ITEM 1. BUSINESS
General
Sport Chalet, Inc. (the “Company”), founded in 1959, is a leading operator of 28 full service, specialty sporting goods superstores in Southern California and Nevada. The Company has 26 locations in California consisting of eleven located in Los Angeles County, six in Orange County, three in each of San Diego and San Bernardino Counties, two in Riverside, and one in Ventura County. Both Nevada locations are in Clark County. These stores average 38,800 square feet in size. In addition, the Company operates a retail e-commerce store through GSI Commerce, Inc. at www.sportchalet.com. The Company’s executive offices are located at One Sport Chalet Drive, La Canada, California 91011, and its telephone number is (818) 949-5300.
Operating History and Growth Plans
In 1959 Norbert Olberz, the Company’s Chairman Emeritus and Principal Stockholder (the “Principal Stockholder”), purchased a small ski and tennis shop in La Canada, California. A focus on providing quality merchandise with outstanding customer service was the foundation of Norbert’s vision. As a true pioneer in the industry Norbert’s mission was three simple things. To “see things through the eyes of the customer”; “to do a 1,000 little things better” and to focus on “being the best, not the biggest”. Over the last 44 years Sport Chalet has grown into a chain of 28 specialty retail superstores serving both Southern California and Nevada.
The Company’s growth strategy had historically focused on Southern California, but now contemplates opening new stores throughout California and Nevada as suitable locations are found over the next several fiscal years. Over the past three years, the Company has opened six new stores, two of which include the Company’s recent expansion into the Las Vegas market, and relocated one store. The Company currently plans to open at least three stores during the next 12 months, of which two will be the Company’s initial expansion into Northern California. The first Northern California location will be in the East Bay city of Antioch and the second will be in central Sacramento. The Company’s third location will be in the San Bernardino County city of Redlands. Future store openings are subject to availability of satisfactory store locations based on local competitive conditions, site availability and cost and the Company’s ability to provide and maintain high service levels and quality brand merchandising at competitive prices. For fiscal 2003, average sales per store for stores open throughout both fiscal 2003 and fiscal 2002 were $9.2 million, with corresponding average sales per square foot of $241.
Store openings are expected to have a favorable impact on sales volume, but will negatively affect profit in the short term. New stores tend to have higher costs in the early years of operation, due primarily to increased promotional costs and lower sales on a per employee basis until the store matures. As the store matures, sales tend to level off and expenses decline as a percentage of sales. The Company’s stores generally require three years to attract a stable, mature customer base. The Company estimates the cost of opening an average new store to be approximately $2.5 million consisting primarily of the investment in inventory (net of average vendor payables), the cost of fixtures and equipment and pre-opening expenses, such as the costs associated with training employees and stocking the store. Opening costs for each new store can vary significantly depending on how much the landlord has agreed to contribute to the Company’s required improvements.
The Company’s sales partially depend on the economic environment and level of consumer spending in California and Nevada. The retail industry historically has been subject to substantial cyclical variation, and a recession in the general economy or uncertainties regarding future economic prospects that affect consumer spending habits have had, and may in the future have, a materially adverse effect on the Company’s results of operations.
The Company’s corporate offices in prior years were spread over seven nearby buildings in La Canada, California neighboring the store where the Company was founded. To facilitate growth related to the expansion plans, the Company leased a new 27,500 square foot corporate office in La Canada from La Canada Properties, Inc., a corporation controlled by the Principal Stockholder, in October 2002. The Company expects this building to support its growth plans for the foreseeable future.
Stores and Merchandising
The Company’s new prototype stores range in size from 40,000 to 45,000 square feet and showcase each product category with the feel of a specialty shop all contained under one roof. The full service approach to customer service and product knowledge is enhanced by fixtures which feature specific categories, and give the customer an enhanced shopping experience. Each shop is staffed by trained sales associates with expertise in the merchandise they sell, permitting the Company to offer its customers a high level of product knowledge and service for the beginner to the professional sports enthusiast.
The Company’s new prototype format boasts a natural and outdoor-feel color scheme, clear-coated fixtures, 30-foot clear ceilings, large sport-specific graphics, pools for SCUBA and watersports instruction and demonstrations, and a 100 foot shoe wall, among other improvements. In coming years the Company plans to retro-fit certain mature stores to conform to the new prototype. During fiscal 2004, two stores will be remodeled, with expected grand re-openings in early summer 2003. The Company continually updates its prototype format to remain relevant and continually enhance the customer shopping experience. While the Company has taken advantage of unusual building layouts in the past and when appropriate may continue to do so in the future, it will utilize as many prototype design elements as possible.
The stores feature a number of distinct, specialty sporting goods divisions, offering a large assortment of quality brand name merchandise at competitive prices. The stores include traditional sporting goods merchandise (e.g., footwear, apparel and other general athletic products) and nontraditional merchandise such as downhill skiing, mountaineering and SCUBA. The merchandise appeals to both experts and beginners. In addition, the Company’s stores offer over 35 services for the serious sports enthusiast, including custom golf club fitting and repair, golf lessons, ski/snowboard rental and repair, full SCUBA training and certification programs, dive charters, team sales, racquet stringing, and bicycle tune up and repair. The Company’s stores are open seven days a week, typically from 9:30 a.m. to 9:30 p.m. Monday through Saturday, and 10:00 a.m. to 7:00 p.m. on Sunday.
The following table sets forth the percentage of total net sales for each major category for each of the last three fiscal years:
The Company operates its online store through GSI Commerce, Inc. (“GSI”) at www.sportchalet.com. GSI creates and operates all aspects of the www.sportchalet.com shopping experience, including fulfillment and purchasing, while remaining transparent to the customer. The Company receives a license fee based on a percentage of sales generated by the website.
The market for retail sporting goods is seasonal in nature. As with many other retailers, the Company’s business is heavily affected by sales of merchandise during the Holiday season. In addition, the Company’s product mix has historically emphasized cold weather sporting goods merchandise, particularly winter-sports related products. Management anticipates that this seasonal trend in sales will persist. To be less dependent upon winter business, management continues to emphasize a broadened product mix that offers merchandise generally purchased by consumers in the spring, summer and fall seasons. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations -Factors That May Affect Future Results - Seasonality”.
Marketing and Advertising
The Company generates all of its marketing campaigns in-house, with production support from outside vendors as needed. The campaigns are designed to reinforce the strategic direction of the Company through its brand and product offerings, as well as communicate a focused and consistent theme/event calendar for every store location utilizing newspaper, direct mail, radio, billboards, magazines and the Internet. Through the Team Sales Division the Company reaches out to communities in which its stores do business contributing to local teams and leagues. The Company’s advertising leverage has been boosted by vendor payments under cooperative advertising arrangements as well as vendor participation in sponsoring sporting events and programs.
Purchasing and Distribution
In order to provide a full line of specialty and sporting goods brands and a wide selection the Company purchases merchandise from over 1,200 vendors. Vendor payment terms typically range from 30 to 120 days from the Company’s receipt, and there are no long term purchase commitments. The Company’s largest vendor, Nike, Inc., accounted for approximately 8.0% and 7.3% of the Company’s total inventory purchases for fiscal 2003 and 2002, respectively.
In February 2002, the Company moved its distribution operations to a new 326,000 square foot facility located in Ontario, California. This facility replaced the Company’s 150,000 square foot warehouse and a 30,000 square foot satellite facility, and has been designed to support growth plans for the foreseeable future. Labor savings from operating efficiency provided by the new facility have offset increases in occupancy costs in the short term and installation of warehouse management software will further improve warehousing and logistical cost management.
