(Mark One)
| |X| | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. |
| FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2004 |
OR
| |_| | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. |
| FOR THE TRANSITION PERIOD FROM ____________ TO ____________ |
Commission File Number: 0-20736
Sport Chalet, Inc.
(Exact name of registrant as specified in its charter)
| Delaware (State or other jurisdiction of incorporation or organization) |
95-4390071 (I.R.S. Employer Identification No.) |
One Sport Chalet
Drive, La Canada, CA 91011
(Address of principal executive offices)
(818)
949-5300
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes |X| No |_|
Indicate by check mark whether the
registrant is an accelerated filer (as defined in Rule 12b-2 of Act).
Yes |_| No |X|
Number of shares outstanding of the registrant's Common Stock, $0.01 par value, as of November 2, 2004: 6,682,701
1
Table of Contents to Form 10-Q
2
Item 1. Financial Statements.
| Three months
ended September 30, |
Six months
ended September 30, |
|||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2004
|
2003
|
2004
|
2003
|
|||||||||||
| Net sales | $ | 72,465,181 | $ | 61,818,702 | $ | 134,003,300 | $ | 115,127,978 | ||||||
| Cost of goods
sold, buying and occupancy |
49,989,199 | 43,305,377 | 93,828,640 | 81,841,640 | ||||||||||
|
|
|
|
|
|||||||||||
| Gross profit | 22,475,982 | 18,513,325 | 40,174,660 | 33,286,338 | ||||||||||
| Selling,
general and administrative expenses |
19,419,902 | 15,580,745 | 36,656,257 | 31,302,214 | ||||||||||
|
|
|
|
|
|||||||||||
| Income from operations | 3,056,080 | 2,932,580 | 3,518,403 | 1,984,124 | ||||||||||
| Interest expense | 47,616 | 55,746 | 90,907 | 89,756 | ||||||||||
|
|
|
|
|
|||||||||||
| Income before taxes | 3,008,464 | 2,876,834 | 3,427,496 | 1,894,368 | ||||||||||
| Income tax provision | 1,205,000 | 1,149,000 | 1,379,000 | 760,000 | ||||||||||
|
|
|
|
|
|||||||||||
| Net income | $ | 1,803,464 | $ | 1,727,834 | $ | 2,048,496 | $ | 1,134,368 | ||||||
|
|
|
|
|
|||||||||||
| Earnings per share: | ||||||||||||||
| Basic | $ | 0.27 | $ | 0.26 | $ | 0.31 | $ | 0.17 | ||||||
|
|
|
|
|
|||||||||||
| Diluted | $ | 0.25 | $ | 0.25 | $ | 0.28 | $ | 0.16 | ||||||
|
|
|
|
|
|||||||||||
| Weighted
average number of common shares outstanding: |
||||||||||||||
| Basic | 6,679,590 | 6,633,667 | 6,678,631 | 6,631,667 | ||||||||||
|
|
|
|
|
|||||||||||
| Diluted | 7,217,471 | 6,944,024 | 7,202,652 | 6,937,438 | ||||||||||
|
|
|
|
|
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3
| September
30, 2004 |
March 31, 2004 |
|||||||
|---|---|---|---|---|---|---|---|---|
| (Unaudited) | ||||||||
| Assets | ||||||||
| Current assets: | ||||||||
| Cash | $ | 1,371,215 | $ | 3,071,648 | ||||
| Accounts
receivable, less allowance of $235,000 at September 30, 2004 and $30,000 at March 31, 2004 |
4,448,821 | 1,158,934 | ||||||
| Merchandise inventories | 76,625,015 | 54,172,055 | ||||||
| Prepaid expenses and other current assets | 2,443,198 | 2,202,036 | ||||||
| Deferred income taxes | 2,326,380 | 2,443,945 | ||||||
|
|
|
|||||||
| Total current assets | 87,214,629 | 63,048,618 | ||||||
| Furniture, equipment and leasehold improvements-net | 32,228,634 | 29,467,976 | ||||||
| Deferred income taxes | 398,402 | 83,704 | ||||||
| Other assets | 87,403 | 101,036 | ||||||
|
|
|
|||||||
| Total assets | $ | 119,929,068 | $ | 92,701,334 | ||||
|
|
|
|||||||
| Liabilities and stockholders’ equity | ||||||||
| Current liabilities: | ||||||||
| Bank overdraft | $ | 7,543,711 | $ | — | ||||
