granted the motions of the defendants to dismiss the amended complaint, in its entirety, with prejudice. In October 2000, the plaintiffs appealed the dismissal of their public nuisance claim to the Appellate Court of Illinois, First Judicial District. On November 4, 2002, the Appellate Court reversed the dismissal of the public nuisance claim and remanded the case to the trial court for further proceedings. On November 25, 2002, TSA Stores filed a petition for rehearing with the Appellate Court, which was denied on March 7, 2003. On March 27, 2003, TSA Stores joined in a petition by the other defendants for leave to appeal to the Illinois Supreme Court the Appellate Court's decision reversing the trial court's dismissal of the public nuisance claim, which was granted on April 8, 2003. The Illinois Supreme Court heard oral arguments by the parties on September 10, 2003 and has yet to render a decision. We are currently unable to predict the outcome of this case.
There is a risk that claims or liabilities with respect to lawsuits will exceed our insurance coverage. Additionally, we may be unable to purchase adequate liability insurance in the future. Although we have entered into product and infringement liability indemnity agreements with many of our vendors, we cannot assure you that we will be able to collect payments sufficient to offset product liability losses. Furthermore, we are subject to regulation by the Consumer Product Safety Commission and similar state regulatory agencies. If we fail to comply with government and industry safety standards, we may be subject to claims, lawsuits, fines and adverse publicity that could have a material adverse effect on our business and results of operations.
If our suppliers and distributors do not provide us with sufficient quantities of products, or if conditions in any of the foreign countries where they source merchandise adversely change, we may not be able to offer competitively priced merchandise or the quantities or assortment that our customers demand.
We purchase merchandise from over 1,000 vendors. In fiscal 2003, purchases from Nike represented approximately 13.0% of our total purchases. Although purchases from no other vendor represented more than 10.0% of our total purchases, our dependence on our principal suppliers involves risk. We do not have long-term agreements with our suppliers and cannot guarantee that we will be able to maintain our relationships with them. If there is a disruption in supply from a principal supplier or distributor, we may be unable to obtain the merchandise that we desire to sell and that consumers desire to purchase. Moreover, many of our suppliers provide us with incentives, such as return privileges, volume purchasing allowances and cooperative advertising allowances. A decline or discontinuation of these incentives could reduce our profits.
Additionally, we believe that a significant portion of the products that we purchase, including those purchased from domestic suppliers, are manufactured abroad. Government regulations, political unrest, war, changes in local economic or labor conditions, trade issues or interruptions or delays in imports could disrupt or delay shipments of merchandise to our stores and cause shortages in our inventory and a decline in our sales. If one or more of these factors occur, our business and financial results could suffer.
Our comparable store sales will fluctuate and may not be a meaningful indicator of future performance.
Changes in our comparable store sales results could affect the price of our common stock. A number of factors have historically affected, and will continue to affect, our comparable store sales results, including:
•competition;
•our new store openings;
•general regional and national economic conditions;
•actions taken by our competitors;
•consumer trends and preferences;
•changes in the other tenants in the shopping centers in which we are located;
•new product introductions and changes in our product mix;
•timing and effectiveness of promotional events;
•lack of new product introductions to spur growth in the sale of various kinds of sports equipment; and
•weather.
Our comparable store sales may vary from quarter to quarter, and an unanticipated decline in revenues or comparable store sales may cause the price of our common stock to fluctuate significantly.
Our business is seasonal, and our annual results are highly dependent on the success of our holiday selling season.
Our business is highly seasonal in nature. Our highest sales and operating profitability historically occur during the fourth fiscal quarter, which is due, in part, to the holiday selling season and, in part, to our strong sales of cold weather sporting goods and apparel. Any decrease in our fourth quarter sales, whether because of a slow holiday selling season, poor snowfall in ski areas near our markets, or otherwise, could have a material adverse effect on our business, financial condition and operating results for the entire fiscal year.
A downturn in the economy could significantly reduce our revenues.
Sales of sporting goods historically depend on consumers' discretionary spending. An economic downturn in any of our major markets, or in general, could reduce consumer spending on discretionary items that could adversely impact our revenues and cause our business and financial results to suffer.
General economic conditions are beyond our control and are affected by:
•the impact of an economic recession;
•unemployment trends;
•interest rates and inflation;
•consumer and commercial credit availability;
•consumer debt levels;
•geopolitical uncertainty;
•tax rates and tax policy;
•the impact of natural disasters; and
•other factors that influence consumer confidence and spending.
Increasing volatility in financial markets may cause the above factors to change with an even greater degree of frequency and magnitude.
We have a significant amount of debt that could adversely affect our business and growth prospects.
We entered into a credit facility at the completion of the TSA merger that provides for loans of up to $600 million. As of January 31, 2004, we had approximately $317.3 million of long-term debt. This debt could have significant adverse effects on our business. This debt:
•makes it more difficult for us to obtain additional financing on favorable terms;
•requires us to dedicate a substantial portion of our cash flows from operations to the repayment of our debt and the interest on our debt;
•limits our ability to capitalize on significant business opportunities; and
•makes us more vulnerable to economic downturns.
If we are unable to generate sufficient cash flows from operations in the future, we may have to refinance all or a portion of our debt and/or obtain additional financing. We cannot assure you that refinancing or additional financing on favorable terms could be obtained or that we will be able to operate at a profit.
Additionally, the credit facility entered into upon consummation of the merger imposes operating and financial restrictions that may impair our ability to respond to changing business and economic conditions or to grow our business.
Our business depends on our ability to satisfy our labor needs.
Many of our employees are in entry-level or part-time positions that historically have high rates of turnover. We may be unable to satisfy our labor needs and control our costs due to external factors such as unemployment levels, minimum wage legislation and wage inflation. If general economic conditions improve, it may be more difficult to attract and retain quality employees. As a result, our business may suffer.
Terrorist attacks or acts of war may seriously harm our business.
Terrorist attacks or acts of war may cause damage or disruption to us and our employees, facilities, information systems, vendors and customers, which could significantly impact our net sales, costs and expenses and financial condition. The threat of terrorist attacks in the United States since September 11, 2001 continues to create many economic and political uncertainties. The potential for future terrorist attacks, the national and international responses to terrorist attacks and other acts of war or hostility may cause greater uncertainty and cause our business to suffer in ways that we currently cannot predict. The military action taken by the United States and its allies against the government of Iraq could have a short or long term negative economic impact upon the financial markets and our business in general. Additionally, events such as those referred to above could cause or contribute to a general decline in equity valuations, which in turn could reduce the market value of your investment in us.
Because an equity owner of one of our significant stockholders is a member of the board of directors of one of our competitors, there may be conflicts of interest.
Green Equity Investors, L.P. (we refer to Green Equity Investors, L.P. and its affiliates as Leonard Green) currently holds approximately 8% of our outstanding common stock. Jonathan D. Sokoloff, one of our current directors, and Jonathan A. Seiffer, a former director, are equity owners of Leonard Green, and both previously served on Big 5 Sporting Goods' board of directors. John G. Danhakl, also an equity owner of Leonard Green, currently serves on the board of directors of Big 5 Sporting Goods. Leonard Green does not have formal procedures to prohibit Messrs. Seiffer, Sokoloff and Danhakl from sharing information about us and Big 5 Sporting Goods with each other. Messrs. Seiffer, Sokoloff and Danhakl may have conflicts of interest with respect to various matters affecting us, including the pursuit of business opportunities presented to Leonard Green. Leonard Green does not have procedures in place that are designed to resolve conflicts arising in connection with its investments in entities that compete with each other. All potential conflicts may not be resolved in a manner that is favorable to us. We believe that it is impossible to predict the precise circumstances under which future potential conflicts may arise, and, therefore, we intend to address potential conflicts on a case-by-case basis.
Anti-takeover provisions may prevent stockholders from realizing a premium return.
Anti-takeover provisions in our certificate of incorporation and bylaws may deter unfriendly offers or other efforts to obtain control over us. These anti-takeover provisions, among other things:
•allow our board of directors to issue "blank check" preferred stock without stockholder approval, and establish the rights, including voting rights, preferences and limitations of the preferred stock;
•establish advance notice requirements for stockholder nominations to the board of directors or for stockholder proxy proposals;
•permit the board of directors to increase its own size and fill the resulting vacancies through a majority vote of directors, even if less than a quorum; and
•require that mergers and other business combinations with certain interested stockholders, including any holder of 10% or more of our common stock, be approved by a supermajority of the holders of our common stock that are not interested in the transaction.
Section 203 of the Delaware General Corporate Law also imposes restrictions on mergers and other business combinations between us and any holder of 15% or more of our common stock.
These measures could make us less attractive to a potential acquirer and deprive stockholders of the opportunity to sell their common stock at a premium price.
Our quarterly operating results may fluctuate substantially, which may adversely affect our business and the market price of our common stock, particularly if our quarterly results fall below the expectations of securities analysts.
Our sales and results of operations have fluctuated in the past and may vary from quarter to quarter in the future. These fluctuations may adversely affect our business, financial condition and the market price of our common stock, particularly if our quarterly results fall below the expectations of securities analysts. A number of factors, many of which are outside our control, may cause variations in our quarterly net sales and operating results, including:
•changes in consumer demand for the products that we offer in our stores;
•pre-opening costs associated with new stores;
•costs related to the closures of existing stores;
•litigation;
•changes in merchandise mix;
•sales and promotional events sponsored by our competitors; and
•general economic conditions.
Our stock price has been volatile in the past and may remain volatile in the future. The value of our common stock may decline as a result of this volatility.
The market price of our common stock has been in the past, and may in the future be, subject to wide fluctuations in response to factors such as:
•fluctuations in quarterly operating results;
•announcements, by us or our competitors, of actual or expected financial results, significant contracts, acquisitions, strategic partnerships, joint ventures or capital commitments;
•changes in recommendations or financial estimates by securities analysts;
•conditions and trends in the sporting goods industry; and
•general conditions in the economy or the financial markets.
Additionally, in recent years, the stock market has experienced significant price and volume fluctuations that are often unrelated to the performance or condition of particular companies. Such broad market fluctuations could adversely affect the market price of our common stock. Following periods of volatility in the market price of a particular company's securities, securities class action litigation has often been brought against a company. If we become subject to this kind of litigation in the future, it could result in substantial litigation costs, damages awards against us and the diversion of our management's attention and resources.