The distribution center serves as the primary receiving, distribution and warehousing facility. Common carriers deliver merchandise to the Nevada stores, while the Company’s own trucks deliver merchandise from the distribution center to the Southern California stores. A minimal amount of merchandise is shipped directly by vendors to the stores. Most of the product received at the distribution center is processed by unpacking and verifying the contents received and then sorting the contents by store for delivery. Some of the product received at the distribution center is pre-packaged and pre-ticketed by the vendor so it can be immediately cross-docked to trucks bound for the stores. Due to the efficiencies cross-docking creates, the Company encourages its vendors to pre-package and ticket their products. Some of the merchandise is held at the distribution center for future allocation to the stores based on current sales trends as directed by the replenishment system to optimize inventory levels. The company believes that advantages to a single distribution center include reduced per store inventory levels, quicker inventory replenishment, consolidated vendor returns, and reduced transportation costs.
In November 2001 the Company implemented a JDA/E3 inventory replenishment system. The E3 system consists of three modules: (i) advanced warehouse replenishment, which manages purchases from vendors, (ii) advanced store replenishment, which manages warehouse to store replenishment, and (iii) advanced optimization, which synchronizes the two systems. Currently, inventory management utilizes the E3 system to manage approximately 65% of the company’s inventory dollars. The remaining 35% of the inventory purchases are managed by traditional methods conducted by the buying staff on a short-term purchase order basis.
Information Systems
The Company uses a “best of breed” approach to information systems. All new systems communicate with a legacy system that has become the centralized data repository and the primary financial system. Consistent with the stated direction to upgrade the legacy systems, those applications were migrated to a new Sun computer in May 2002. With this enhancement in place, the foundation has been established for future developments. In October 2000 store systems were upgraded to the Encore Retail Suite of applications from CRS Retail Systems, an open technology allowing flexibility for the future. A custom rental program was added to the store system in October 2001. Merchandise replenishment is controlled by E3 software from the JDA Software Group, Inc. running on an IBM AS 400. In fiscal 2003 the processing of debit/credit card authorization was upgraded to allow on-line debit and signature capture, and the distribution center was enhanced with warehouse management software from HighJump. Future projects may include: EDI software from SPS Commerce, customer relationship software, the switch from gift certificates to gift cards, and continual on-going enhancements to the legacy system, among other projects.
Trademarks and Trade Names
The Company uses the “Sport Chalet” name as a service mark in connection with its business operations. The Company has registered “Sport Chalet” as a service mark with the State of California, and has obtained federal registration for certain purposes, which has been successfully defended in the past against attack by third parties. The Company also retains common law rights to the name, which it has used since 1959. The lack of federal registration for certain purposes might pose a problem if the Company were to expand into a geographic area where the name or any confusingly similar name is used by someone with prior rights.
Industry and Competition
The market for retail sporting goods is highly competitive, fragmented and segmented. The Company competes with a variety of other retailers, including the following:
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full-line sporting goods chains, such as The Sports Authority, Galyans, Dick’s Sporting Goods and Big 5;
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specialty stores, such as REI, Footaction, Turner’s, Foot Locker and West Marine;
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supplier-owned stores, such as Nike, The North Face, adidas and New Balance;
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mass merchandisers, club stores, discount stores and department stores, such as Wal-Mart, Costco, Target, Macy’s and Sears; and
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E-tailers and catalog merchandisers.
Many of these competitors have greater financial resources than the Company, or better name recognition in regions into which the Company seeks to expand. The Company’s industry is dominated by sporting goods superstore retailers, i.e., full-line sporting goods chains with stores typically larger than 30,000 square feet, often in freestanding locations. Superstore chains generally provide a greater selection of higher quality merchandise than other retailers, while remaining price competitive. Specialty retailers often have the advantage of a lower cost structure and a smaller “footprint” that can be located in shopping centers and strip malls, offering more customer convenience.
Historically, the Company has distinguished itself from its competitors by providing a broader selection of higher-end specialty items that require higher levels of customer service and sales associate expertise than other superstore retailers in the Southern California and Nevada areas. The Company believes that its broad selection of high quality name brands and numerous specialty items at competitive prices, showcased by its well-trained sales associates, differentiates its self from discount and department stores, traditional and specialty sporting goods stores and other superstore operations. Management believes the Company’s format takes advantage of several significant trends and conditions in the sporting goods industry. These trends include the size of the industry, fragmented competition, superstore dominance, limited assortments offered by many sporting goods retailers, consumer preference for one-stop shopping, and the importance of delivering value through selection, quality, service and price.
Employees
As of March 31, 2003, the Company had 2,274 full and part-time employees, 2,060 of whom were employed in the Company’s stores and 214 of whom were employed in warehouse and delivery operations or in executive office positions. None of the employees are covered by a collective bargaining agreement. The Company believes that its employee relations are good. A typical store has approximately 75 employees, of whom 15 to 30 are in the store at any given time on a normal operating basis. Generally, each store employs a general manager, two to three assistant managers, who along with area managers and department heads supervise the sales associates in customer service, merchandising, and operations. Additional part-time employees are typically hired during the Holiday and other peak seasons.
The Company is committed to the growth and training of its employees in order to provide the “Expert” product knowledge and service to its customers. A “Certified Pro” program where employees attend product line specific clinics in addition to receiving hands-on training ensures that sales associates have technical product and service expertise. Only after completing all of the clinics and training, in addition to passing specific testing, may an associate be considered a Certified Pro. Certified Pro certification is offered in 19 different service disciplines.
ITEM 2.
ITEM 2. PROPERTIES
At June 9, 2003, the Company had 28 store locations. The following table summarizes the key information on the Company’s retail properties:
All facilities are located on leased property. The initial terms of the retail leases expire in 2004 through 2020 and typically provide for multiple five-year renewal options. All retail store leases provide for base rent which may or may not be credited against percentage rent based upon gross sales from the premises. In some of the leases, base rental amounts increase as the lease term progresses, although in some cases, the Company expects that percentage rent will more than offset the base rental amounts.
The Company leases from corporations controlled by Norbert Olberz, the Chairman Emeritus and the Company’s Principal Stockholder (the “Principal Stockholder”), its corporate office space in La Canada and its stores in La Canada, Huntington Beach and Porter Ranch, California. In prior years the Company also leased its warehouse and distribution facility in Montclair, California and although the term of this lease ran to 2007, the Principal Stockholder agreed to cancel the lease when the Company moved to the new distribution center in February 2002. The new distribution center located in Ontario, California is leased from an unrelated third party. The Company has incurred rental expense to the Principal Stockholder of $2.2 million, $2.4 million and $2.5 million in fiscal 2003, 2002 and 2001, respectively.
The Company’s corporate offices in prior years were spread over seven nearby buildings in La Canada, California neighboring the store where the Company was founded. To facilitate growth related to the expansion plans, the Company leased a new 27,500 square foot corporate office in La Canada from La Canada Properties, Inc., a corporation controlled by the Principal Stockholder, in October 2002. The Company expects this building to support its growth plans for the foreseeable future.
Management believes that the occupancy costs under the leases with corporations controlled by the Principal Stockholder described above are no higher than those which would be charged by unrelated third parties under similar circumstances.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
The Company is involved in various routine legal proceedings incidental to the conduct of its business. Management does not believe that any of these legal proceedings will have a material adverse impact on the business, financial condition or results of operations of the Company, either due to the nature of the claims, or because management believes that such claims should not exceed the limits of the Company’s insurance coverage.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS
No matters were submitted to the Company’s stockholders during the fourth quarter of fiscal 2003.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Market Price for Common Shares
The Company’s Common Stock is traded on The Nasdaq Stock Market’s National Market under the symbol “SPCH.” The following table reflects the range of high and low sale prices of the Company’s Common Stock by quarter over the last two fiscal years as reported by Nasdaq:
On June 9, 2003, the closing price of the Company’s Common Stock as reported by Nasdaq was $7.25. Stockholders are urged to obtain current market quotations for the Common Stock.
Approximate Number of Holders of Common Shares
The approximate number of stockholders of record of the Company’s Common Stock as of June 9, 2003 was 183 (excluding individual participants in nominee security position listings), and as of that date, the Company estimates that there were approximately 1,000 beneficial owners holding stock in nominee or “street” name.