| Accounts payable | 29,351,024 | 11,131,473 | ||||||
| Salaries and wages payable | 2,988,752 | 3,354,368 | ||||||
| Income taxes payable | 574,512 | 35,631 | ||||||
| Other accrued expenses | 6,781,965 | 7,830,961 | ||||||
|
|
|
|||||||
| Total current liabilities | 47,239,964 | 22,352,433 | ||||||
| Deferred rent | 6,007,412 | 5,818,026 | ||||||
| Stockholders’ equity | ||||||||
| Preferred stock, $.01 par value: | ||||||||
| Authorized shares – 2,000,000 | ||||||||
| Issued and outstanding shares – none | — | — | ||||||
| Common stock, $.01 par value: | ||||||||
| Authorized shares – 15,000,000 | ||||||||
| Issued
and outstanding shares – 6,680,701 at September 30, 2004 and 6,673,534 at March 31, 2004 |
66,807 | 66,735 | ||||||
| Additional paid-in capital | 22,933,155 | 22,830,906 | ||||||
| Retained earnings | 43,681,730 | 41,633,234 | ||||||
|
|
|
|||||||
| Total stockholders’ equity | 66,681,692 | 64,530,875 | ||||||
|
|
|
|||||||
| Total liabilities and stockholders’ equity | $ | 119,929,068 | $ | 92,701,334 | ||||
|
|
|
|||||||
4
| Six months
ended September 30,
|
||||||||
|---|---|---|---|---|---|---|---|---|
| 2004
|
2003
|
|||||||
| Operating activities | ||||||||
| Net income | $ | 2,048,496 | $ | 1,134,368 | ||||
| Adjustments
to reconcile net income to net cash provided by operating activities: |
||||||||
| Depreciation and amortization | 3,761,783 | 2,986,396 | ||||||
| Loss on disposal of furniture, equipment and leasehold improvements | — | 244,821 | ||||||
| Deferred income taxes | (197,133 | ) | (149,542 | ) | ||||
| Tax benefit on employee stock options | 61,923 | 4,134 | ||||||
| Changes in operating assets and liabilities: | ||||||||
| Accounts receivable | (3,289,887 | ) | 87,982 | |||||
| Merchandise inventories | (22,452,960 | ) | (10,838,835 | ) | ||||
| Prepaid expenses and other current assets | (241,162 | ) | (242,571 | ) | ||||
| Refundable income taxes | — | 58,990 | ||||||
| Bank overdraft | 7,543,711 | (566,426 | ) | |||||
| Accounts payable | 18,219,551 | 9,586,711 | ||||||
| Salaries and wages payable | (365,616 | ) | (264,144 | ) | ||||
| Income taxes payable | 538,881 | 746,488 | ||||||
| Other accrued expenses | (1,048,996 | ) | (18,889 | ) | ||||
| Deferred rent | 189,386 | 295,261 | ||||||
|
|
|
|||||||
| Net cash provided by operating activities | 4,767,977 | 3,064,744 | ||||||
| Investing activities | ||||||||
| Purchase of furniture, equipment and leasehold improvements | (6,522,441 | ) | (3,681,844 | ) | ||||
| Other assets | 13,633 | 13,464 | ||||||
|
|
|
|||||||
| Net cash used in investing activities | (6,508,808 | ) | (3,668,380 | ) | ||||
| Financing activities | ||||||||
| Proceeds from exercise of stock options | 40,398 | 39,430 | ||||||
|
|
|
|||||||
| Net cash provided by financing activities | 40,398 | 39,430 | ||||||
|
|
|
|||||||
| Decrease in cash and cash equivalents | (1,700,433 | ) | (564,206 | ) | ||||
| Cash and cash equivalents at beginning of period | 3,071,648 | 4,230,003 | ||||||
|
|
|
|||||||
| Cash and cash equivalents at end of period | $ | 1,371,215 | $ | 3,665,797 | ||||
|
|
|
|||||||
| Supplemental Disclosure of Cash Flow Information | ||||||||
| Cash paid during the period for: | ||||||||
| Income taxes | $ | 975,000 | $ | 100,000 | ||||
| Interest | — | — | ||||||
5
| 1. | Basis of Presentation |
The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments, consisting of normal recurring accruals, considered necessary for a fair presentation of the results of operations for the periods presented have been included.