The loss of key executives could have a material adverse effect on our business.
Our future success depends on the continued services of our senior management, particularly John Douglas Morton, our vice chairman of the board and chief executive officer. Any loss or interruption of the services of our senior management could significantly reduce our ability to effectively manage our operations and implement our key initiatives because we may not be able to find appropriate replacements for our senior management should the need arise. If we were to lose any key senior management, our business could be materially adversely affected.
We rely on our information systems to operate our business, and if our information systems fail to adequately perform these functions, our business and financial results could be adversely affected.
The efficient operation of our business is dependent on the successful integration and operation of our information systems. In particular, we rely on our information systems to manage effectively our sales, warehousing, distribution, merchandise planning and replenishment and to optimize our overall inventory levels. Most of our information systems are centrally located at our headquarters, with offsite backup at other locations. Following the TSA merger, we continue to focus on the integration of the warehouse management systems and store point-of-sale systems. Some of our systems have not been fully implemented and require additional configuration, testing and user training before they become fully operational. Systems integration issues are complex, time-consuming and expensive. The failure to integrate successfully our information systems or their failure to perform as we anticipate could disrupt our business, lead to unanticipated costs, adversely affect our revenues and cause our business and financial results to suffer.
A disruption in the operation of our distribution centers would affect our ability to deliver merchandise to our stores, which could impact adversely our revenues and harm our business and financial results.
Most of our merchandise is shipped by our vendors to a limited number of distribution centers. Our distribution centers receive and allocate merchandise to our stores. Events such as fire or other catastrophic events, any malfunction or disruption of our centralized information systems or shipping problems may result in delays or disruptions in the timely distribution of merchandise to our stores, which could adversely impact our revenues and our business and financial results.
Our ability to successfully operate the new regional distribution center in Burlington, New Jersey will depend on the successful integration of our warehouse management systems. Additionally, the success of this and other supply chain initiatives is heavily dependent on the implementation and consistent execution of new processes and the use of new systems capabilities by our merchandising and supply chain personnel. The new distribution center may not enable us to improve the flow of merchandise to our stores or improve our inventory management.
Lack of available retail store sites on terms acceptable to us, rising real estate prices and other costs and risks relating to new store openings could severely limit our growth opportunities.
Our strategy includes opening stores in new and existing markets. We must successfully choose store sites, execute favorable real estate transactions on terms that are acceptable to us, hire competent personnel and effectively open and operate these new stores. Our plans to increase the number of our retail stores will depend in part on the availability of existing retail stores or store sites. We may not have stores or sites available to us for purchase or lease, or available on terms acceptable to us. If additional retail store sites are unavailable on acceptable terms, we may not be able to carry out a significant part of our growth strategy. Rising real estate costs and acquisition, construction and development costs could also inhibit our ability to grow. If we fail to locate desirable sites, obtain lease rights to these sites on terms acceptable to us, hire adequate personnel and open and effectively operate these new stores, our financial performance could be adversely affected.
We may pursue strategic acquisitions, which could have an adverse impact on our business.
We may from time to time acquire complementary companies or businesses. Acquisitions may result in difficulties in assimilating acquired companies, and may result in the diversion of our capital and our management's attention from other business issues and opportunities. We may not be able to successfully integrate operations that we acquire, including their personnel, financial systems, distribution, operations and general store operating procedures. If we fail to successfully integrate acquisitions, our business could suffer. In addition, the integration of any acquired business, and their financial results, into ours may adversely affect our operating results. We currently do not have any agreements with respect to any such acquisitions.
ITEM 7A.
ITEM 7A. Quantitative and Qualitative Disclosures about Market Risk
Our primary interest rate risk exposure results from our long-term debt agreement. Our long-term debt bears interest at variable rates that are tied to either the U.S. prime rate or LIBOR at the time of the borrowing. We maintain portions of our debt in LIBOR traunches that mature in one to nine months. As those traunches mature, the interest rates on our outstanding borrowings are changed to reflect current prime or LIBOR rates. Therefore, our interest expense changes as the prime or LIBOR market rates change. We have entered into two interest rate swap instruments, designated as cash flow hedges, as shown in the following table:
Based on our overall interest rate exposure at January 31, 2004, a hypothetical instantaneous increase or decrease of one percentage point in interest rates applied to borrowings under our revolving credit facility would change our after-tax earnings by approximately $1.6 million over a 12-month period prior to considering the effects of our interest rate swaps.
Our exposure to foreign currency exchange rates is limited because we do not operate any stores outside of the United States. We do not consider the market risk exposure relating to foreign currency exchange to be material. Foreign currency fluctuations did not have a material impact on us during the quarter or year to date periods in fiscal 2003, 2002 or 2001.
ITEM 8.
ITEM 8. Financial Statements and Supplementary Data
The financial statements and supplementary financial information required by this Item and included in this report are listed in the Index to Consolidated Financial Statements appearing on page.
ITEM 9.
ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None
ITEM 9A.
ITEM 9A. Controls and Procedures
Under the supervision and with the participation of our management, including the Chief Executive Officer and Chief Financial Officer, we have conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange Act")) as of the end of the period covered by this report (the "Evaluation Date"). There are inherent limitations to the effectiveness of any system of disclosure controls and procedures, including the possibility of human error and the circumvention or overriding of the controls and procedures. Accordingly, even effective disclosure controls and procedures can only provide reasonable assurance of achieving their control objectives. Based on such evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that, as of the Evaluation Date, our disclosure controls and procedures are effective in alerting them on a timely basis to material information relating to us required to be included in our reports filed or submitted under the Exchange Act.
There was no change in our internal control over financial reporting during our fourth fiscal quarter in 2003 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
PART III
ITEM 10.
ITEM 10. Directors and Executive Officers of the Registrant
Directors
The following table and information sets forth the names of the Directors, the year from which each individual has served as a Director, the age of each Director and the principal occupation of each Director.
Martin E. Hanaka. Mr. Hanaka serves as chairman of the board and has served in such position since August 2003, the time of the merger of The Sports Authority and Gart Sports Company. Mr. Hanaka joined the former The Sports Authority in February 1998 as its vice chairman and served as its chief executive officer from September 1998 to August 2003. He served as The Sports Authority's chairman since November 1999. From 1994 until October 1997, Mr. Hanaka served as president and chief operating officer and a director of Staples, Inc., an office supply retailer. Mr. Hanaka's extensive retail career includes serving as executive vice president of marketing and as president and chief operating officer of Lechmere, Inc. from 1992 to 1994, and serving in various capacities during his 20-year career at Sears Roebuck & Co., most recently as Vice President in charge of Sears Brand Central. Mr. Hanaka also serves as a director of Trans-World Entertainment, a movie and video retail chain operating under several brands, and the Sporting Goods Manufacturers Association, as a national trustee of the Boys & Girls Clubs of America, and as a member of the Cornell University Entrepreneurship and Personal Enterprise Council and the Cornell University Council.
John Douglas Morton. Mr. Morton is vice chairman of the board and chief executive officer of the Company and has held such positions since August 2003. Prior to that time, from May 1995, Mr. Morton was our president, chairman of the board and chief executive officer. Mr. Morton joined us in 1986 as division manager of our Utah region. In 1988, he was promoted to division vice president of the Utah region, and, in 1990, he was promoted to vice president of operations. In 1994, Mr. Morton was promoted to executive vice president with responsibility for stores, distribution and marketing. Prior to joining us, he served in various positions with Wolfe's Sporting Goods, a seven-store sporting goods retailer, from 1972 to 1980, including merchandise manager-ski, camping, golf and tennis, store manager, and operations manager. From 1980 until joining us, he served as a district manager for Malone and Hyde's sporting goods division, a 40-store retail sporting goods retailer. Mr. Morton has worked for over 30 years in the sporting goods retail industry. Mr. Morton also serves on the board of Ultimate Electronics, Inc., an electronics retail chain.
Gordon D. Barker. Mr. Barker became one of our directors in April 1998. Mr. Barker was the chief executive officer and a director of Thrifty Payless Holdings, Inc., a subsidiary of RiteAid Corporation, from 1996 until its acquisition by RiteAid Corporation in 1997. He previously served in various capacities at Thrifty Payless since 1968, including as chief operating officer from 1994 to 1996 and as president from 1994 to 1997. Mr. Barker served as chief executive officer of Snyder Drug Stores/Drug Emporium, a privately held mid-western chain of approximately 240 corporate and affiliate
drug stores, from October 1999 until September 2003, at which time Snyder Drug Stores filed for bankruptcy protection under Chapter 11 of the United States Bankruptcy Code. Mr. Barker is also a director of United Natural Foods, a distributor of natural food products.
Mary Elizabeth Burton. Ms. Burton became one of our directors in August 2003 at the time of the merger of The Sports Authority and Gart Sports Company. Ms. Burton was a director of the former Sports Authority since 1999. Since July 1992, Ms. Burton has also served as chairman and chief executive officer of BB Capital, Inc., a management services and advisory company, which she owns. From June 1998 until April 1999, Ms. Burton serves as the chief executive officer of The Cosmetic Center, Inc., a specialty retailer of cosmetics and fragrances. From July 1991 to June 1992, Ms. Burton served as the chief executive officer of PIP Printing, Inc., a leading business printing franchise chain. In addition, Ms. Burton was the chief executive officer of Supercuts, Inc., from September 1987 until May 1991, as well as having served in various other senior executive level capabilities in the retailing industry. Ms. Burton currently also serves as a director of Staples, Inc., Zale Corporation, Aeropostale, Inc. and Rent-A-Center, Inc.
Cynthia R. Cohen. Ms. Cohen became one of our directors in August 2003 at the time of the merger of The Sports Authority and Gart Sports Company. Ms. Cohen was a director of the former Sports Authority since 1998. Ms. Cohen is the founder of Strategic Mindshare, a strategic management consulting firm serving retailers, consumer product manufacturers and e-businesses. She has served as President of Strategic Mindshare since the company's organization in 1990. Prior to that, Ms. Cohen was a partner in management consulting with Deloitte & Touche LLP. Ms. Cohen is a director of Office Depot, Inc., an office supply retailer, and Hot Topic, a teen apparel retailer. In addition, Ms. Cohen serves on the executive advisory board for the Center for Retailing Education and Research at the University of Florida and is Vice Chair of the Board of the Center for Women's Business Research.