Dividend Policy
The Company has not paid any dividends to stockholders since its initial public offering in November 1992. It is currently contemplated that the Company will retain earnings for use in the operation and potential expansion of its business and, therefore, Management does not anticipate declaring or paying any cash dividends in the foreseeable future. The declaration and payment of any such dividends in the future will depend upon the Company’s earnings, financial condition, capital needs and other factors deemed relevant by the Board of Directors.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following sets forth selected financial data as of and for the periods presented. This data should be read in conjunction with the financial statements and related notes thereto and other financial information included herein.
(1)
A store’s sales are included in the comparable store sales calculation after its twelfth full month of operation.
(2)
EBITDA is earnings before income taxes, interest expense and depreciation and amortization. The Company believes that, in addition to cash flows from operations and net income, EBITDA is a useful financial performance measure for assessing operating performance as it provides an additional basis to evaluate the ability of the Company to incur and service debt and to fund capital expenditures. In evaluating EBITDA, consideration should be given, among other things, to the amount by which EBITDA exceeds interest costs for the period and how EBITDA compares to capital expenditures for the period. To evaluate EBITDA, the components of EBITDA such as revenue and operating expenses and the variability of such components over time should also be considered. EBITDA should not be construed, however, as an alternative to operating income (as determined in accordance with accounting principles generally accepted in the United States of America (“GAAP”)) as an indicator of the Company’s operating performance or to cash flows from operating activities (as determined in accordance with GAAP) as a measure of liquidity. The Company’s method of calculating EBITDA may differ from methods used by other companies, and as a result, EBITDA measures disclosed herein may not be comparable to other similarly titled measures used by other companies.
(3)
Total square footage of all stores open at the end of the period represented in thousands of square feet.
(4)
Calculated by using stores that were open for the full current fiscal period and were also open for the full prior fiscal year.
ITEM 7.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following should be read in conjunction with “Item 6. Selected Financial Data” and the Company’s financial statements and related notes thereto.
Results of Operations
The following tables set forth statements of income data and relative percentages of net sales for the periods indicated (dollar amounts in thousands, except per share amounts).
Fiscal 2003 Compared to Fiscal 2002. Sales increased from $227.3 million for the fiscal year ending March 31, 2002 to $238.0 million for fiscal 2003, a 4.7% increase. The increase is the result of opening two stores in fiscal 2003 and three in fiscal 2002, offset by a comparable store sales decrease of 0.9%. The comparable store decrease reflects a prolonged sluggish retail environment, lackluster economic recovery, and the war in Iraq. In addition, the decrease reflects a second year of increasingly unseasonable warm and dry winter weather conditions at the resorts frequented by those residing in Southern California throughout the third and fourth quarters resulted in decreased sales of winter-related merchandise. Sales exclusive of winter-related merchandise increased 7.0% in total and 0.9% on a comparable store basis.
Gross profit for the year increased as a percent of sales from 28.7% to 29.1%. The 40 basis point increase for fiscal 2003 compared to fiscal 2002 resulted from better inventory procurement and administration compared to fiscal 2002, when additional markdowns on winter-related merchandise were taken to stimulate sales and turn inventory in reaction to an increasingly weakening economic climate. The improvement in merchandise margins was partially offset by the effects of decreased comparable store sales which caused occupancy costs to increase as a percent of sales in fiscal 2003 compared to fiscal 2002.
Selling, general and administrative expenses increased as a percent of sales from 25.1% in fiscal 2002 to 26.1% in fiscal 2003, caused by increases in utility expenses, advertising expense, professional fees, incentive-based labor and employment-based insurance costs.
Interest expense increased from $71,000 to $307,000 as the Company’s expansion was partially funded by the increased use of the Company’s credit facility in fiscal 2003, as compared to fiscal 2002.
The effective tax rate as a percent of pretax income is 39.0% for fiscal 2003 and 40.5% for fiscal 2002. These rates differ from the statutory rate of 39.8% primarily as a result of permanent differences between financial reporting and tax-basis income. The decrease is the result of reduced blended state income tax rate, from the Company’s expansion into Nevada which has no income tax and qualifying tax credits from California not earned in the same period in the prior year.
Net income decreased to $4.2 million, or $0.60 per diluted share, from $4.8 million, or $0.69 per diluted share, in the prior year, primarily due to higher selling, general and administrative expenses partially offset by higher sales and improved merchandise margins.
Fourth Quarter 2003 Compared to Fourth Quarter 2002. Sales increased from $57.3 million for the quarter ended March 31, 2002 to $58.2 million for the same period in fiscal 2003, a 1.6% increase. The increase results from the opening of two stores in fiscal 2003, offset by a comparable store sales decrease of 4.0%. The comparable store sales decrease reflects a prolonged sluggish retail environment, lackluster economic recovery, and the war in Iraq. In addition, unseasonably warm and dry winter weather conditions resulted in decreased sales of winter-related merchandise. Sales exclusive of winter-related merchandise increased 7.4% in total and 0.9% on a comparable store basis.
Gross profit for the period increased as a percent of sales from 26.3% to 27.6%. The 130 basis point increase in the period ended March 31, 2003 was a result of better inventory procurement and administration compared to the same period ended March 31, 2002 when additional markdowns were taken on winter-related merchandise to stimulate sales and turn inventory. The improvement in merchandise margins were partially offset by the effects of decreased comparable store sales which caused occupancy costs to increase as a percent of sales in the current period compared to the same period last year.
Selling, general and administrative expenses increased as a percent of sales from 26.1% in the period ended March 31, 2002 to 27.4% for the period ended March 31, 2003 primarily reflecting increases in advertising expense attributable to the timing of vendor-funded participation compared to the same period last year.
Interest expense decreased from $41,000 to $34,000 due to decreased use of the Company’s credit facility in the period ended March 31, 2003, compared to the same period ended March 31, 2002.
The effective income tax rate as a percent of pretax income for the fourth quarter of 2003 is 53.0% compared to 94.9% for the same period of fiscal 2002. Both differ from the statutory rate of 39.8% as a result of fourth quarter provision adjustments reconciling the estimated effective rate utilized in prior quarters to the annual effective tax rate.
Net income increased to $53,000, or $0.01 per diluted share, for the period ended March 31, 2003 from $2,000, or $0.00 per diluted share, for the period ended March 31, 2002, primarily due to higher sales and improved merchandise margins partially offset by higher selling, general and administrative expenses.
Fiscal 2002 Compared to Fiscal 2001. Sales increased from $214.8 million for the fiscal year ending March 31, 2001 to $227.3 million for fiscal 2002, a 5.8% increase. The increase was the result of opening three stores in fiscal 2002 and one in fiscal 2001, offset by a comparable store sales decrease of 1.1%. In addition to a generally weak economic climate, the comparable store sales decrease reflected unseasonably warm and dry winter weather conditions experienced in the third and fourth quarters compared to the same quarters of the prior year, along with a decline in consumer demand for in-line scooters, sales of which were significant in the prior year. Sales exclusive of winter-related merchandise and scooters increased 12.3%, and comparable store sales increased by 5.2%.
Gross profit for fiscal 2002 decreased as a percent of sales from 30.8% to 28.7%. The decrease for fiscal 2002, as compared to fiscal 2001, was the result of higher markdowns taken to stimulate sales and turn inventory. Additionally, the decrease in comparable store sales caused occupancy costs to increase as a percent of sales in fiscal 2002 as compared to fiscal 2001.
Selling, general and administrative expenses decreased as a percent of sales from 25.3% to 25.1%, as decreases in litigation and incentive-based labor were partially offset by costs related to the Company’s expansion plans. Expenses related to expansion include the opening of three new stores, one of which is the Company’s first store outside Southern California, and costs related to opening a new larger distribution center, most of which related to the disposal of leasehold improvements from the old facility.
Interest income decreased from $361,000 to an expense of $71,000 due to the use of the Company’s credit facility in fiscal 2002, as compared to fiscal 2001 when the credit facility was not utilized. Invested cash was used to fund expansion including new stores, a larger distribution center and computer upgrades. The Company borrowed up to $10 million during the third quarter for the seasonal build up of inventory.