The financial data at March 31, 2004 is derived from audited financial statements which are included in the Company’s Annual Report on Form 10-K for the year ended March 31, 2004, and should be read in conjunction with the audited financial statements and notes thereto. Interim results are not necessarily indicative of results for the full year.
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.
| 2. | Earnings per Share |
Earnings per share, basic, is computed based on the weighted average number of common shares outstanding for the period. Earnings per share, diluted, is computed based on the weighted average number of common and potentially dilutive common equivalent shares outstanding for the period. A reconciliation is as follows:
| Three
months ended September 30, |
Six
months ended September 30, |
||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2004
|
2003
|
2004
|
2003
|
||||||||||
| Net income | $ | 1,803,464 | $ | 1,727,834 | $ | 2,048,496 | $ | 1,134,368 | |||||
| Weighted average number of common shares: | |||||||||||||
| Basic | 6,679,590 | 6,633,667 | 6,678,631 | 6,631,667 | |||||||||
| Effect
of dilutive securities- stock options |
537,881 | 310,357 | 524,021 | 305,771 | |||||||||
|
|
|
|
|
||||||||||
| Diluted | 7,217,471 | 6,944,024 | 7,202,652 | 6,937,438 | |||||||||
|
|
|
|
|
||||||||||
| Earnings per share: | |||||||||||||
| Basic | $ | 0.27 | $ | 0.26 | $ | 0.31 | $ | 0.17 | |||||
| Effect
of dilutive securities- stock options |
$ | 0.02 | $ | 0.01 | $ | 0.03 | $ | 0.01 | |||||
|
|
|
|
|
||||||||||
| Diluted | $ | 0.25 | $ | 0.25 | $ | 0.28 | $ | 0.16 | |||||
|
|
|
|
|
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6
| 3. | Stock Compensation |
The Financial Accounting Standards Board’s (“FASB”) SFAS No. 148, “Accounting for Stock-Based Compensation-Transition and Disclosure, and Amendment of FASB Statement No. 123” (“SFAS No.148”) amends SFAS No. 123 “Accounting for Stock-Based Compensation,” to provide alternative methods of transition for a voluntary change to fair value based method of accounting for employee stock-based compensation. In addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to require prominent disclosure in annual and interim financial statements about the method of accounting for stock-based compensation and its effects on reporting. The Company continues to apply the principles of APB Opinion No. 25 and related interpretations in accounting for its stock-based compensation plans. Accordingly, no compensation expense has been recorded in conjunction with options issued to employees. Had compensation cost been determined based on the fair value of the options at the grant date and amortized over the option’s vesting period, consistent with the method prescribed by SFAS No. 123, the Company’s net income would have been:
| Three months
ended September 30, |
Six months
ended September 30, |
|||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2004
|
2003
|
2004
|
2003
|
|||||||||||
| Net income as reported | $ | 1,803,464 | $ | 1,727,834 | $ | 2,048,496 | $ | 1,134,368 | ||||||
| Add: | ||||||||||||||
| Stock-based
compensation expense included in reported net income, net of related tax effects |
— | — | — | — | ||||||||||
| Deduct: | ||||||||||||||
| Total
stock-based employee compensation expense determined under fair market value based method for all awards, net of related tax effects |
145,193 | 131,268 | 279,840 | 265,470 | ||||||||||
|
|
|
|
|
|||||||||||
| Pro forma net income | $ | 1,658,271 | $ | 1,596,566 | $ | 1,768,656 | $ | 868,898 | ||||||
|
|
|
|
|
|||||||||||
| Earnings per share – basic and diluted | ||||||||||||||
| As reported – basic | $ | 0.27 | $ | 0.26 | $ | 0.31 | $ | 0.17 | ||||||
| As reported – diluted | $ | 0.25 | $ | 0.25 | $ | 0.28 | $ | 0.16 | ||||||
| Pro forma – basic | $ | 0.25 | $ | 0.24 | $ | 0.27 | $ | 0.13 | ||||||
| Pro forma – diluted | $ | 0.23 | $ | 0.23 | $ | 0.25 | $ | 0.13 | ||||||
The fair value of each option granted is estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions used for grants in fiscal 2004: expected volatility of 41%; risk-free interest rate of 4.0%; expected lives from one to four years; and expected dividends of 0%. The Black-Scholes 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 necessarily provide a reliable single measure of the fair value of its employee stock options.