Peter R. Formanek. Mr. Formanek became one of our directors in April 1998. Mr. Formanek was co-founder of AutoZone Inc., a retailer of aftermarket automotive parts, and served as president and chief operating officer of AutoZone, Inc. from 1986 until his retirement in 1994. He currently is a director of The Perrigo Company, a manufacturer of store brand over-the-counter drug products and vitamins. While Mr. Fornanek currently also serves as a director of Borders Group, Inc., the second largest operator of book superstores and the largest operator of mall-based bookstores in the United States, his term expires on May 20, 2004 and he is not standing for re-election to the Borders board.
Kevin M. McGovern. Mr. McGovern became one of our directors in August 2003 at the time of the merger of The Sports Authority and Gart Sports Company. Mr. McGovern was a director of the former Sports Authority since 2000. Mr. McGovern is currently the chairman and chief executive officer of McGovern Capital LLC, which structures, funds and implements capital formation, joint ventures and business alliances. He is the principal in the law firm of McGovern & Associates. Mr. McGovern also serves as the chairman of Greenwhich Alliances, which specializes in the formation and negotiation of strategic alliances. He is also a Trustee of Cornell University.
Jonathan D. Sokoloff. Mr. Sokoloff became one of our directors in April 1993. Mr. Sokoloff has been a partner of Leonard Green & Associates, L.P., a merchant banking firm and the general partner of Green Equity Investors, L.P., the holder of approximately 8% of our outstanding common stock, since 1990, and was employed at Drexel Burnham Lambert Incorporated from 1985 through 1990, most recently as a managing director. He has been an executive officer and equity owner of Leonard Green & Partners, L.P., a merchant banking firm affiliated with Leonard Green & Associates, L.P., since its formation in 1994, and is also a director of Rite Aid Corporation, Diamond Triumph Auto Glass, Inc., Dollar Financial Group, Inc., and several private companies.
Executive Officers
The following table sets forth the name and age of each of our executive officers and all positions and offices held with us:
John Douglas Morton. See "Directors" for information concerning Mr. Morton.
Elliott Kerbis. Mr. Kerbis is president and chief merchandising officer for The Sports Authority. He joined TSA in October 2000 as executive vice president-merchandising and sales promotion and was promoted to president and chief merchandising officer in January 2002. He previously served as Senior Vice President of Merchandise at Filene's, a department store owned by The May Department Store Company from May 1999 to August 2000, and as Executive Vice President of Merchandise for Hardlines of The Caldor Corporation, a discount retailer, from 1987 to 1999. Prior to joining Caldor Corporation, Mr. Kerbis served in various capacities with R.H. Macy & Co. from 1977 to 1987.
Thomas T. Hendrickson. Mr. Hendrickson became our non-director vice chairman and chief administrative officer in August 2003 in addition to being our chief financial officer and treasurer which he became in January 1998. Mr. Hendrickson previously served as the executive vice president and chief financial officer of Sportmart, which position he held since September 1996. He joined Sportmart in January 1993 as vice president-financial operations. In March 1993, he was named chief financial officer of Sportmart, and, in March 1995, he was named senior vice president and chief financial officer of Sportmart. From 1987 until joining Sportmart, Mr. Hendrickson was employed as the vice president and controller of Millers Outpost Stores. Mr. Hendrickson is a certified public accountant and has over 20 years of business experience.
Greg A. Waters. Mr. Waters became our chief operating officer in August 2003 in addition to being our executive vice president-store operations which he became in June 2001. He joined us in April 1998 as senior vice president-store operations. Prior to joining us, Mr. Waters served as the western regional vice president for The Sports Authority since 1994 and as a district manager for The Sports Authority since 1991.
Nesa E. Hassanein. Ms. Hassanein became our executive vice president in addition to being our general counsel and secretary which she became in June 2000. From June 2000 to August 2003, she was senior vice president, general counsel and secretary. Ms. Hassanein joined us in July 1998 as vice president and corporate counsel. Prior to joining us, Ms. Hassanein served as senior vice president and general counsel for Atlas Air Inc. during 1997. Ms. Hassanein previously served as a partner with Morrison & Foerster, LLP from 1995 to 1997, as a shareholder with Brownstein Hyatt Farber & Strickland, PC from 1992 to 1995, and as an associate with Skadden, Arps, Slate, Meagher & Flom from 1982 to 1991.
The remaining information required by this Item 10 is incorporated herein by reference, when filed, to our Proxy Statement for our 2004 Annual Meeting of Stockholders expected to be filed no later than May 3, 2004.
ITEM 11.
ITEM 11. Executive Compensation
Information required to be set forth in Item 11 has been omitted and will be incorporated herein by reference, when filed, to our Proxy Statement for our 2004 Annual Meeting of Stockholders expected to be filed no later than May 3, 2004.
ITEM 12.
ITEM 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Information required to be set forth in Item 12 has been omitted and will be incorporated herein by reference, when filed, to our Proxy Statement for our 2004 Annual Meeting of Stockholders expected to be filed no later than May 3, 2004.
ITEM 13.
ITEM 13. Certain Relationships and Related Transactions
Information required to be set forth in Item 13 has been omitted and will be incorporated herein by reference, when filed, to our Proxy Statement for our 2004 Annual Meeting of Stockholders expected to be filed no later than May 3, 2004.
ITEM 14.
ITEM 14. Principal Accountant Fees and Services
Information required to be set forth in Item 14 has been omitted and will be incorporated herein by reference, when filed, to our Proxy Statement for our 2004 Annual Meeting of Stockholders expected to be filed no later than May 3, 2004.
PART IV
ITEM 15.
ITEM 15. Exhibits, Financial Statement Schedules, And Reports on Form 8-K
(a) 1. Financial Statements:
See Index to Consolidated Financial Statements on page hereof.
2. Financial Statement Schedules:
All schedules are omitted because of the absence of conditions under which they are required or because the required information is presented in the consolidated financial statements or notes thereto.
3. Exhibits:
*Filed as part of this Annual Report on Form 10-K. (b) Reports on Form 8-K
We filed a Current Report on Form 8-K with the Commission dated December 2, 2003, to report under Item 5 that we issued a news release to report our earnings for the fiscal quarter ended November 1, 2003.
We filed a Current Report on Form 8-K with the Commission dated March 17, 2004, to report under Item 5 that we issued a news release to report our earnings for the fiscal year ended January 31, 2004.
THE SPORTS AUTHORITY, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Independent Auditors' Report
Consolidated Balance Sheets as of January 31, 2004 and February 1, 2003
Consolidated Statements of Income for the periods ended January 31, 2004, February 1, 2003 and February 2, 2002
Consolidated Statements of Stockholders' Equity and Comprehensive Income for the periods ended January 31, 2004, February 1, 2003 and February 2, 2002
Consolidated Statements of Cash Flows for the periods ended January 31, 2004, February 1, 2003 and February 2, 2002
Notes to Consolidated Financial Statements
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of
The Sports Authority, Inc.
We have audited the accompanying consolidated balance sheets of The Sports Authority, Inc. and subsidiaries as of January 31, 2004 and February 1, 2003, and the related consolidated statements of income, stockholders' equity and comprehensive income, and cash flows for each of the fiscal years ended January 31, 2004, February 1, 2003 and February 2, 2002. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of The Sports Authority, Inc. and subsidiaries as of January 31, 2004 and February 1, 2003, and the results of their operations and their cash flows for each of the fiscal years ended January 31, 2004, February 1, 2003 and February 2, 2002 in conformity with accounting principles generally accepted in the United States of America.
/s/ DELOITTE & TOUCHE LLP
Denver, Colorado
April 13, 2004
THE SPORTS AUTHORITY, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in Thousands, Except Share and Per Share Amounts)
See accompanying notes to consolidated financial statements.
THE SPORTS AUTHORITY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Dollars in Thousands, Except Share and Per Share Amounts)
See accompanying notes to consolidated financial statements.
THE SPORTS AUTHORITY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY AND COMPREHENSIVE INCOME
(Dollars in Thousands, Except Share Amounts)
See accompanying notes to consolidated financial statements.
THE SPORTS AUTHORITY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in Thousands)
See accompanying notes to consolidated financial statements.
THE SPORTS AUTHORITY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) Company
On August 4, 2003, a wholly-owned subsidiary of Gart Sports Company completed a merger with The Sports Authority, Inc. In connection with the merger, Gart Sports Company ("Gart") was renamed The Sports Authority, Inc. The references made to the entities herein refer to The Sports Authority, Inc. (formerly Gart Sports Company, which is also referred to as "Sports Authority" or "Company"). "TSA" refers to TSA Stores, Inc., (formerly known as The Sports Authority, Inc.). The statement of income for the year ended January 1, 2004 reflects the results of the combined company from the merger date. Prior year results, as well as results for the first 26 weeks of the year ended January 31, 2004, include the former Gart Sports Company on a stand-alone basis. In the merger, the TSA shareholders received 0.37 shares of Sports Authority common stock for each share of TSA stock they owned. With the addition of the 205 TSA stores, the combined company operated 384 retail sporting goods stores in 45 states as of January 31, 2004.
Under license and e-commerce agreements with GSI Commerce Inc. ("GSI"), GSI operates sporting goods retail websites at www.thesportsauthority.com, www.gartsports.com, www.sportmart.com, and www.oshmans.com. Under these agreements, GSI owns certain content and technology related to the website, purchases and owns the merchandise sold on the websites, and hosts, maintains, fulfills orders and furnishes all other "back-end" operations required to operate the websites. GSI receives all revenue generated from the websites and pays us a royalty based on a certain percentage of sales from these sites.
Mega Sports Co., Ltd. ("Mega Sports"), a joint venture between the Company and AEON Co., Ltd. ("AEON"), operates The Sports Authority stores in Japan pursuant to a license agreement with the Company. Under the agreement, Mega Sports pays a royalty based on its gross sales, in exchange for use of trademarks and other intangible property owned by the Company and for merchandising assistance provided by the Company. In April 2004, the license agreement was amended to extend the term of the agreement from 2005 to 2014 and to revise the royalty payable by Mega Sports, among other things. TSA Stores has a 19.9% ownership interest in Mega Sports. AEON is a major Japanese retailer that owns 4.5% of the Company's outstanding stock.