The effective tax rate as a percent of pretax income is 40.5% for fiscal 2002 and 40.3% for fiscal 2001. These rates differ from the statutory rate of 39.8% primarily as a result of permanent differences between financial reporting and tax-basis income.
Net income decreased to $4.8 million, or $0.69 per diluted share, from $7.3 million, or $1.07 per diluted share, in the prior year primarily due to decreased gross profit as markdowns were taken to drive consumer demand in the face of a difficult retail sales environment.
Liquidity and Capital Resources
The Company’s primary capital requirements are for inventory and store
expansion, relocation and remodeling. Historically, cash from operations, credit terms from vendors and bank borrowing have met the Company’s liquidity needs. The Company believes that these sources will be sufficient to fund currently anticipated cash requirements for the foreseeable future.
Net cash provided by operating activities of $5.7 million, $7.3 million and $11.5 million for fiscal 2003, 2002 and 2001, respectively, was primarily the result of net income, adjusted for depreciation and amortization, and increases in bank overdraft combined with accounts payable offset by inventory purchases.
Typically, inventory levels from year-to-year increase due to the addition of new stores. The addition of two stores in fiscal 2003 and three stores in 2002, increased inventories $3.0 million and $5.4 million, respectively, while in fiscal 2001 the inventory increase of $5.6 million was a result of a significant increase in comparable store sales along with the purchase of John Wells Golf Shops and the addition of one new store.
Bank overdraft represents the total of checks in transit in excess of cash on hand. Beginning in fiscal 2002, invested cash built-up in prior years was used to fund the Company’s expansion plan. The overdraft is expected to continue and fluctuate due to the timing of vendor payments. Accounts payable historically increases as inventory increases. However, in fiscal 2003, accounts payable combined with the bank overdraft decreased by $2.9 million primarily as the result of the timing of payments to vendors, while in fiscal 2002, accounts payable combined with the bank overdraft increased by $6.0 million primarily due to increased inventory. During fiscal 2001, accounts payable increased only $371,000 as part of the inventory increase occurred early in the year due to a new store and the purchase of John Wells Golf Shops and vendors were paid before year end.
Other accrued expenses increased by $1.0 million for fiscal 2003, compared to a decrease of $1.8 million for fiscal 2002, as expenses related to the settlement of litigation were accrued during fiscal 2001, and subsequently paid in fiscal 2002.
Net cash used in investing activities was $5.9 million, $12.1 million, and $8.0 million for fiscal 2003, 2002 and 2001, respectively. In fiscal 2003, 2002 and 2001, capital expenditures for information technology totaled $2.2 million, $993,000, and $3.7 million, respectively, while ongoing capital expenditures for the Company’s existing stores totaled $500,000, $2.8 million, and $3.0 million, respectively. The Company spent less in fiscal 2003 as it evaluated a new prototype store format.
In fiscal 2003, two stores were opened in addition to the relocation of the corporate headquarters, while in fiscal 2002, three stores were opened and the distribution center was relocated, and in fiscal 2001 one store was opened, one was remodeled and one was relocated.
As a result of the Company’s ongoing growth and strategic initiatives, forecasted capital expenditures for fiscal 2004 are expected to be approximately $11.0 million. Approximately $3.6 million of this amount will be used to open three new stores. In addition, expenditures on information technology and existing store improvements, which include two large scale remodels, are expected to approximate $3.6 million and $3.5 million, respectively.
Net cash provided by financing activities reflects advances and repayments of borrowings under the Company’s revolving credit facility. As of March 31, 2003, 2002, and 2001, the Company had no outstanding borrowings on this facility.
The Company’s credit facility with Bank of America National Trust and Savings Association, Inc. (the “Lender”) provides for advances up to $20 million, less the amount of any outstanding draws, up to a $1.5 million maximum in authorized letters of credit. Interest accrues at the Lender’s prime rate plus 0.25% (4.5% at March 31, 2003) or can be fixed for a period of time at the then current rate established under one of several indices, all at the Company’s option. This credit facility expires on September 30, 2003, and the Company expects to renegotiate and extend the term of this agreement or obtain another form of financing before that date. The Company’s obligation to the Lender is presently secured by a first priority lien on substantially all of the Company’s non-real estate assets, and the Company is subject to several restrictive covenants. The principal operating covenants require the Company to maintain certain minimum cash flow coverage and debt to equity ratios and restrict the level of capital expenditures, calculated on a quarterly basis. The Company currently is in compliance with the covenants. The Company believes its credit line with the Lender is sufficient to fund capital expenditures for the foreseeable future and to meet seasonal fluctuations in cash flow requirements. However, unexpected conditions could require the Company to request additional borrowing capacity from the Lender or alter its expansion plans or operations.
The Company’s primary contractual obligations and commitments are its store leases with initial terms expiring from 2004 through 2020 and typically provide for multiple five-year renewal options:
All retail store leases provide for base rent which may or may not be credited against percentage rent based upon gross sales from the premises. In some of the leases, base rental amounts increase as the lease term progresses, although in some cases, the Company expects that percentage rent will more than offset the base rental amounts.
No cash dividends have been declared on Common Stock in fiscal 2003. The Company intends to retain earnings for use in the operation and expansion of its business and, therefore, does not anticipate paying any cash dividends in the foreseeable future.
Critical Accounting Policies and Use of Estimates
The Company’s significant accounting policies are described in Note 2 to the Financial Statements, which have been prepared in accordance with accounting principles generally accepted in the United States. In preparing the financial statements, the Company is required to make estimates and judgments which affect the results of its operations and the reported value of assets and liabilities. Actual results may differ from these estimates. The Company believes that the following summarizes critical accounting policies which require significant judgments and estimates in the preparation of its financial statements.
Inventory Valuation. Merchandise inventories are stated at the lower of cost (first-in, first-out determined by the retail method of accounting) or market. The Company considers cost to include direct cost of merchandise, plus internal costs associated with merchandise procurement, storage and handling. The Company regularly reviews aged and excess inventories to determine if the carrying value of such inventories exceeds market value. A reserve is recorded to reduce the carrying value to market value as necessary. A determination of market value requires estimates and judgment based on the Company’s historical markdown experience and anticipated markdowns based on future merchandising and advertising plans, seasonal considerations, expected business trends and other factors.
Gift Certificate Redemption. The Company offers its customers the option of purchasing gift certificates which may be used toward the future purchase of the Company’s product offerings. These gift certificates have no expiration dates. The Company records unredeemed gift certificates as a liability until the point of redemption. The Company’s historical experience indicates that not all issued gift certificates are ultimately redeemed. Accordingly, the Company periodically adjusts the carrying value of the gift certificate liability. The Company monitors redemption rates as a percent of issuances and uses this information to estimate probable redemption of all outstanding gift certificates. This calculation is based on historical experience, and future redemption rates may vary if consumer purchasing practices change.
Impairment of Long-Lived Assets. The Company accounts for long-lived assets in accordance with the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” The Company reviews long-lived 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 determined by a comparison of the carrying amount of an asset to future undiscounted net cash flows expected to be generated by the asset. If such assets are considered impaired the impairment recognized is measured by comparing projected individual store discounted cash flow to the asset carrying values.
Accounting for Income Taxes. As part of the process of preparing the financial statements, income taxes are estimated for each of the jurisdictions in which the Company operates. This process involves estimating actual current tax exposure together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included within the balance sheet. The likelihood that deferred tax assets will be recovered from future taxable income is assessed, recognizing that future taxable income may give rise to new deferred tax assets. To the extent that that future recovery is not likely, a valuation allowance would be established. To the extent a valuation allowance is established or increased, an expense will be included within the tax provision in the income statement.
Significant management judgment is required in determining the provision for income taxes, deferred tax assets and liabilities and any valuation allowance recorded against net deferred tax assets. Based on the Company’s history of operating earnings, no valuation allowance has been recorded as of March 31, 2003. In the event that actual results differ from these estimates, or these estimates are adjusted in future periods, a valuation allowance may need to be established, which could impact the Company’s financial position and results of operations.