7
| 4. | New Accounting Pronouncements |
On October 13, 2004, the Financial Accounting Standards Board (“FASB”) concluded that the Proposed Statement of Financial Accounting Standards, Share-Based Payment, which would require all companies to measure compensation cost for all share-based payments (including employee stock options) at fair value, would be effective for public companies for interim or annual periods beginning after June15, 2005. The Company could adopt the new standard in one of two ways — the modified prospective transition method or the modified retrospective transition method. The Company expects to adopt this new standard in the second quarter ending September 30, 2005 and is currently evaluating the effect that the adoption of this standard will have on its financial position and results of operations.
Except for the historical information contained herein, the matters addressed in this Item 2 constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Such forward-looking statements are subject to a variety of risks and uncertainties, including those discussed below under the heading “Factors That May Affect Future Results” and elsewhere in this Quarterly Report on Form 10-Q, that could cause actual results to differ materially from those anticipated by the Company’s management. The Private Securities Litigation Reform Act of 1995 (the “Act”) provides certain “safe harbor” provisions for forward-looking statements. All forward-looking statements made in this Quarterly Report on Form 10-Q are made pursuant to the Act.
The following should be read in conjunction with the Company’s financial statements and related notes thereto provided under Item 1–Financial Statements above.
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).
| Three
months ended September 30,
|
Six
months ended September 30, |
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|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2004
|
2003
|
2004
|
2003
|
|||||||||||||||||||||||||
| Amount
|
Percent
|
Amount
|
Percent
|
Amount
|
Percent
|
Amount
|
Percent
|
|||||||||||||||||||||
| Net sales | $ | 72,465 | 100.0 | % | $ | 61,819 | 100.0 | % | $ | 134,003 | 100.0 | % | $ | 115,128 | 100.0 | % | ||||||||||||
| Gross profit | 22,476 | 31.0 | % | 18,513 | 29.9 | % | 40,175 | 30.0 | % | 33,286 | 28.9 | % | ||||||||||||||||
| Selling,
general and administrative expenses |
19,420 | 26.8 | % | 15,581 | 25.2 | % | 36,656 | 27.4 | % | 31,302 | 27.2 | % | ||||||||||||||||
| Income from operations | 3,056 | 4.2 | % | 2,932 | 4.7 | % | 3,519 | 2.6 | % | 1,984 | 1.7 | % | ||||||||||||||||
| Interest expense | (48 | ) | (0.1 | %) | (56 | ) | (0.1 | %) | (91 | ) | (0.1 | %) | (90 | ) | (0.1 | %) | ||||||||||||
| Income before taxes | 3,008 | 4.2 | % | 2,876 | 4.7 | % | 3,428 | 2.6 | % | 1,894 | 1.6 | % | ||||||||||||||||
| Net income | 1,803 | 2.5 | % | 1,727 | 2.8 | % | 2,048 | 1.5 | % | 1,134 | 1.0 | % | ||||||||||||||||
| Earnings per share: | ||||||||||||||||||||||||||||
| Basic | $ | 0.27 | $ | 0.26 | $ | 0.31 | $ | 0.17 | ||||||||||||||||||||
| Diluted | $ | 0.25 | $ | 0.25 | $ | 0.28 | $ | 0.16 | ||||||||||||||||||||
8
Three Months Ended September 30, 2004 Compared to Three Months Ended September 30, 2003. Sales increased $10.7 million, or 17.2%, from $61.8 million for the three months ended September 30, 2003 to $72.5 million for the same period this year. The increase is the result of opening five new stores which contributed $6.7 million in sales, or 10.9% of total sales, as well as a same store sales increase of 5.2%. Three new stores were opened in the third quarter of fiscal 2004 and two new stores opened in the second quarter of fiscal 2005. The same store sales increase is due to stronger end of summer sales resulting from better inventory assortment compared to the same period last year. In addition, the Company acquired a Southern California based team dealer and consolidated the team business during the quarter. Same store sales are based upon stores opened throughout both periods and exclude team sales.