(2) Summary of Significant Accounting Policies
(a) Consolidation
The consolidated financial statements present the financial position, results of operations and cash flows of The Sports Authority, Inc. and its subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.
(b) Fiscal Year
The Company's fiscal reporting year ends on the Saturday closest to the end of January. The fiscal years referred to in these consolidated financial statements are the 52 weeks ended January 31, 2004 ("fiscal 2003"), the 52 weeks ended February 1, 2003 ("fiscal 2002"), and the 52 weeks ended February 2, 2002 ("fiscal 2001").
(c) Cash and Cash Equivalents
The Company considers cash on hand in stores, bank deposits and all highly liquid investments with original maturities of 3 months or less to be cash and cash equivalents.
(d) Accounts Receivable, Net
Receivables include trade and non-trade receivables. Trade receivables were $1.7 million at January 31, 2004 and $1.4 million at February 1, 2003. Non-trade receivables were $51.0 million at January 31, 2004 and $11.8 million at February 1, 2003 and consist primarily of amounts due from vendors under various incentive and promotional programs. Non-trade receivables at January 31, 2004 also included $10.9 million related to the sale-leaseback of a Sports Authority location.
(e) Inventories
The Company accounts for inventories at the lower of cost or market. Cost is determined using the average cost of items purchased and applying the dollar value last-in, first-out ("LIFO") inventory method. The Company's dollar value LIFO pools are computed using the Inventory Price Index Computation ("IPIC") method. LIFO cost of the Company's inventories is then compared to estimated market value. This assessment of estimated market value is based on the quality and age of merchandise, the rate of sale of merchandise, the quantities on hand, and the Company's assessment of the market conditions. Estimates and judgments are required in the determination of the market value of the Company's inventory and future events, like changes in customer merchandise preferences or unseasonable weather patterns, could impact the market value of the Company's inventory. At January 31, 2004 and February 1, 2003, the replacement cost of inventory, calculated by valuing inventories at the first-in, first-out method, approximated its carrying value.
Inventory shrinkage is accrued as a percentage of merchandise sales based on historical inventory shrinkage trends. The Company performs physical inventories at stores and distribution centers throughout the year. The reserve for inventory shrinkage represents an estimate for inventory shrinkage for each location since the last physical inventory date through the reporting date. These estimates are impacted by internal and external factors and may vary from actual results.
(f) Property and Equipment
Property and equipment are recorded at cost. Property under capital leases is stated at the present value of future minimum lease payments. Depreciation is provided on the straight-line method over the estimated useful lives of the assets, which range from three to nine years for furniture, fixtures, equipment and software. Property held under capital leases and leasehold improvements are amortized on the straight-line method over the shorter of the lease term or estimated useful life of the asset. Maintenance and repairs, which do not extend the useful life of the respective assets, are charged to expense as incurred.
The Company capitalizes the costs of major purchased and internally developed software systems and certain costs associated with customizing those systems. Related training costs and costs incurred post-implementation are expensed as incurred. The Company capitalized $894,000, $1,335,000 and $717,000 of internal payroll and related costs for fiscal years 2003, 2002 and 2001, respectively. Depreciation of purchased and internally developed software systems is calculated using the straight-line method over the estimated useful lives of the software, which range from three to seven years.
(g) Accounting for Long-Lived Assets and Long-Lived Assets to Be Disposed Of
Pursuant to Statement of Financial Accounting Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS No. 144"), the Company reviews long-lived tangible and intangible assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future net cash flows expected to be generated by the asset. If such assets are determined to be impaired, an impairment charge is recorded as measured by the excess of the carrying amount of the assets over their fair value. The Company did
not record a charge for asset impairment in fiscal 2003, 2002 or 2001. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell.
(h) Goodwill and Other Intangible Assets
In accordance with Statement of Financial Accounting Standards No. 142, "Accounting for Goodwill and Other Intangible Assets" ("SFAS No. 142"), the Company ceased amortization of goodwill derived from purchase business combinations completed prior to or on June 30, 2001 at the beginning of fiscal 2002. Prior to fiscal 2002, goodwill was amortized using the straight-line method over a period of 40 years. In lieu of amortization, SFAS No. 142 requires that goodwill and intangible assets deemed to have indefinite lives be evaluated for impairment on an annual basis.
The Company performs annual impairment testing which considers the Company's fair value to determine whether an impairment charge related to the carrying value of the Company's recorded goodwill and other intangible assets is necessary. As a result of this testing, the Company concluded that there was no such impairment loss at January 31, 2004 or February 1, 2003. The Company will continue to assess whether goodwill and trademarks are impaired on an annual basis. Additional impairment assessments may be performed on an interim basis if the Company encounters events or changes in circumstances, that would indicate that, more likely than not, the book value of goodwill has been impaired. Finite-lived intangible assets will continue to be amortized over their useful lives and periodically reviewed for impairment or if events or circumstances indicate impairment.
The adoption of SFAS No. 142 did not have a material impact on the Company's consolidated financial position, results of operations, or cash flows in regard to the impairment provisions of the statement while the application of the non-amortization provisions of the statement have resulted in the cessation of amortization of approximately $1.1 million per year.
Finite-lived intangible assets include favorable leases, loan origination costs and certain capitalizable costs incurred to obtain store locations. Additionally, in conjunction with the merger, the Company recorded an intangible asset representing the estimated fair value of a license agreement between TSA and Mega Sports Co., Ltd. ("Mega Sports"), a joint venture which operates The Sports Authority stores in Japan. Under the license agreement, Mega Sports pays royalties based on a percentage of Mega Sports gross sales, in exchange for use of trademarks, technology, and know-how of the Company and merchandising assistance by the Company. The fair value of the contract reflects estimated, discounted royalty income to be received under the license agreement. Loan origination costs are amortized using the interest method over the term of the related debt. Favorable lease assets and other costs incurred to obtain store locations are amortized over the related lease term, and the Mega Sports license agreement is amortized over the life of the contract. Non-amortized intangible assets include goodwill and trademarks. Goodwill is related to previous acquisitions and the TSA merger. Trademarks primarily represent an estimate of the value of the TSA name. The carrying amount of intangible assets, including goodwill, is as follows (in thousands):
The changes in the carrying amount of goodwill for the year ended January 31, 2004 are as follows:
During the year ended January 31, 2004, amortization of intangible assets was $5.3 million. The estimated amortization of intangible assets for each of the five fiscal years ending in fiscal 2008 is as follows (in thousands):
(i) Self Insured Reserves
The Company is self-insured for its workers' compensation, general liability and employee medical plans up to a self-insured retention amount. The Company records a reserve for the estimated cost of both reported and incurred but not reported ("IBNR") claims. The estimate of its current claim obligation requires significant judgment and is based on specific loss estimates for reported claims, and on loss triangulation estimates of future claims payments, including IBNR's. Reserves are regularly evaluated for adequacy based on the most current available information, including historical claims experience and expected future claims costs.
(j) Revenue Recognition
Revenue from merchandise sales is recognized when merchandise is sold, net of an allowance for estimated returns. Revenue from service sales is recognized when the services are performed. Sales returns approximated 6% of net sales in fiscal year 2003, and approximated 4% of net sales in fiscal years 2002, and 2001. The Company's allowance for sales returns is reviewed for adequacy based on current returns experience. The Company records revenue from sales made under its layaway program upon the final payment and delivery of the layaway merchandise to the customer. Any deposits received prior to final delivery of the product are recorded as a current liability. The Company records royalties under license agreements with Mega Sports and GSI Commerce, Inc. ("GSI") as a component of net sales when earned. These royalties totaled less than 0.5% of Net Sales in each of the fiscal years 2003, 2002 and 2001.
(k) Vendor Allowances
The Company receives certain allowances from its vendors, which include rebates and cooperative advertising funds. These amounts are negotiated with vendors typically on an annual basis and are, at times, dependent on projected purchase volumes and advertising plans. The amounts are subject to changes in market conditions or marketing strategies of our vendors, and changes in our product purchases. We record an estimate of earned allowances based on the latest information available with respect to purchase volumes, advertising plans and status of our negotiation with vendors. Cooperative advertising funds are recorded as a reduction of advertising costs in the period in which the costs are
incurred. Volume allowances that are not a reimbursement of specific costs are recorded as a reduction of the cost of inventory.
(l) Pre-Opening Expenses
The Company expenses pre-opening costs in the period in which they are incurred. Pre-opening expenses include payroll, supplies and other costs incurred prior to the store opening date, and typically approximate $125,000 per new store and totaled $1.6 million, $1.2 million and $0.8 million for fiscal 2003, fiscal 2002 and fiscal 2001, respectively.
(m) Advertising Costs
Advertising costs are expensed in the period in which the advertising occurs. The Company participates in various advertising and marketing cooperative programs with its vendors, who, under these programs, reimburse the Company for certain costs incurred. A receivable for cooperative advertising to be reimbursed is recorded as a decrease to expense as the reimbursements are earned. Gross advertising expense incurred prior to vendor allowances was approximately $80.1 million, $46.0 million and $41.2 million in fiscal years 2003, 2002 and 2001, respectively. Cooperative advertising allowances recorded as a reduction of advertising expense were $32.8 million, $28.2 million and $22.9 million in fiscal years 2003, 2002 and 2001, respectively, resulting in net advertising costs, which are included in operating expenses, of $47.3 million, $17.8 million and $18.3 million in fiscal years 2003, 2002 and 2001, respectively.
(n) Merger Integration Costs
Merger integration costs are costs incurred in connection with the Company's merger and acquisitions. These costs include only non-recurring, incremental costs arising as a direct result of the merger or acquisition, are included as a component of operating income in the accompanying statements of income and are expensed as incurred. Merger integration costs totaled $43.8 million, $0.0 million and $12.5 million for fiscal years 2003, 2002 and 2001, respectively.