Provisions for income taxes for 2003, 2002 and 2001 are based on numerous factors that are subject to audit by the Internal Revenue Service and the tax authorities in the various jurisdictions in which the Company does business.
Impact of Recent Accounting Pronouncements. In June 2002, the Financial Accounting Standards Board (‘FASB”) issued Statement of Accounting Standards (“SFAS”) No. 146, “Accounting for Costs Associated with Exit or Disposal Activities,” which supercedes Emerging Issues Task Force Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit and Activity (including Certain Costs Incurred in a Restructuring).” SFAS No. 146 addresses the accounting and reporting for one-time employee termination benefits, certain contract termination costs, and other costs associated with exit of disposal activities such as facility closing or consolidations and employee relocations. The standard is effective for exit or disposal activities initiated after December 31, 2002.
In November 2002, the FASB issued Emerging Issues Task Force Issue No. 02-16 (“Issue 02-16”), “Accounting by a Reseller for Cash Consideration Received from a Vendor.” Issue 02-16 addresses the issue of how a reseller of a vendor’s product should account for cash consideration received from a vendor. The adoption of Issue 02-16, effective with agreements entered into after November 21, 2002, did not have a material impact on the Company’s financial position or results of operations. The Company is in the process of reviewing the effect that the application of Issue 02-16 will have on the financial statements of fiscal 2004.
In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation-Transition and Disclosure.” This statement amends SFAS No. 123 to provide alternative methods of transition for voluntary change to the fair value based method of accounting for stock based employee compensation. In addition, this statement amends the disclosure requirements of SAFS No. 123 to require disclosures in both annual and interim financial statements regarding the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The provision of SFAS No. 148 are effective for financial statements for fiscal years and interim periods ending after December 15, 2002. The Company has adopted the disclosure provisions of SFAS No. 148. SFAS No. 148 did not require the Company to change to the fair value based method of accounting for stock-based compensation.
Factors That May Affect Future Results
The Company’s short and long-term success is subject to many factors that are beyond the Company’s control. Stockholders and prospective stockholders in the Company should consider carefully the following risk factors, in addition to other information contained in this report. This Annual Report on Form l0-K contains forward-looking statements, which are subject to a variety of risks and uncertainties. The Company’s actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors including those set forth below.
Economic Conditions. The retail industry historically has been subject to substantial cyclical variations. The merchandise sold by the Company is generally a discretionary expense for its customers. A recession in the general economy or uncertainties regarding future economic prospects that affect consumer spending habits has had, and may do so in the future have, a materially adverse effect on the Company’s results of operations.
Competition. The sporting goods business and the retail environment are highly competitive, and the Company competes with national, regional and local full-line sporting goods chains, specialty stores, supplier owned stores, discount and department stores, and e-tailers. A number of the Company’s competitors are larger and have greater resources than the Company.
Regional Market Concentration. Currently, all of the Company’s stores are located in Southern California and the Las Vegas area of Nevada. Accordingly, the Company is subject to regional risks, such as the economy, weather conditions, natural disasters and government regulations. For example, warm winter weather in the resorts frequented by Southern California residents has affected sales in the past. If the region were to suffer an economic downturn or if other adverse events were to occur, there could be an adverse effect on the Company’s net sales and profitability and its ability to implement its planned growth. Several of the Company’s competitors operate stores across the United States and, thus, are not as vulnerable as the Company to such regional risks.
Reliance on a Single Distribution Center. The Company currently relies on a single distribution center in Ontario, California. Any natural disaster or other serious disruption to this distribution center due to fire, earthquake or any other cause could damage a significant portion of the Company’s inventory and could materially impair both the Company’s ability to adequately stock its stores and the Company’s net sales and profitability.
Expansion Plan. The Company’s continued growth depends on a strategy of opening new, profitable stores in existing markets and in new regional markets. The ability to successfully implement this growth strategy could be negatively affected by any of the following:
•
suitable sites may not be available for leasing;
•
the Company may not be able to negotiate acceptable lease terms;
•
the Company might not be able to hire and retain qualified store personnel; and
•
the Company might not have the financial resources necessary to fund the Company’s expansion plans.
In addition, the Company’s expansion in new and existing markets may present competitive, distribution and merchandising challenges that differ from the current challenges. These potential new challenges include competition among the Company’s stores, added strain on the Company’s distribution center, additional information to be processed by the Company’s management information systems and diversion of management attention from ongoing operations. The Company faces additional challenges in entering new markets, including consumers’ lack of awareness of the Company, difficulties in hiring personnel and problems due to the Company’s unfamiliarity with local real estate markets and demographics. New markets may also have different competitive conditions, consumer tastes and discretionary spending patterns than the Company’s existing markets. To the extent that the Company is not able to meet these new challenges, net sales could decrease and operating costs could increase. Furthermore, a decline in the Company’s overall financial performance, increased rents or any other adverse effects arising from the commercial real estate market in the Company’s markets may adversely affect the Company’s current growth plan. There can be no assurance that the Company will possess sufficient funds to finance the expenditures related to its planned growth, that new stores can be opened on a timely basis, that such new stores can be operated on a profitable basis, or that such growth will be manageable.
Future Capital Requirements. The Company may not be able to fund its future growth or react to competitive pressures if it lacks sufficient funds. Unexpected conditions could cause the Company to be in violation of its Lender’s operating covenants. Currently, the Company feels it has sufficient cash available through its bank credit facilities and cash from operations to fund existing operations for the foreseeable future. The Company cannot be certain that additional financing will be available in the future if necessary.
Management of Growth. Since its inception, the Company has experienced periods of rapid growth. No assurance can be given that the Company will be successful in maintaining or increasing its sales in the future. Any future growth in sales will require additional working capital and may place a significant strain on the Company’s management, management information systems, inventory management, distribution facilities and receivables management. Any failure to timely enhance the Company’s operating systems, or unexpected difficulties in implementing such enhancements, could have a material adverse effect on the Company’s results of operations.
Dependence on Key Personnel. The Company depends on the continued service of its senior management. The loss of the services of any key employee could hurt the business. Also, the future success of the Company depends on its ability to identify, attract, hire, train and motivate other highly skilled personnel. Failure to do so may adversely affect future results.
Seasonality. The Company’s sales volume increases significantly during the Holiday season as is typical with other sporting goods retailers. In addition, the Company’s product mix has historically emphasized cold weather sporting goods increasing the seasonality of the Company’s business. In recent years the months of November, December and January represent between 31% and 33%, of the Company’s total net sales in recent years, while winter-related products ranged from 15% to 19% of total net sales. The operating results historically have been influenced by the amount and timing of snowfall at the resorts frequented by those living in Southern California. An early snowfall often has influenced sales because it generally extends the demand for winter apparel and equipment, while a late snowfall may have the opposite effect. Suppliers in the ski and snowboard industry require the Company to make commitments for purchases of apparel and equipment by April for fall delivery, and only limited quantities of merchandise can be reordered during the fall. Consequently, the Company places its orders in the spring anticipating snowfall in the winter. If the snowfall does not at least provide an adequate base or occurs late in the season, or if sales do not meet projections, the Company may be required to mark down its winter apparel and equipment.
Variability of Quarterly Results. The Company has experienced, and expects to continue to experience, a substantial variation in its net sales and operating results from quarter to quarter. The Company believes that the factors which influence this variability of quarterly results include general economic and industry conditions that affect consumer spending, changing consumer demands, the timing of the Company’s introduction of new products, the level of consumer acceptance of each new product, the seasonality of the markets in which the Company participates, the weather and actions of competitors. Accordingly, a comparison of the Company’s results of operations from period to period is not necessarily meaningful, and the Company’s results of operations for any period are not necessarily indicative of future performance.