Gross profit increased $4.0 million, or 21.4%, primarily from increased sales. As a percent of sales, gross profit increased from 29.9% for the three months ended September 30, 2003 to 31.0% for the same period this year. The increase in gross profit as a percent of sales is primarily due to reduced costs from more efficient inbound logistics as well as continued improvements in inventory procurement, which lowered markdowns as a percent of sales.
Selling, general and administrative expenses increased $3.8 million, or 24.6%, primarily from additional stores. As a percent of sales, these expenses increased from 25.2% for the three months ended September 30, 2003, to 26.8% for the same period this year. The increase is primarily a result of the additional labor and advertising expense required to open three new stores, partially offset by the leverage created by an increase in same store sales.
The effective income tax rate was 39.9% for the three months ended September 30, 2003 compared to 40.1% for the same period this year. 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 increased $76,000, from $1.7 million, or $0.25 per diluted share, for the three months ended September 30, 2003 to $1.8 million, or $0.25 per diluted share, for the same period this year, primarily as a result of increased sales and improved gross profit partially offset by the expenses required to open three new stores.
Six Months Ended September 30, 2004 Compared to Six Months Ended September 30, 2003.Sales increased $18.9 million, or 16.4%, from $115.1 million for the six months ended September 30, 2003 to $134.0 million for the same period this year. The increase is the result of opening five new stores which contributed $11.8 million in sales, or 10.2% of total sales, as well as a same store sales increase of 5.7%. Three new stores were opened in the third quarter of fiscal 2004 and two new stores opened in the second quarter of fiscal 2005. The same store sales increase is due to stronger sales resulting from better inventory assortment compared to the same period last year. In addition, the Company acquired a Southern California based team dealer and consolidated the team business during the period. Same store sales are based upon stores opened throughout both periods and exclude team sales.
Gross profit increased $6.9 million, or 20.7%, primarily from increased sales. As a percent of sales, gross profit increased from 28.9% for the six months ended September 30, 2003 to 30.0% for the same period this year. The increase in gross profit as a percent of sales is primarily due to reduced costs from more efficient inbound logistics as well as continued improvements in inventory procurement, which lowered markdowns as a percent of sales.
Selling, general and administrative expenses increased $5.4 million, or 17.1%, primarily from additional stores. As a percent of sales, these expenses increased from 27.2% for the six months ended September 30, 2003, to 27.4% for the same period this year. The increase is primarily a result of the additional labor and advertising expense required to open three new stores, partially offset by the leverage created by an increase in same store sales.
9
The effective income tax rate was 40.1% for the six months ended September 30, 2003 compared to 40.2% for the same period this year. 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 increased $914,000, from $1.1 million, or $0.16 per diluted share, for the six months ended September 30, 2003 to $2.0 million, or $0.28 per diluted share, for the same period this year, primarily as a result of increased sales and improved gross profit partially offset by the expenses required to open three new stores.
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 borrowings have met the Company’s liquidity needs. Management believes that these sources will be sufficient to fund currently anticipated cash requirements for the foreseeable future.
Net cash provided by operating activities is primarily the result of net income, adjusted for depreciation and amortization, and increases in accounts payable partially offset by inventory purchases. For the six months ended September 30, 2004, $4.8 million was generated by operating activities compared to $3.1 million for the same period last year.