(o) Income Taxes
In connection with the TSA merger, the Company changed its tax year from the Saturday closest to the end of September to the Saturday closest to the end of January, commensurate with its fiscal year end. Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in operations in the period that includes the enactment date. Deferred tax assets are reviewed for recoverability based on projections of future operating results, which dictate the Company's ability to realize the tax assets. A valuation allowance to reduce the carrying value of the deferred tax assets is recorded when this amount exceeds the amount more likely than not to be realized. As of January 31, 2004, the Company had no valuation allowance on its deferred tax assets.
(p) Earnings Per Share
Basic earnings per share ("EPS") is computed by dividing earnings available to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution of securities that could share in earnings. In loss periods, including common stock equivalents would be anti-dilutive and, accordingly, no impact is provided for common stock equivalents. The computation of diluted EPS also excludes the effect of anti-dilutive stock options outstanding in each of the respective periods aggregating 455,910 in fiscal 2003, 19,451 in fiscal 2002 and 61,827 in fiscal 2001.
(q) Stock Compensation Plans
At January 31, 2004, the Company has three stock-based employee compensation plans, which are described more fully in Note 17. The Company accounts for the stock-based compensation granted to employees under the plans using the recognition and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations. Historically, no stock-based employee compensation cost has been recorded in net income for the Company's stock options, as options granted under the plan had an exercise price equal to the market value of the underlying common stock on the date of grant. Compensation expense is recorded by the Company for its grants of unvested restricted stock or for grants of stock-based compensation to nonemployee directors. The compensation expense is amortized on a straight-line basis over the vesting period of the stock and is based on the fair value of the stock on the date of the grant. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation, to stock-based employee compensation (in thousands).
The per share weighted-average fair value of stock options granted during fiscal 2003, 2002, and 2001 was $19.19, $15.59, and $10.26, respectively, on the date of grant or exchange using the Black Scholes option-pricing model (which incorporates a present value calculation).
The following weighted-average assumptions were used for grants issued in fiscal 2003, 2002, and 2001:
(r) Fair Value of Financial Instruments
The Company has estimated the fair value of its financial instruments using the following methods and assumptions: the carrying amounts of cash and cash equivalents, receivables and accounts payable approximate fair value because of their short-term nature, and the carrying amount of debt
approximates fair value because of the variable market rate of interest charged and use of interest rate swap agreements that qualify for hedge accounting.
(s) Derivative Instruments and Hedging
In June 1998, the Financial Accounting Standards Board (the "FASB") issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities". The Statement became effective in the first quarter of fiscal year 2001. The statement requires that every derivative instrument be recorded on the balance sheet as either an asset or liability, measured at its fair value, and requires that changes in the derivative's fair value be recognized currently in earnings, unless specific hedge accounting criteria are met. The Company adopted this statement on February 4, 2001. The Company utilizes two interest rate swap agreements to minimize the risks and costs associated with its financing activities (see Note 12). The Company has no other derivative instruments.
(t) Store Closing Reserves
Prior to December 31, 2002 and the adoption of SFAS No. 146, "Accounting for Costs associated with Exit or Disposal Activities," the Company recorded a provision for store closing when the decision to close a store was made. In accordance with SFAS No. 146, for store closing activities initiated after December 31, 2002, the Company records a liability at fair value for costs associated with exit or disposal activities when a liability is incurred rather than when the decision to close a store is made. This changes the timing of recognition for certain exit costs, so that certain exit costs will be recognized over the period in which the exit activities occur. The Company also records store exit reserves arising from its various mergers and acquisitions pursuant to SFAS No. 141, "Business Combinations" and EITF Issue No. 95-3, "Recognition of Liabilities in Connection with a Purchase Business Combination" ("EITF 95-3"). Under EITF 95-3, the costs of a plan to exit an activity of the acquired company are recognized as liabilities assumed in the business combination. As such, reserves are recorded in purchase accounting for the net present value of projected costs to be incurred after the store closing date. The costs incurred in connection with store closings primarily consist of future net lease obligations, utilities, property taxes, and employee costs directly related to the store closing.
(u) Acquisitions and Mergers Accounting
The Company's acquisitions and mergers are accounted for under the purchase method of accounting. Accordingly, the total costs of such transactions are allocated to the tangible and intangible assets acquired and liabilities assumed based on their respective fair values. The determination of fair values involves the use of estimates and assumptions, which are subject to adjustment in the future.
(v) Comprehensive Income
Accumulated other comprehensive income (loss) is comprised of unrealized holding gains (losses) on the Company's marketable securities and the fair value of the Company's interest rate swap agreements.
(w) Enterprise-Wide Operating Information
The Company is the largest publicly traded full-line sporting goods retailer in the United States. Given the economic characteristics of the store formats, the similar nature of the products sold, the type of customer and method of distribution, the operations of the Company are aggregated in one reportable segment as defined by Statement of Financial Accounting Standards No. 131, "Disclosure About Segments of an Enterprise and Related Information."
(x) Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States 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 date of the
financial statements and reported amounts of revenues and expenses during the reporting period. On an ongoing basis, management evaluates its estimates and judgments, including those related to inventory valuation, accounts receivable, the recoverability of long-lived assets including intangible assets, store closing reserves, income taxes, and the estimates used to apply the purchase method of accounting to the Company's mergers and acquisitions. Actual results could differ from those estimates.
(y) New Accounting Pronouncements
In April 2003, the FASB issued Statement No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities." This Statement amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities under Statement No. 133, "Accounting for Derivative Instruments and Hedging Activities." The provisions of this Statement are effective for the Company for all derivatives and hedging activity entered into after June 30, 2003. The adoption of this Statement had no impact on the Company's overall financial position and results of operations.
In May 2003, the FASB issued Statement No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity." This Statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. The provisions of this Statement are effective for these financial instruments with the Company's fiscal year beginning February 1, 2004. It is anticipated that the adoption of this Statement will have no material impact on the Company's overall financial position and results of operations.
In November 2002, the EITF of the FASB issued consensus No. 02-16, "Accounting by a Customer (Including a Reseller) for Certain Consideration Received from a Vendor" ("EITF 02-16"). EITF 02-16 addresses how a reseller of a vendor's products should account for cash consideration received from the vendor and addressed two Issues. On Issue 1, the Task Force reached a consensus that cash consideration received from a vendor is presumed to be a reduction of cost of sales when recognized in the reseller's income statement. This presumption is overcome when the consideration is a reimbursement for specific, incremental, identifiable costs incurred by the reseller to sell the vendor's products, in which case the cash consideration should be characterized as a reduction of that cost when recognized in the reseller's income statement. Additionally, the Task Force concluded on Issue 2 that a refund or a rebate of a specified amount of cash consideration payable only if the reseller completes a specified level of purchases should be recognized as a reduction of cost of sales based on a systematic and rational allocation of the cash consideration offered to each of the underlying transactions that results in progress by the reseller toward earning the refund or rebate, provided the amounts are probable and reasonably estimable. In its January 2003 meeting, the Task Force amended the transition guidance relative to adoption of EITF 02-16 to require that the consensus on Issue 1 be applied to new arrangements, including modifications of existing arrangements, entered into after December 31, 2002. Issue 2 remains applicable to arrangements entered into after November 21, 2002.
The Company has historically treated certain vendor entitlements as a reduction of inventory costs, while cooperative advertising reimbursements have been reflected as a reduction of selling, general, and administrative expense. The impact of EITF 02-16 on fiscal 2002 was immaterial and for fiscal 2003 was a recharacterization of $3.0 million, from reduction of advertising expense to reduction of cost of inventory purchased, of which $2.1 million was recognized in cost of goods sold in fiscal 2003. The net impact of EITF 02-16 on fiscal 2003 was a reduction of net income of $0.5 million, or $0.03 per diluted share.
(z) Reclassifications
Certain prior year amounts have been reclassified to conform to the current year presentation.
(3) Merger
On August 4, 2003, TSA was merged with a wholly-owned subsidiary of Gart Sports Company, as a result of which Gart Sports Company became the owner of 100 percent of the outstanding common stock of TSA and was renamed The Sports Authority, Inc. The primary reasons for the merger of Gart and TSA, and the primary factors that contributed to a purchase price that resulted in recognition of goodwill are:
•The merger would create a national sporting goods retailer, melding the complementary geographic footprints of Gart and TSA;
•The combined company could realize significant operating synergies and cost savings;
•The opportunity for enhanced brands offering, given the potential for the expansion of premium brands into all stores and the ability to strengthen vendor relationships and gain volume discounts with key national brands and use the best practices of each company in marketing;
•The opportunity for private label expansion, leveraging TSA's hardlines expertise and Gart's softline expertise and leveraging the size of the combined company to facilitate new product offerings and lower costs;
•The merger would enable the combined company to offer a broader selection of sporting goods to a greater number of consumers at competitive prices; and
•The combination would improve the combined company's access to financial resources in the future
Based on an exchange ratio of 0.37 shares of Gart common stock for each TSA share, Gart issued approximately 12.4 million common shares and 1.5 million vested employee stock options in the exchange, which increased stockholders' equity by approximately $201 million. The common stock was valued at $15.51 per share, which was the average closing price of Gart's common stock for two business days prior to and after the date the Agreement and Plan of Merger was executed, as well as the closing price on February 19, 2003, the date the Agreement and Plan of Merger was executed. The employee stock options were valued using the Black-Scholes option pricing model, based on assumptions prevalent at the February announcement date, which included an expected volatility rate of 69.1%, a risk free interest rate of 3.5%, an expected life of 1 year, and no dividend yield. The transaction is being accounted for using the purchase method of accounting as required by SFAS No. 141, "Business Combinations," with Gart as the accounting acquirer. Accordingly, the assets and liabilities of TSA have been adjusted to their fair values and the excess of the purchase price over the fair value of TSA assets acquired is recorded as goodwill in the accompanying balance sheet. The statement of income for the year ended January 31, 2004 reflects the results of the combined company from the merger date. Prior year results, as well as results for the first 26 weeks of the 52 weeks ended January 31, 2004, include the former Gart Sports Company on a stand-alone basis. The allocation of the purchase price to specific assets and liabilities is based, in part, upon independent appraisals and internal estimates of cash flow and recoverability, and may be revised as more definitive facts and
evidence become available. The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at August 4, 2003:
The following unaudited pro forma summary presents information as if TSA had been acquired at the beginning of each period presented. The pro forma amounts include certain adjustments, including recognition of depreciation and amortization based on the preliminary allocated purchase price of property and equipment acquired, amortization of favorable leases, amortization of other finite lived intangible assets acquired, interest expense, and cessation of the amortization of certain lease acquisition costs. The pro forma amounts do not reflect any benefits from synergies, which might be achieved from combining the operations. No adjustments have been made to the pro forma statement of income to conform accounting policies and practices. In addition, no adjustments have been made to eliminate the after-tax effect of certain items included in the amounts below, for the 52 weeks ended January 31, 2004, including: $26.7 million of merger integration costs; $0.9 million of costs to settle class-action wage and hour lawsuits; $1.8 million of merger related costs recorded by TSA prior to the merger date of August 4, 2003; and $1.3 million of interest income and a $1.7 million tax benefit, both related to the settlement of a tax dispute with the Company's former parent.