Closely Controlled Stock. At June 9, 2003, Norbert Olberz, the Company’s founder, Chairman Emeritus, director and Principal Stockholder, owned approximately 66% of the Company’s outstanding Common Stock. Mr. Olberz effectively has the ability to control the outcome on all matters requiring stockholder approval, including, but not limited to, the election and removal of directors, and any merger, consolidation or sale of all or substantially all of the Company’s assets, and to control the Company’s management and affairs.
Information Systems are Vulnerable. The Company’s success, in particular the Company’s ability to successfully manage inventory levels and its centralized distribution system, largely depends upon the efficient operation of the Company’s computer hardware and software systems. The Company uses management information systems to track inventory information at the store level, replenish inventory from the Company’s warehouse, and aggregate daily sales information among other things. These systems and the Company’s operations are vulnerable to damage or interruption from:
•
earthquake, fire, flood and other natural disasters;
•
power loss, computer systems failures, internet and telecommunications or data network failure, operator negligence, improper operation by or supervision of employees, physical and electronic loss of data and similar events; and
•
computer viruses, penetration by hackers seeking to disrupt operations or misappropriate information and other breaches of security.
The Company seeks to minimize these risks by the use of backup facilities and redundant systems. Nevertheless any failure that causes an interruption in the Company’s operations or a decrease in inventory tracking could result in reduced net sales.
The Company’s Business Depends on Anticipating Consumer Tastes. If the Company fails to anticipate changes in consumer preferences, it may experience lower net sales, higher inventory markdowns and lower margins. Products must appeal to a broad range of consumers whose preferences cannot be predicted with certainty. These preferences are also subject to change. Sporting goods are often subject to short-lived trends, such as the short-lived popularity of in-line scooters. Outdoor wear is significantly influenced by fashion. The Company’s success depends upon the ability to anticipate and respond in a timely manner to trends in sporting goods merchandise and consumers’ participation in sports. Failure to identify and respond to these changes may cause net sales to decline. In addition, because the Company generally makes commitments to purchase products from vendors up to six months in advance of the proposed delivery, misjudging the market may over-stock unpopular products and force inventory markdowns that could have a negative impact on profitability, or have insufficient inventory of a popular item that can be sold at full markup.
Stock Price. The Company’s Common Stock is thinly traded making it difficult to sell large amounts. The market price of the Company’s Common Stock is likely to be volatile and could be subject to significant fluctuations in response to factors such as quarterly variations in operating results, operating results which vary from the expectations of securities analyst and investors, changes in financial estimates, changes in market valuations of competitors, announcements by the Company or its competitors of a material nature, additions or departures of key personnel, future sales of Common Stock and stock volume fluctuations. Also, general political and economic conditions such as a recession or interest rate fluctuations may adversely affect the market price of the Company’s Common Stock.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company’s exposure to interest rate risk consists primarily of borrowings under its credit facility, which bears interest at floating rates (primarily LIBOR rates). The impact on earnings or cash flows during the next fiscal year from a change of 100 basis points in the interest rate would not be significant.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements required by this section are submitted as part of Item 15 of this report.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information concerning the directors and executive officers of the Company is incorporated here by reference from the section entitled “Proposal 1-Election of Directors” contained in the definitive Proxy Statement of the Company to be filed pursuant to Regulation 14A within 120 days after the end of the Company’s last fiscal year (the “Proxy Statement”).
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information concerning executive compensation is incorporated herein by reference from the section entitled “Proposal 1 - Election of Directors” contained in the Proxy Statement.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information concerning the security ownership of certain beneficial owners and management is incorporated herein by reference from the sections entitled “General Information-Security Ownership of Principal Stockholders and Management” and “Proposal 1-Election of Directors” contained in the Proxy Statement.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information concerning certain relationships and related transactions is incorporated herein by reference from the section entitled “Proposal 1-Election of Directors-Certain Relationships and Related Transactions” contained in the Proxy Statement.
PART IV
ITEM 14.
ITEM 14. CONTROLS AND PROCEDURES
Within the 90 days prior to the filing date of this report, the Chief Executive Officer and the Chief Financial Officer of the Company, with the participation of the Company’s management, carried out an evaluation of the effectiveness of the Company’s disclosure controls and procedures pursuant to Exchange Act Rule 13a-14. Based upon that evaluation, the Chief Executive Officer and the Chief Financial Officer believe that, as of the date of the evaluation, the Company’s disclosure controls and procedures are effective in making known to them material information relating to the required to be included in this report.
Disclosure controls and procedures, no matter how well designed and implemented, can provide only reasonable assurance of achieving an entity’s disclosure objectives. The likelihood of achieving such objections is affected by limitations inherent in disclosure controls and procedures. These include the fact that human judgment in decision-making can be faulty and that breakdowns in internal control can occur because of human failures such as simple errors or mistakes or intentional circumvention of the established process.
There were no significant changes in the Company’s internal controls or in other factors that could significantly affect internal controls, known to the Chief Executive Officer or the Chief Financial Officer, subsequent to the date of the evaluation.
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a)
(1)
Financial Statements - The financial statements listed on the accompanying Index to Audited Financial Statements are filed as part of this report.
(2)
Schedules - Not applicable.
(b)
Reports on Form 8-K - None
(c)
Exhibits - See Index on Page E-1 hereof
Sport Chalet, Inc.
Index to Audited Financial Statements
Report of Independent Auditors
To the Stockholders and Board of Directors
Sport Chalet, Inc.
We have audited the accompanying balance sheets of Sport Chalet, Inc. as of March 31, 2003 and 2002, and the related statements of income, stockholders’ equity, and cash flows for each of the three years in the period ended March 31, 2003. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Sport Chalet, Inc. at March 31, 2003 and 2002, and the results of its operations and its cash flows for each of the three years in the period ended March 31, 2003, in conformity with accounting principles generally accepted in the United States.
/s/ Ernst & Young LLP
Los Angeles, California
May 15, 2003
Sport Chalet, Inc.
Statements of Income
See accompanying notes.
Sport Chalet, Inc.
Balance Sheets
See accompanying notes.
Sport Chalet, Inc.
Statements of Stockholders’ Equity
See accompanying notes.
Sport Chalet, Inc.
Statements of Cash Flows
See accompanying notes.
Sport Chalet, Inc.
Notes to Financial Statements
1. Description of Business
Sport Chalet, Inc. (the “Company”), founded in 1959, is a leading operator of 28 full service, specialty sporting goods superstores in Southern California and Nevada. The Company has 26 locations in California consisting of eleven located in Los Angeles County, six in Orange County, three in each of San Diego and San Bernardino Counties, two in Riverside, and one in Ventura County; both Nevada locations are in Clark County.
The Chairman of the Board (Principal Stockholder) owned approximately 66% of the Company’s outstanding Common Stock at March 31, 2003.
2. Summary of Significant Accounting Policies
Cash and Cash Equivalents
The Company considers all highly liquid investments with maturities of less than three months when purchased to be cash equivalents.
The Company has a concentration of credit risk when cash deposits in banks are in excess of federally insured limits in the event of nonperformance by the related financial institution. However, management does not anticipate nonperformance by these financial institutions.
Merchandise Inventories
Merchandise inventories are stated at the lower of cost (first-in, first-out determined by the retail method of accounting) or market and consist principally of merchandise held for resale. The Company considers cost to include the direct cost of merchandise, plus internal costs associated with merchandise procurement, storage and handling.
Furniture, Equipment and Leasehold Improvements
Furniture, equipment, and leasehold improvements are stated on the basis of cost. Depreciation of furniture and equipment is computed primarily on the straight-line method over the estimated useful lives of the assets. Leasehold improvements are amortized on the straight-line method over the shorter of the life of the asset or the remaining lease term. The estimated useful lives of the assets are as follows:
Maintenance and repairs are charged to expense as incurred and the costs of additions and betterments that increase the useful lives of the assets are capitalized. When leasehold improvements or equipment are disposed of, the cost and related accumulated depreciation and amortization are removed from the accounts and any gain or loss is included in operations.
Sport Chalet, Inc.