Inventories increased by $22.5 million and $10.8 million for the six months ended September 30, 2004 and 2003, respectively, compared to the respective year-end balances primarily due to the build-up of seasonal inventory. In addition, the Company opened three new stores in the third quarter of fiscal 2004 and two new stores in the second quarter of fiscal 2005. The average inventory per store increased by 2.2%, at September 30, 2004 as compared to September 30, 2003, primarily from the planned early receipt of winter related product, without which the average inventory per store decreased 5.4%. The decrease is due to continuing improvements in inventory procurement. Winter related product was received earlier to improve efficiencies of overall merchandise flow.
Bank overdraft represents the total of checks in transit in excess of cash on hand. The bank overdraft at September 30, 2004 was $7.5 million and the overdraft is expected to continue and fluctuate due to the timing of vendor payments in the future. Historically, accounts payable has increased as inventory increases. In the six months ended September 30, 2004, accounts payable combined with the bank overdraft, increased by $25.8 million as compared to an increase of $9.0 million for the six months ended September 30, 2003. The relative change as compared to inventory levels is primarily the result of the timing of inventory receipts during the period.
Net cash used in investing activities for the six months ended September 30, 2004 was $6.5 million compared to $3.7 million for the same period ended September 30, 2003. In addition to routine capital spending, the Company remodeled two stores during the six months ended September 30, 2003. For the six months ended September 30, 2004, the Company started two store remodels, opened three new stores and incurred additional expenditures for two new stores scheduled to open later this fiscal year. The Southern California based team dealer acquired during the quarter ended September 30, 2004 had an immaterial effect on the Company’s cash flow.
10
The Company’s amended credit facility with Bank of America, N.A. (the “Lender”) provides for advances up to $20 million, increasing to $35.0 million for the period October 1, through December 31, each year, less the amount of any outstanding draws, up to a $4.0 million maximum in authorized letters of credit. Interest accrues at the Lender’s prime rate plus 0.25% (5.0% at September 30, 2004) 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. In addition, there is an unused commitment fee of 0.20% per year, based on a weighted average formula. This credit facility expires on September 30, 2005, 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. Due to improved inventory management the Company did not borrow on this facility during the period ended September 30, 2004.
The Company’s primary contractual obligations and commitments as of September 30, 2004, are its store leases with initial terms expiring from 2005 through 2020, which typically provide for multiple five-year renewal options, and employment contracts:
| Payments due by period:
|
Operating Leases |
Employment
Contracts |
||||||
|---|---|---|---|---|---|---|---|---|
| Within 1 year | $ | 20,435,934 | $ | 319,500 | ||||
| 2 - 3 years | 41,343,437 | 639,000 | ||||||
| 4 - 5 years | 37,565,815 | 639,000 | ||||||
| After 5 years | 76,616,276 | 1,437,750 | ||||||
|
|
|
|||||||
| Total | $ | 175,961,462 | $ | 3,035,250 | ||||
|
|
|
|||||||
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. Generally, purchase obligations are cancelable 45 days prior to shipment from vendors. Letters of credit amounting to $2,309,000 relating to self-insurance reserves were outstanding as of September 30, 2004 and expire within one year.
No cash dividends were declared on Common Stock in the first two quarters of fiscal 2005. 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.
The Company’s significant accounting policies are described in Note 2 of the Company’s Annual Report on Form 10-K for the year ended March 31, 2004, 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 consolidated financial statements.
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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.
Revenue Recognition. Sales are recognized upon the purchase by customers at the Company’s retail store locations, less merchandise returned by customers. The Company provides a reserve for projected merchandise returns based on historical experience. As the reserve for merchandise returns is based on estimates, the actual returns could differ from the reserve, which could impact sales. Revenue from gift cards, gift certificates and store merchandise credits is recognized at the time of redemption.
Self-insurance. Property, general liability and workers’ compensation insurance coverage is self-insured for various levels. Self-insurance accruals include claims filed, as well as estimates of claims incurred but not yet reported based on historical trends. Projections of future loss are inherently uncertain because of the random nature of insurance claim occurrences and could be significantly affected if future occurrences and claims differ from historical trends.