The pro forma information does not necessarily reflect the actual results that would have occurred had the companies been combined during the periods presented, nor is it necessarily indicative of the future results of operations of the combined companies.
(4) Acquisition
On June 7, 2001, Gart Sports Company completed its acquisition of Oshman's Sporting Goods, Inc. The consideration consisted of approximately 3.4 million shares of Gart Sports Company common stock valued at approximately $37.8 million and approximately $50.2 million in cash. At the time of the acquisition, Oshman's operated 58 sporting goods specialty stores, including 43 SuperSports USA stores and 15 traditional stores. The acquisition was accounted for under the purchase method of accounting, and accordingly, the accompanying statements of income include the results of Oshman's since the date of the acquisition.
The total cost of the acquisition has been allocated to the tangible and intangible assets acquired and liabilities assumed based on their respective fair values. The final adjusted allocation of the purchase price is as follows (in thousands):
(5) Accounts Receivable
Activity in the allowance for doubtful accounts is as follows (in thousands):
(6) Property and Equipment
Property and equipment consist of the following (in thousands):
Land and buildings at January 31, 2004 includes six owned and operating store sites acquired in the TSA merger, as well as three closed store sites. Prior to year-end, the Company completed separate sale-leaseback transactions on two additional TSA-owned store sites for combined proceeds of $16.0 million, of which $10.9 million was received in early fiscal 2004.
(7) Favorable Leases
Favorable leases acquired in the TSA merger and Oshman's acquisition were primarily the result of net current market rents of store locations exceeding the contractual lease rates at the merger date. The favorable lease amounts are based upon independent appraisals and are amortized over the existing lease terms on a straight-line basis. In fiscal 2003 and 2001, the Company recorded $14.5 million and $13.3 million of favorable leases in connection with the TSA merger and Oshman's acquisition, respectively. Amortization expense was $3,064,000 for fiscal 2003, $1,859,000 for fiscal 2002 and $1,152,000 for fiscal 2001.
(8) Accrued Expenses
Accrued expenses consist of the following (in thousands):
(9) Long-Term Debt
Upon consummation of the merger, the Company entered into a new credit financing agreement (the "Credit Agreement") with CIT, as agent, that allows the Company to borrow up to $600,000,000, limited to an amount equal to 70% of eligible inventory or 85% of the appraised net orderly liquidation value of eligible inventory (as defined in the Credit Agreement). The Company is also entitled to seasonal increases in the inventory advance rate for up to 120 days during any calendar year as designated by the Company for the lesser of 80% of eligible inventory or 90% of appraised net orderly liquidation value. Borrowings are secured by substantially all present and future accounts (as defined in the Credit Agreement), inventories, trade receivables, equipment, documents of title and intangible assets. The borrowings mature, absent an occurrence of default under the agreement, on August 4, 2007. The Credit Agreement contains certain covenants, including financial covenants that require the Company to maintain a specified minimum level earnings before interest, taxes, depreciation and amortization to interest ratios if the Company does not have at least $50 million available for borrowing in the first year, $60 million in the second year and $75 million thereafter. In addition, the Credit Agreement restricts, among other things, the Company's ability to incur additional debt, to merge, consolidate or sell assets, to make loans or advances to others, to guaranty obligations of others, to pledge its assets, to make certain investments, and to engage in transactions with affiliates. The Company's ability to declare or pay dividends on its common stock and to repurchase its common stock is limited to $16 million per year under the Credit Agreement. The Company is in compliance with all covenants under the Credit Agreement. In connection with the Credit Agreement, the Company pledged all of the outstanding common stock of its subsidiaries, including TSA Stores, Inc.,
its principal operating retail subsidiary, as collateral for the Credit Agreement. Interest is payable monthly at Chase Manhattan Bank's prime rate plus a margin rate ranging from 0% to 0.50% or, at the option of the Company, at Chase Manhattan Bank's LIBOR rate plus a margin rate ranging from 1.50% to 2.50%. At January 31, 2004, and February 1, 2003, $317.3 million and $121.1 million, respectively, remained outstanding under the Credit Agreement and $139.5 million and $90.6 million, respectively, was available for borrowing.
Loan interest is payable monthly at Chase Manhattan Bank's prime rate plus a margin rate ranging from 0% to 0.50% or, at the option of the Company, at Chase Manhattan Bank's LIBOR rate plus a margin rate ranging from 1.50% to 2.50%. The Company's margin rates for the first loan year were 0.0% on prime and 2.0% on LIBOR borrowings The margin rates on borrowings during the term of the agreement may be reduced to as low as 0.0% on prime and 1.50% on LIBOR, respectively, if certain Earnings Before Interest, Taxes, Depreciation, and Amortization ("EBITDA") levels are achieved. The margin rates on current borrowings under the agreement are 0.0% on prime and 2.00% on LIBOR, based on the historical earnings levels achieved by the Company.
The terms of the agreement provide for an annual collateral management fee of $200,000 and an unused line of credit fee, payable monthly, of .375% per annum on the unused portion of the line of credit. At the end of fiscal 2003 and 2002, $317.3 million and $121.1 million, respectively, were outstanding under the Credit Agreement and $139.5 million and $90.6 million, respectively, were available for borrowing, as calculated using eligible inventory. Borrowings under the new Credit Agreement of approximately $123 million were utilized to repay outstanding borrowings owed by TSA under its revolving credit facility at the time of the merger.
The Company paid one-time fees of approximately $6.1 million in fiscal 2003 to secure the new Credit Agreement, and is amortizing that amount over the life of the agreement on the effective interest method.
The new Credit Agreement replaced a $300,000,000 credit agreement between Gart Bros. Sporting Goods Company and CIT. Interest under the prior facility was payable monthly at Chase Manhattan Bank's prime rate plus a margin rate not to exceed 0.25% or, at the option of the Company, at Chase Manhattan Bank's LIBOR rate plus a margin rate not to exceed 2.25%. The replaced agreement contained terms and conditions substantially like those of the new Credit Agreement, but provided for a lower inventory advance rate and a higher interest margin rate. Borrowings under the prior agreement were paid in full at the merger date.
As of January 31, 2004, the Company has 25 letters of credit outstanding that total approximately $15.8 million and expire throughout 2004.
(10) Other Long-Term Liabilities
Other long-term liabilities consist of the following (in thousands):
(11) Store Closing Activities
In fiscal 2003, the Company recorded $79.0 million of store closing reserves as a part of its purchase accounting for the TSA merger, comprised of: (a) $22.4 million for the estimated fair value of
store closing reserves related to TSA stores closed prior to the merger, (b) $53.2 million for 27 TSA stores that have been targeted for closure due to the merger, as well as the TSA corporate office, and (c) $3.4 million for excess space at two open TSA stores. The $53.2 million reserve relates to stores targeted for closure as a result of the merger, due principally to their location in overlapping Gart markets or due to historical underperformance. The $3.4 million reserve relates to vacant space at one TSA store due to the loss of a subtenant, and at another store where the Company entered into an agreement with the landlord to buy out of the unutilized space in 2004. As of January 31, 2004, the Company had closed eleven TSA locations and relocated two others. The remaining stores in the TSA store exit plan are expected to close within the next 12 to 15 months.
The Company also recorded store exit reserves of $1.3 million for one Oshman store closed in the third quarter of 2003 due to its close proximity to an existing TSA store, which was included in integration expense in the accompanying statement of income. Additionally, reserves for two previously closed store sites and the former Gart corporate office were increased by $0.8 million, due primarily to loss of subtenant revenues. The charge was recorded as a component of operating expenses in the accompanying statement of income. Finally, reserves for two previously recorded Oshman's store closures were reversed due to no future obligations, and such reversal reduced goodwill in the accompanying balance sheet. The Company regularly evaluates the adequacy of its store closing reserves based on recent broker analyses, general economic conditions, current trends in the real estate market, and historical experience with respect to marketing its closed store sites.
Activity in the provision for closed stores is as follows:
(1)At January 31, 2004, the ending reserve balance is comprised of $74.2 million of remaining reserves established as a component of purchase accounting in connection with the Company's merger and acquisitions. The remaining balance of $1.3 million represents remaining reserves established in connection with routine store closing activities unrelated to the Company's merger or acquisitions.
(12) Financial Instruments and Risk Management
Interest Rate Instruments
The Company entered into an interest rate swap agreement on June 28, 2001, expiring on June 30, 2004, for a notional amount of $20 million and entered into a second interest rate swap agreement on December 11, 2002 for a notional amount of $40 million, beginning September 2, 2003, and expiring on May 31, 2005, to minimize the risks and costs associated with its financing activities in general and to minimize its exposure to variable cash flows in particular. Under the swap agreements, the Company pays fixed rate interest and receives variable LIBOR interest rate payments periodically over the life of the agreement. The total notional interest rate swap amounts are $60 million and are used to measure interest to be paid or received and do not represent the exposure due to credit loss.
The Company's interest rate swaps are each designated as a cash flow hedge and are considered highly effective, as defined by FASB Statement No. 133. There is no charge to earnings for changes in the fair value of the swap agreements. Cash settlements on the swap agreements are recorded as interest expense. At January 31, 2004 and February 1, 2003, the fair value of the swaps was a loss of $759,000 and $903,000, respectively, net of the related tax benefit. The unrealized losses from these interest rate swaps are included in other comprehensive income and are shown as a component of stockholders' equity.