Notes to Financial Statements (continued)
2. Summary of Significant Accounting Policies (continued)
Long Lived Assets
The Company accounts for long-lived assets in accordance with the provisions of Statement of Financial Standards (“SFAS”) No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” The Company reviews long-lived 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 determined by a comparison of the carrying amount of an asset to future undiscounted net cash flows expected to be generated by the asset. If such assets are considered impaired the impairment recognized is measured by comparing projected individual store discounted cash flow to the asset carrying values.
Financial Instruments
Cash and cash equivalents, marketable securities, accounts receivable and accounts payable are carried at cost which approximates fair value due to their short-term nature.
Pre-opening Costs
Non-capital expenditures incurred prior to the opening of a new store are charged to operations as incurred.
Revenue Recognition
Revenue from retail sales are recognized at the time the customer receives the merchandise. Issuance of gift certificates and store credits are recorded as a liability until redeemed for merchandise.
Advertising Costs
Advertising costs are expensed as incurred. Advertising expense, net of vendor reimbursement, amounted to $6,125,976, $5,145,848 and $5,111,472 for the years ended March 31, 2003, 2002 and 2001, respectively.
Income Taxes
The Company utilizes the liability method of accounting to compute the difference between the tax basis of assets and liabilities and the related financial reporting amounts using currently enacted tax laws and rates.
Sport Chalet, Inc.
Notes to Financial Statements (continued)
2. Summary of Significant Accounting Policies (continued)
Earnings Per Share
Earnings per share has been computed in accordance with Statement of Financial Accounting Standards No. 128, “Earnings Per Share” (EPS). Basic EPS equals net income divided by the number of weighted average common shares. Diluted EPS includes potentially dilutive securities such as stock options and convertible securities.
A reconciliation of the numerators and denominators of the basic and diluted EPS computations is illustrated below:
Deferred Rent
The Company is a party to various lease agreements which require scheduled rent increases over the noncancelable lease term. Rent expense for such leases is recognized on a straight-line basis over the related lease term. The difference between rent based upon scheduled monthly payments and rent expense recognized on a straight-line basis is recorded as deferred rent.
Sport Chalet, Inc.
Notes to Financial Statements (continued)
2. Summary of Significant Accounting Policies (continued)
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 amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.
Stock-Based Compensation
The Company accounts for its employee stock option plan under the recognition and measurement principles of Accounting Principles Board Opinion (“APB”) No. 25, “Accounting for Stock Issued to Employees,” and related Interpretations. Under APB No. 25, no stock-based compensation is reflected in net income, as all options granted under the plans had an exercise price equal to the market value of the underlying common stock on the date of grant and the related number of shares granted is fixed at that point in time.
Reclassification
Certain reclassifications were made to the prior year financial statements to conform to current year presentation.
Sport Chalet, Inc.
Notes to Financial Statements (continued)
2. Summary of Significant Accounting Policies (continued)
New Accounting Pronouncements
In June 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities,” which supercedes Emerging Issues Task Force Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit and Activity (including Certain Costs Incurred in a Restructuring).” SFAS No. 146 addresses the accounting and reporting for one-time employee termination benefits, certain contract termination costs, and other costs associated with exit of disposal activities such as facility closing or consolidations and employee relocations. The standard is effective for exit or disposal activities initiated after December 31, 2002. The adoption of the standard did not have a material impact on the Company’s financial statements.
In November 2002, the FASB issued Emerging Issues Task Force Issue No. 02-16 (“Issue 02-16”), “Accounting by a Reseller for Cash Consideration Received from a Vendor.” Issue 02-16 addresses the issue of how a reseller of a vendor’s product should account for cash consideration received from a vendor. The adoption of Issue 02-16, effective with agreements entered into after November 21, 2002 did not have a material impact on the Company’s financial position or results of operations. The Company is in the process of reviewing the effect that the application of EITF 02-16 will have on the financial statements of fiscal 2004.
In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation-Transition and Disclosure.” This statement amends SFAS No. 123 to provide alternative methods of transition for voluntary change to the fair value based method of accounting for stock based employee compensation. In addition, this statement amends the disclosure requirements of SAFS No. 123 to require disclosures in both annual and interim financial statements regarding the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The provisions of SFAS No. 148 are effective for financial statements for fiscal years and interim periods ending after December 15, 2002. The Company has adopted the disclosure provisions of SFAS No. 148. SFAS No. 148 did not require the Company to change to the fair value based method of accounting for stock-based compensation.
Sport Chalet, Inc.
Notes to Financial Statements (continued)
3. Loans Payable to Bank
The Company’s credit facility with Bank of America National Trust and Savings Association, Inc. (the “Lender”) provides for advances up to $20 million, less the amount of any outstanding draws, up to a $1.5 million maximum in authorized letters of credit. Interest accrues at the Lender’s prime rate plus 0.25% (4.5% at March 31, 2003) or can be fixed for a period of time at the then current rate established under one of several indices, all at the Company’s option. This credit facility expires on September 30, 2003, and the Company expects to renegotiate and extend the term of this agreement or obtain another form of financing before that date. The Company’s obligation to the Lender is presently secured by a first priority lien on substantially all of the Company’s non-real estate assets, and the Company is subject to several restrictive covenants. The principal operating covenants require the Company to maintain certain minimum cash flow coverage and debt to equity ratios and restrict the level of capital expenditures, calculated on a quarterly basis. As of March 31, 2003 the Company was in compliance with the debt covenants.
At March 31, 2003, there were no outstanding borrowings under the facility. Letters of credit amounting to $617,044 relating to purchase commitments were outstanding as on March 31, 2003.
The weighted average interest rate on borrowings during the year ended March 31, 2003 was 6.89%.
The agreement, as amended, provides for an annual non-utilization fee of 0.20 percent, plus a one-time facility fee of $20,000.
4. Commitments and Contingencies
The Company leases all buildings (including its corporate office space and three stores from the Company’s Principal Stockholder) under certain noncancelable operating lease agreements. Rentals of the retail locations in most instances require the payment of contingent rentals based on a percentage of sales in excess of minimum rental payment requirements. Most of the leases obligate the Company to pay costs of maintenance, utilities, and property taxes. Most leases contain renewal options of five years and certain leases provide for various rate increases over the lease term.
Sport Chalet, Inc.
Notes to Financial Statements (continued)
4. Commitments and Contingencies (continued)
Future minimum payments, by year and in the aggregate, under those leases with terms of one year or more, consist of the following at March 31, 2003:
Total rent expense amounted to $19,994,428, $16,912,075 and $15,504,720 for the years ended March 31, 2003, 2002 and 2001, respectively, of which $2,168,753, $2,351,571 and $2,469,373, respectively, was paid on the leases with the Principal Stockholder. Also, total rent expense includes contingent rentals calculated as a percentage of gross sales over certain base amounts of $1,277,879, $1,105,928 and $977,592 for the years ended March 31, 2003, 2002 and 2001, respectively. Included in the accompanying balance sheets are amounts representing prepaid rent to the Principal Stockholder of $128,959 at March 31, 2003 and $141,818 at March 31, 2002.
The Company is involved from time to time in routine legal matters incidental to its business. In the opinion of the Company’s management, based on the advice of counsel, resolution of such matters will not have a material effect on its financial position or results of operations.
Sport Chalet, Inc.
Notes to Financial Statements (continued)
5. Income Taxes
The provision for income taxes for the years ended March 31, 2003, 2002 and 2001 consists of the following:
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company’s deferred tax liabilities and assets as of March 31, 2003 and 2002 are as follows:
Sport Chalet, Inc.
Notes to Financial Statements (continued)
5. Income Taxes (continued)
A reconciliation of the provision for income taxes for the years ended March 31, 2003, 2002 and 2001 with the amount computed using the federal statutory rate follows:
6. Award Plan and Stock Award
Award Plan
The Company has an Incentive Award Plan (1992 Plan) under which stock options or other awards to purchase or receive up to 1,500,000, amended from 1,200,000 in fiscal 2003, shares of the Company’s Common Stock may be granted to employees and non-employee directors. The option price per share shall not be less than fair market value at the date of grant. Options vest over three- to five-year periods and if not exercised, expire five to 10 years from the date of grant. The 1992 Plan also provides for issuance by the Company of stock appreciation rights, restricted stock and performance awards. At March 31, 2003 and 2002, there were 431,999 and 191,999 remaining shares, respectively, reserved for future issuance and available for grant under the Plan.