Gift Card/Certificate Redemption. The Company offers its customers the option of purchasing gift cards and, in the past, gift certificates which may be used toward the future purchase of the Company’s product offerings. The gift cards and certificates have no expiration dates. The Company records unredeemed gift cards or certificates as a liability until the point of redemption. The Company’s historical experience indicates that not all issued gift cards or certificates get redeemed. Accordingly, the Company periodically adjusts the carrying value of the related liability. Pending legislation could impact the method in which the Company calculates carrying value in the future. The Company monitors redemptions rates as a percent of issuances and uses this information to estimate probable redemption of all outstanding gift cards or certificates. This calculation is based on historical experience, and future redemption rates may vary if consumer purchasing practices change or if the pattern of redeeming gift cards is significantly different than the Company has experienced with gift certificates.
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. Declines in projected store cash flow could result in the impairment of assets.
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 future recovery is not likely, a valuation allowance would be established. To the extent that a valuation allowance is established or increased, an expense will be included within the tax provision in the income statement.
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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 September 30, 2004. 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 2004, 2003 and 2002 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.
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 Report on Form l0-Q 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.
Implementing Section 404 of the Sarbanes-Oxley Act of 2002. The regulations implementing Section 404 of the Sarbanes-Oxley Act of 2002 require the Company to provide an assessment of the effectiveness of its internal control over financial reporting beginning with the Annual Report on Form 10-K for the fiscal year ending March 31, 2006. The Company’s independent auditors will be required to confirm in writing whether the assessment of the effectiveness of its internal control over financial reporting is fairly stated in all material respects, and separately report on whether they believe the Company maintained, in all material respects, effective internal control over financial reporting as of March 31, 2006.
This process will be expensive, time consuming and will require significant attention of management. The Company cannot assure that it will not discover material weaknesses in its internal controls. The Company also cannot assure that it will complete the process of its evaluation and the auditors’ attestation on time. If the Company discovers a material weakness, corrective action may be time consuming, costly and further divert the attention of management. The disclosure of a material weakness, even if quickly remedied, could reduce the market’s confidence in the Company’s financial statements and harm its stock price, especially if a restatement of financial statements for past periods were to be necessary.
Until the Company completes the review and any necessary remedial action, and secures the written attestation of its independent auditors that its internal controls are adequate, the Company will not be able to file its Annual Report on Form 10-K for fiscal year 2006 as required by the Securities Exchange Act of 1934. If the Company’s Form 10-K is delayed, its stock price could fall. If the delay is significant, the Company could be subject to a variety of administrative sanctions, including the delisting of its Common Stock from Nasdaq and the inability of registered broker-dealers to make a market in its Common Stock, which would further reduce its stock price.
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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 in the future have, a material adverse effect on the Company’s results of operations.
Terrorism/War. Terrorist attacks may cause damage or disruption to the Company’s employees, facilities, information systems, vendors and customers, which could significantly impact net sales, costs and expenses and financial condition. 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 the Company to suffer in ways that the Company currently cannot predict. The Company’s geographical focus in California and Nevada may make the Company more vulnerable to such uncertainties than other comparable retailers who may not have similar geographical concentration.
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 internet retailers. A number of the Company’s competitors are larger and have greater resources than the Company.
Regional Market Concentration. Currently, most of the Company’s stores are located in Southern California and the balance are located in Northern 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. When the region suffers an economic downturn or when other adverse events occur, historically there has been an adverse effect on the Company’s net sales and profitability and this could also affect the Company’s 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. |
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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 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, information systems, inventory management and distribution facilities. 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 30% and 34% of the Company’s total net sales, 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.
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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 November 2, 2004, Norbert Olberz, the Company’s founder, Chairman Emeritus, director and principal stockholder, owned approximately 65% 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 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.
Our 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 nine 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.
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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 analysts 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 3. 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. The impact on earnings or cash flow during the next fiscal year from a change of 100 basis points in the interest rate would not be significant.
Item 4. Controls and Procedures.