(13) Income Taxes
Income tax benefit (expense) consists of the following (in thousands):
A reconciliation of the U.S. federal statutory tax rate to the Company's effective tax rate is as follows:
The tax effects of temporary differences that give rise to significant portions of deferred tax assets and deferred tax liabilities are presented below (in thousands):
On a tax basis, the Company generated a net operating loss for the fiscal year 2003, and utilized approximately $36.6 million and $0 of its net operating loss carryforwards to reduce taxable income in fiscal 2002 and 2001, respectively. Of the $36.6 million utilized in fiscal 2002, approximately $20.0 million was in connection with the agreement entered into with the IRS on November 1, 2002, described below. At January 31, 2004, the Company has $132.0 million of federal and $300.0 million of state net operating loss carryforwards expiring from 2014 to 2024. Of these, $14.1 million of federal and $181.3 million of state net operating loss carryforwards relate to the TSA merger. In addition, the Company also has tax credit carryforwards of $5.7 million, of which $2.9 million have no expiration date and $2.8 million expire in varying amounts through 2024. Based upon the Company's performance, current tax planning strategies and management estimates of future taxable income, management believes it is more likely than not, that all of the Company's tax assets including operating loss carryforwards, will be utilized. As such, no valuation allowance has been established.
Prior to April 21, 1994, the Company's financial results were included in the consolidated U.S. federal income tax returns of its former parent. Pursuant to the tax sharing agreement between the Company and its former parent, which was effective from September 25, 1992 up to and including April 20, 1994, the Company recorded income taxes assuming the Company filed a separate income tax return. The tax sharing agreement also provides for the treatment of tax loss carrybacks, indemnifications, and resolution of disputes.
On November 1, 2002, in order to eliminate the accrual of additional interest on taxes owed to the IRS, the Company entered into an agreement with the IRS, based upon the terms of a settlement between the IRS and the Company's former parent which was subsequently approved by the Joint Committee of Taxation in August of 2003. Pursuant to the agreement, the Company paid the IRS tax
of $1.1 million and interest of $0.5 million. As such, the Company recorded a reversal of its remaining accrued interest payable to the IRS, totaling approximately $0.7 million. The tax liability settled under the agreement was recorded as a reduction of the long-term deferred tax liability that had been established previously in relation to this matter. A significant portion of the tax liability agreed to by the Company under the agreement did not require cash payment as those adjustments reduced existing net operating losses carryforwards previously generated by the Company. The Company believes this to be a full and complete settlement of all its separate return issues under review by the IRS. In addition, during the first quarter of fiscal 2003, the Company finalized a settlement with its former parent under the tax sharing agreement. As a result, the Company received a refund of $4.6 million, which included tax and interest in the amount $2.5 million and $2.1 million, respectively. An income tax benefit in the amount of $1.7 million was recognized in the first quarter of fiscal 2003 for that part of the tax refund in which a deferred asset had not previously been established.
(14) Leases
The Company is obligated for one leased property which is classified as a capital lease for financial reporting purposes. The lease term expires in 2007 and provides for minimum annual rental payments plus contingent rentals based upon a percentage of sales in excess of stipulated amounts. The gross amount of capitalized property under capital leases and related accumulated amortization recorded is included in property and equipment.
The Company has noncancelable operating leases primarily for stores, distribution facilities, corporate offices and equipment, expiring at various dates from 2004 to 2023. These leases generally contain renewal options for multiple five-year renewal periods and require the Company to pay all executory costs such as real estate taxes, maintenance and insurance. Certain leases include contingent rentals based upon a percentage of sales in excess of a specified amount. The Company also subleases all or parts of certain excess property it currently leases. Eight of the leases are with partnerships, the partners of which are former directors of the Company and thier family members. Rent expense under these related party lease agreements was as follows (in thousands):
Total rent expense under all operating lease agreements was as follows (in thousands):
Minimum base rentals include noncash rent expense related to the amortization of deferred rent totaling $5,434,000 in fiscal 2003, $2,686,000 in fiscal 2002, and $2,022,000 in fiscal 2001.
At January 31, 2004, future minimum lease payments under noncancelable leases, with initial or remaining lease terms in excess of one year, are as follows (in thousands):
The total future minimum lease payments include amounts to be paid to related parties and are shown net of $23,483,484 of noncancelable sublease payments and exclude estimated executory costs, which are principally real estate taxes, maintenance, and insurance.
In connection with the transfer of certain leased stores to a former affiliate in 1991, the Company remains liable as assignor on one lease. The former affiliate has agreed to indemnify the Company for any losses it may incur as assignor, however, such indemnification is unsecured. In addition, the Company remains liable as assignor on three leases as a result of the Sportmart acquisition. The remaining future minimum lease payments on these leases, exclusive of any variable rent or cost reimbursement that might be required, are as follows at January 31, 2004 (in thousands):
In the event of default on the lease obligations, and failure by the assignee to indemnify the Company, the Company would incur a loss to the extent of any remaining obligations, less any obligation mitigated by the lessor re-leasing the property.
(15) Employee Benefit Plans
Profit Sharing Plan
In January 2004, the Company amended its 401(k) Retirement Plan to, among other things, increase the employer's matching contribution rate, reduce the eligibility period, and to cause employees of TSA Stores to vest 100% in matching contribution in their account as of January 1, 2004, qualified defined contribution profit sharing plan to include a 401(k) plan feature for all eligible
employees. On August 4, 2003, the TSA Stores, Inc. 401(k) Savings and Profit Sharing Plan was merged into the Company's plan. On August 1, 2001 the Oshman's Profit Sharing Plan was merged into the Company's plan. Participants vest in the Company's contributions at a rate of 20% per year after the first year of service. The plan provides for discretionary contributions, if any, by the Company in amounts determined annually by the Board of Directors. The Company matching contributions were $1,405,000 in fiscal 2003, $522,000 in fiscal 2002 and $320,000 in fiscal 2001.
(16) Deferred Compensation Plan
The Company has a nonqualified Deferred Compensation Plan (the "DCP") for certain members of management. Eligible employees may contribute a portion of base salary or bonuses to the plan annually. The DCP provides for additional matching contributions by the Company, with limitations similar to the Company's 401(k) plan, as well as discretionary contributions in an amount determined by the Company prior to the end of each plan year. The Company made no matching contributions to the DCP during fiscal 2003, 2002 or 2001.
(17) Stock Compensation Plans
Long Term Incentive Compensation Plan
In August 2003, the Company adopted a long term incentive compensation plan (the "Long Term Incentive Compensation Plan") following approval by the shareholders which authorizes the issuance of various equity based awards of 2,500,000 shares of common stock. As of January 31, 2004, 619,500 options and 482,000 restricted stock units have been issued and remain outstanding under the Long Term Incentive Compensation Plan. Stock options are granted with an exercise price equal to the fair value of the underlying stock at the date of grant. All stock options have a ten-year term and vest 25% per year over four years from the date of grant. Restricted stock, recorded at the fair value of the stock at the grant date, is granted to certain employees of the Company and either cliff vests after five years from the grant date or vests 20% per year over five years from the date of grant. The Company recorded approximately $15.4 million of unamortized compensation as a reduction to stockholders' equity in fiscal 2003 related to grants of restricted stock. These amounts are being amortized to compensation expense on a straight-line basis over the vesting period.
Management Equity Plan
The Company adopted a management equity plan (the "Management Equity Plan") which authorized the issuance of common stock plus grants of options to purchase shares of authorized but unissued common stock up to 3,000,000 combined shares and options. As of January 31, 2004, 147,600 purchased shares of common stock, 1,008,370 options, and 494,408 shares of restricted stock have been issued and remain outstanding under the Management Equity Plan. Stock options are granted with an exercise price equal to the estimated fair value of the underlying stock at the date of grant. All stock options have a ten-year term and vest 20% per year over five years from the date of grant. Restricted stock, recorded at the fair value of the stock at the grant date, is granted to certain employees of the Company and either cliff vests after five years from the grant date or vests 20% per year over five years from the date of grant. The Company recorded approximately $0.1, $0.2 and $1.5 million of unamortized compensation as a reduction to stockholders' equity in fiscal 2003, 2002 and 2001, respectively, related to grants of restricted stock under this Management Equity Plan. These amounts are being amortized to compensation expense on a straight-line basis over the vesting period.
Substitute Company Options
In connection with the merger with TSA, options outstanding under TSA's 2000 Stock Option and Stock Award Plan, the Salaried Employees' Stock Option and Stock Award Plan and the Director
Stock Plan were assumed by the Company. These substitute options were modified to Company options utilizing the same conversion ratio of 0.37 to one as the common stock and dividing the exercise price of the previous options by the conversion ratio. The holders of TSA substitute options vested fully on August 4, 2003. All such persons had their original terms during which holders can exercise those options. As of August 4, 2003, 4,008,059 TSA options were exchanged for 1,482,982 Company substitute options. As of January 31, 2004, 879,918 options remain outstanding under the TSA substitute options.
Stock option activity during the periods indicated for the Company's stock option plans was as follows:
Canceled options are a result of employee terminations.
The following table summarizes the status of outstanding stock options as of January 31, 2004:
Unvested stock grants under the equity award plans during the periods indicated were as follows:
(18) Related Party Transactions
Prior to the merger, Green Equity Investors, whose general partner is Leonard Green & Associates, LP ("LGA"), owned approximately 26% of the outstanding common stock of the Company, which equated to approximately 13% of the combined company post merger. In December 2003, LGA sold 1.1 million shares of stock, reducing its beneficial interest in the Company to approximately 8%. The Company had a management services agreement with LGA whereby LGA received an annual retainer fee of $0.5 million plus reasonable expenses for providing certain management, consulting and financial planning services. The management services agreement also provided that LGA may receive reasonable and customary fees and reasonable expenses from time to time for providing financial advisory and investment banking services in connection with major financial transactions that are undertaken. The management services agreement was due to terminate in January 2004. In September 2003, the Company bought out the remaining term of the agreement for $0.2 million. In addition, in the third quarter of 2003, the Company paid LGA a fee of $4.25 million, plus out-of-pocket expenses, in connection with the TSA merger which is included in the total purchase price paid.