The Company has adopted the disclosure-only provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123, Accounting for Stock-Based Compensation, (“Statement 123”) as amended by SFAS No. 148, Accounting for Stock-Based Compensation-Transition and Disclosure-an amendment of FASB Statement No. 123 (“Statement 148”). Statement 148 requires prominent disclosures in annual and interim financial statements regarding the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The Company measures compensation expense for its stock option awards under the intrinsic value method in accordance with the provisions of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, (“APB 25”) and related interpretations. APB 25 requires compensation expense to be recognized based on the excess, if any, of the quoted market price of the stock at the date of the grant and the amount an employee must pay to acquire the stock. Options awarded under the Company’s stock option plans are granted with an exercise price equal to the fair market value on the date of the grant.
Sport Chalet, Inc.
Notes to Financial Statements (continued)
6. Award Plans and Stock Award (continued)
Award Plan (continued)
The Company used the Black-Scholes option-pricing model with the following weighted-average assumptions in determining the fair value of options granted in fiscal 2003, 2002 and 2001: weighted-average risk-free interest rates of 4.0%, 4.5% and 6%, respectively; dividend yields of 0%; weighted-average volatility factors of the expected market price of the Company’s common stock of 0.41 for 2003, 0.45 for 2002 and 0.48 for 2001; and a weighted average expected life of the option of five years. The following table presents the effect on net income and basic and diluted net income per common share had the Company adopted the fair value method of accounting for stock-based compensation under Statement 123. Because additional options are expected to be granted each year, the pro forma disclosures may not be representative of pro forma effects on reported results for future periods. The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company’s employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management’s opinion, the existing models do not provide a reliable single measure of the fair value of employee stock options.
On December 20, 2002, the Company’s founder and Principal Stockholder, Norbert Olberz, and his wife, through a family trust, granted an option to purchase all of the shares (currently 4,400,510) of the Company’s Common Stock held by the family trust to a newly formed limited liability company (the “LLC”). The managers of the LLC currently are the Company’s Chairman and Chief Executive Officer and the Company’s Chief Financial Officer, who own 59.1% and 39.4% respectively, of the interests in the LLC. Other senior executives of the Company own the remaining interest in the LLC. Under the terms of the grant, the option becomes exercisable for 181 days from the date of death (“vesting” or “measurement” date) of Mr. Olberz, at an exercise price equal to the market price on the date of Mr. Olberz’ death. The option terminates by mutual consent between the family trust and the members of the LLC or in the event that the Company’s Chairman and Chief Executive Officer ceases to be the Chief Executive Officer of the Company. The family trust may borrow against the shares until the vesting date and may also sell shares provided that the family trust maintains ownership of at least 51% of the Company’s shares on a fully diluted basis.
Sport Chalet, Inc.
Notes to Financial Statements (continued)
6. Award Plans and Stock Award (continued)
Award Plan (continued)
For financial accounting purposes, the grant of the option by the principal stockholder of the Company is being treated in a manner consistent with a grant of an option by the Company. The Company has also treated the grant of the option to the LLC as if the grant was made directly to employees of the Company, as the members of the LLC are employees of the Company and no non-employee services will be provided to the Company by the LLC or members of the LLC and, for economic and tax purposes, the LLC is a pass through entity in that all income or losses of the LLC are passed through to its individual members. In addition, vesting of the option, except for the Company’s Chief Financial Officer, is contingent upon continued employment. Because the option has been granted with an exercise price equal to the market price on the measurement date, the Company will not be required to recognize compensation expense in connection with the grant of the option. The fair value of the option is being recognized as compensation expense for purposes of calculating pro forma net income and pro forma earnings per share as required by FASB Statement No.123, Accounting for Stock-Based Compensation. The fair value for the option was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions: weighted-average risk-free interest rate of 4.0%, dividend yields of 0%; weighted-average volatility factors of the expected market price of the Company’s Common Stock of 0.407 and an expected life of the option of 180 days. For purposes of pro forma disclosures, the estimated fair value of $3,872,000 for the option is being amortized to expense over the option’s vesting period, which has been estimated at nine years.
Sport Chalet, Inc.
Notes to Financial Statements (continued)
6. Award Plans and Stock Award (continued)
Award Plan (continued)
A summary of the Company’s stock option activity and related information follows:
Sport Chalet, Inc.
Notes to Financial Statements (continued)
6. Award Plans and Stock Award (continued)
The following table provides certain information with respect to stock options outstanding and stock options exercisable at year end 2003:
Stock Award
During the year ended March 31, 2001, the Principal Stockholder and his spouse, through their Family Trust, awarded 27,645 registered shares to certain employees. Award recipients were not required to pay consideration for the shares. The fair market value of the shares was treated as a capital contribution by the Principal Stockholder and expensed as compensation to recipients as of March 31, 2001.
The Company granted loans to employees to pay the income taxes associated with certain stock awards granted and expensed in fiscal 1999 and fiscal 2001. These loans bear interest at 6% and were originally payable over four years and secured by the awarded shares. In 2003 a two-year extension was granted. At March 31, 2003 and 2002 the loan balance was $109,905 and $215,468, respectively.
7. Employee Retirement Plan
Effective April 1, 1997, the Company adopted the Sport Chalet, Inc. Employee Retirement Savings Plan (the 401(k) Plan). All employees who have been employed by the Company for at least three months of service (provided that such service represents a minimum of 1,000 hours worked during the year) and are at least 21 years of age are eligible to participate. Employees may contribute to the 401(k) Plan up to 24% of their current compensation, subject to a statutorily prescribed annual limit. The Company matches 25% of employee contributions up to 1% of the employee’s current compensation. The Company expense related to this plan was $147,291, $123,158 and $118,742 for the years ended March 31, 2003, 2002 and 2001, respectively.
8. Quarterly Results of Operations (Unaudited)
A summary of the unaudited quarterly results of operations follows (dollar amounts in thousands, except per share amounts):
9. Other Accrued Expenses
Other accrued expenses consist of the following:
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized, on June 20, 2003.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the date indicated above.
/s/ NORBERT OLBERZ
Norbert Olberz,
Chairman Emeritus and Director
/s/ JOHN R. ATTWOOD
John R. Attwood, Director
/s/ AL D. MCCREADY
Al D. McCready, Director
/s/ ERIC S. OLBERZ
Eric S. Olberz, Director
/s/ KENNETH OLSEN
Kenneth Olsen, Director
/s/ FREDERICK H. SCHNEIDER.
Frederick H. Schneider, Director
CERTIFICATION
I, Craig Levra, certify that:
1.
I have reviewed this annual report on Form 10-K of Sport Chalet, Inc.;
2.
Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
3.
Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant. as of and for, the periods presented in this annual report;
4.
The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a)
designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;
b)
evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the “Evaluation Date”); and
c)
presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5.
The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions):
a)
all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and
b)
any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and
6.
The registrant’s other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
Date: June 20, 2003
/s/ Craig Levra
Craig Levra,
Chief Executive Officer
CERTIFICATION
I, Howard Kaminsky, certify that:
1.
I have reviewed this annual report on Form 10-K of Sport Chalet, Inc.;
2.
Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
3.
Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;
4.
The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a)
designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;
b)
evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the “Evaluation Date”); and
c)
presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5.
The registrant’s other certifying officers and I have disclosed based on our most recent evaluation, to the registrant’s auditors and the audit committee registrant’s board of directors (or persons performing the equivalent function):
a)
all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and
b)
any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and
6.
The registrant’s other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
Date: June 20, 2003
/s/ Howard Kaminsky
Howard Kaminsky,
Chief Financial Officer
EXHIBIT INDEX