The Company’s Chief Executive Officer, Craig Levra, and Chief Financial Officer, Howard Kaminsky, 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-15(e). Based upon that evaluation, the Chief Executive Officer and the Chief Financial Officer believe that, as of the end of the period covered by this report, the Company’s disclosure controls and procedures are effective in making known to them material information relating to the Company (including its consolidated subsidiaries) 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 objectives 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 changes in the Company’s internal controls over financial reporting, known to the Chief Executive Officer or the Chief Financial Officer that occurred during the period covered by this report that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
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Item 1. 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, cash flows 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 2. Unregistered Sales of Equity Securities and Use of Proceeds.
Not Applicable.
Item 3. Defaults Upon Senior Securities.
Not Applicable.
Item 4. Submission of Matters to a Vote of Security Holders.
On August 2, 2004, we held our 2004 annual meeting of stockholders. At the annual meeting, there were 6,679,115 shares entitled to vote, and 6,338,480 shares were represented at the meeting in person or by proxy.
The following summarizes the results for those matters submitted to our stockholders for action at the annual meeting:
| 1. | Election of Directors. To elect three Class 3 directors to hold office until the annual meeting of stockholders to be held in 2007, or until their respective successors have been elected and qualified. |
| Director
|
For
|
Withheld
|
|||||||
|---|---|---|---|---|---|---|---|---|---|
| Donald J. Howard | 6,321,347 | 17,133 | |||||||
| Norbert Olberz | 6,228,447 | 110,033 | |||||||
| Kenneth Olsen | 6,322,919 | 15,561 |
| 2. | Approval of the 2004 Equity Incentive Plan. To approve the Company’s 2004 Equity Incentive Plan. |
| For
|
Against
|
Abstain
|
Broker Non-Voter
|
||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| 5,326,746 | 304,795 | 106,364 | 660,575 | ||||||||
| 3. | Ratification of Appointment of Independent Auditors. To ratify the appointment of Ernst & Young LLP as the Company’s independent auditors for the fiscal year ending March 31, 2005. |
| For
|
Against
|
Abstain
|
||||||
|---|---|---|---|---|---|---|---|---|
| 6,328,070 | 10,146 | 264 |
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Item 5. Other Information.
The proxy materials for the 2004 annual meeting of the stockholders held on August 2, 2004 were mailed to stockholders of the Company on June 21, 2004.
Under certain circumstances, stockholders are entitled to present proposals at stockholder meetings. The 2005 annual meeting of stockholders is presently expected to be held on or about August 1, 2005. Any such proposal to be included in the proxy statement for the Company’s 2005 annual meeting of stockholders must be received by the Secretary of the Company at the Company’s office at One Sport Chalet Drive, La Canada, California 91011 on or before February 21, 2005 in a form that complies with applicable regulations. If the date of the 2005 annual meeting is advanced or delayed more than 30 days from the date of the 2004 annual meeting, stockholder proposals intended to be included in the proxy statement for the 2005 annual meeting must be received by the Company within a reasonable time before the Company begins to print and mail the proxy statement for the 2005 annual meeting. Upon any determination that the date of the 2005 annual meeting will be advanced or delayed by more than 30 days from the date of the 2004 annual meeting, the Company will disclose the change in the earliest practicable Quarterly Report on Form 10-Q.
In the event a stockholder proposal is not submitted to the Company on or before May 6, 2005, the proxies solicited by the Board of Directors for the 2005 annual meeting of the stockholders will confer authority on the holders of the proxy to vote the shares in accordance with the recommendations of the Board of Directors if the proposal is presented at the 2005 annual meeting of stockholders without any discussion of the proposal in the proxy statement for such meeting.
Item 6. Exhibits and Reports on Form 8-K.
| (a) | Exhibits: |
| 31.1 | Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
| 31.2 | Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
| 32.1 | Certification Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
| (b) | Reports on Form 8-K: |
| None |
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Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
DATE: November 3, 2004 |
SPORT CHALET,
INC. By: /s/ HOWARD K. KAMINSKY ———————————————— Howard K. Kaminsk Executive Vice President-Finance, Chief Financial Officer and Secretary (On behalf of the Registrant and as Principal Financial and Accounting Officer) |
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