The Company entered into a severance and noncancelable consulting agreement with Martin E. Hanaka, our Chairman of the Board and the former Chairman and CEO of TSA. Pursuant to the severance agreement, Mr. Hanaka's employment with the Company ceased as of December 31, 2003. Under this agreement, the Company will continue, until August 3, 2006, to nominate Mr. Hanaka, and, if elected by our shareholders, he shall serve as Chairman of the Board, to the extent the Board appoints him to such position. Pursuant to the terms of the agreement, Mr. Hanaka was paid a cash payment of $2.5 million, received $1.0 million in Company common stock, and his unvested equity awards became fully vested and remain exercisable until at least August 4, 2006. The amounts related to this agreement were recorded as merger integration costs in the accompanying Statement of Income. In addition and simultaneous with this agreement, the Company executed a consulting agreement with Mr. Hanaka. Mr. Hanaka has agreed to provide consulting services to the Company focussing on the cultural integration and the long-term strategic growth of the Company and the enhancement of the public reputation and image of the Company. Pursuant to the consulting agreement, the Company agreed to pay a fee of $100,000 per year to Mr. Hanaka and to pay his related office expenses in Fort Lauderdale, Florida, for his services to be rendered over a period of approximately 31 months, terminating August 3, 2006.
During 2001, the Company had noncancelable consulting agreements with certain former Oshman's executives who were formerly Directors of the Company. The Company paid fees ranging from $175,000 to $400,000 per year for services rendered for periods ranging from 12 to 30 months following the June 7, 2001 merger agreement. The consultants agreed to be available, from time to time, to advise the Company on strategic issues, planning, merchandising and operational issues related to the acquisition of Oshman's.
Mr. Morton, our Vice Chairman and Chief Executive Officer, has a brother who is the President for Scott USA. In the Company's view, all such purchases were made on an arm's length basis at prices that did not exceed those that the Company would have paid to another vendor. The Company purchased $2.1 million, $2.2 million, and $2.8 million in fiscal 2003, 2002 and 2001, respectively. In each of these years, such purchases represented less than 1% of our total purchases.
As of January 31, 2004, there were no payments due to LGA or other related parties except $1.0 million in Company common stock due to Mr. Hanaka, in connection with his severance agreement as outlined above. See future minimum lease payments at Note 14.
(19) Contingencies
Legal Proceedings
The Company is, from time to time, involved in various legal proceedings and claims arising in the ordinary course of business. Management believes that the outcome of all such pending legal proceedings to which the Company is a party will not, in the aggregate, have a material adverse effect on the Company's business, financial condition, or operating results.
In June 2000, a former employee of Sportmart brought two class action complaints in California against the Company, alleging various wage and hour claims in violation of the California Labor Code, California Business and Professional Code section 17200 and other related matters. One complaint alleges that the Company classified some of its managers in its California stores as exempt from overtime pay when they would have been classified as non-exempt and paid overtime. The second complaint alleges that the Company failed to pay hourly employees in its California stores for all hours worked. In March 2001, a third class action complaint was filed in the same court in California alleging the same wage and hour violations regarding classification of certain managers as exempt from overtime pay. In July 2001, a fourth complaint was filed alleging that store managers should also not be classified as employees exempt from overtime pay. All the complaints seek compensatory damages, punitive damages and penalties. The amount of damages sought is unspecified. The Company has entered into a settlement agreement relating to the first two complaints that were filed, which has received preliminary approval by the court. With the settlement of the first two complaints, the named plaintiffs in the third and fourth actions will be included in the settlement class although they may opt to proceed with their lawsuits on an individual basis. The Company recorded an estimated liability totaling $1.5 million, including attorney fees and expenses, in the year ended January 31, 2004.
In June 2003, Financo, Inc., a financial advisory firm, filed a complaint against Gart Sports Company in the Delaware Court of Chancery alleging that Gart Sports owed Financo $2,000,000 for services provided to Gart Sports in connection with the merger negotiations with TSA. No written contract exists between Gart Sports and Financo. The Company reached a settlement with Financo and paid a total of $500,000, including attorney fees and expenses, during the year ended January 31, 2004.
TSA Stores is one of thirty-three named defendants, including firearms manufacturers, distributors and retailers, in City of Chicago and County of Cook v. Beretta U.S.A. Corp. et al., Circuit Court of Cook County, Illinois. This suit was served on TSA Stores in November 1998. The original complaint was based on legal theories of public nuisance and negligent entrustment of firearms and alleged that the defendants created a public nuisance by distributing, marketing and selling firearms in the portion of Cook County outside Chicago knowing or recklessly disregarding that these guns would be illegally transferred and used in Chicago to commit crimes. The complaint sought damages allocated among the defendants exceeding $433 million to compensate the City of Chicago and Cook County for their alleged costs resulting from the alleged public nuisance. The complaint also sought punitive damages and injunctive relief imposing additional regulations on the methods the defendants use to distribute, market and sell firearms in Cook County. In February 2000, the Court dismissed the complaint's negligent entrustment count. The plaintiffs filed an amended complaint with the Court's permission in March 2000, which contained both the public nuisance and negligent entrustment counts. In September 2000, the Court granted the motions of the defendants to dismiss the amended complaint, in its entirety, with prejudice. In October 2000, the plaintiffs appealed the dismissal of their public nuisance claim to the Appellate Court of Illinois, First Judicial District. On November 4, 2002, the Appellate Court reversed the dismissal of the public nuisance claim and remanded the case to the trial court for further proceedings. On November 25, 2002, TSA Stores filed a petition for rehearing with the Appellate Court which was denied on March 7, 2003. On March 27, 2003, TSA Stores joined in a petition by the other defendants for leave to appeal to the Illinois Supreme Court of the Appellate Court's decision reversing the trial court's dismissal of the public nuisance claim, which was granted on
April 8, 2003. The Illinois Supreme Court heard oral arguments by the parties on September 10, 2003 and has yet to render a decision. The Company is currently unable to predict the outcome of this case.
(20) Earnings Per Share
The following table sets forth the computations of basic and diluted earnings per share.
(21) E-Commerce Agreement
In June 2001 and July 2001, the former Gart Sports Company and former Sports Authority, Inc., respectively, entered into separate license and e-commerce agreements with GSI, which expire on December 31, 2011 and November 8, 2019, respectively. Under the terms of the agreements, GSI developed and is currently operating four online sporting goods stores at www.thesportsauthority.com, www.gartsports.com, www.sportmart.com, and www.oshmans.com. Under these agreements, GSI owns certain content and technology related to the websites, purchases and owns the merchandise sold on the websites, and hosts, maintains, fulfills orders and furnishes all other "back-end" operations required to operate the websites. GSI receives all revenue generated from the websites and pays the Company a royalty based on a certain percent of sales from these sites. In connection with the e-commerce agreements, GSI granted Gart Sports a warrant to purchase 60,000 shares of common stock of GSI. A similar warrant for 30,000 GSI shares was acquired from Oshman's at the time of the acquisition. The Company sold 60,000 of these warrants in October 2001, and recognized a gain of $195,000. The remaining warrant to purchase 30,000 shares was exercised on November 2, 2001, and the shares that were acquired upon exercise of the warrant were classified as available-for-sale marketable equity securities and were sold in September 2003 for a realized gain of $100,000.
(22) Stock Offering
On May 29, 2002, the Company completed a stock offering for 3.5 million shares of common stock. This offering resulted in net proceeds of approximately $52 million from the sale of 1.75 million new shares by the Company. The Company used the net proceeds to repay certain borrowings under the revolving line of credit agreement with CIT Group/Business Credit, Inc. The balance of the shares was sold by selling stockholders, including Green Equity Investors, L.P. The Company did not receive any proceeds from the sale of shares by selling stockholders.
(23) Quarterly Financial Data (unaudited)
Note that the amounts below are not necessarily comparable to one another or to anticipated future periods due to the inclusion of TSA results since the August 4, 2003 merger date, Oshman's results since the June 7, 2001 acquisition date, and non-recurring merger integration costs.
(a)During the fourth quarter of 2003, the Company recorded vendor incentives, pursuant to vendor agreements and arising as a result of the TSA merger, resulting in an increase of gross profit of $4.3 million.
(b)During the fourth quarter of 2003, the Company recorded merger integration costs, net of tax, of $13.7 million related to the TSA merger.
(c)During the fourth quarter of 2002, the Company recorded a reduction of its required LIFO inventory reserve, increasing the Company's gross profit by $1.5 million.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on April 14, 2004 on its behalf by the undersigned thereunto duly authorized.
THE SPORTS AUTHORITY, INC.
BY:
/S/ JOHN DOUGLAS MORTON John Douglas Morton,
Vice Chairman of the Board and Chief Executive Officer
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that the undersigned officers or directors of the Registrant, by virtue of their signatures to this report, appearing below, hereby constitute and appoint John Douglas Morton and Thomas T. Hendrickson, or any one of them, with full power of substitution, as attorneys-in-fact in their names, places and stead to execute any and all amendments to this report in the capacities set forth opposite their names and hereby ratify all that said attorneys-in-fact do by virtue hereof.
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 indicated on April 14, 2004.
Signature
Title
/s/ JOHN DOUGLAS MORTON John Douglas Morton
Vice Chairman of the Board and Chief Executive Officer (Principal Executive Officer)
/s/ THOMAS T. HENDRICKSON Thomas T. Hendrickson
Chief Financial Officer, Chief Administrative Officer and Treasurer (Principal Financial and Accounting Officer)
/s/ MARTIN E. HANAKA Martin E. Hanaka
Chairman of the Board
/s/ JONATHAN D. SOKOLOFF Jonathan D. Sokoloff
Director
/s/ GORDON D. BARKER Gordon D. Barker
Director
/s/ PETER R. FORMANEK Peter R. Formanek
Director
II-1
/s/ MARY ELIZABETH BURTON Mary Elizabeth Burton
Director
/s/ CYNTHIA R. COHEN Cynthia R. Cohen
Director
/s/ KEVIN M. MCGOVERN Kevin M. McGovern
Director
II-2
EXHIBIT INDEX
II-3
II-4
II-5
*Filed as part of this Annual Report on Form 10-K. II-6