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SPCHA > SEC Filings for SPCHA > Form 10-K on 24-May-2013All Recent SEC Filings

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Form 10-K for SPORT CHALET INC


24-May-2013

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This Annual Report on Form 10-K contains statements that 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. These forward-looking statements are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements include statements relating to trends in, or representing management's beliefs about, our future strategies, operations and financial results, as well as other statements including words such as "believe," "anticipate," "expect," "estimate," "predict," "intend," "plan," "project," "will," "could," "may," "might" or any variations of such words or other words with similar meanings. Forward-looking statements are made based upon management's current expectations and beliefs concerning trends and future developments and their potential effects on the Company. You are cautioned not to place undue reliance on forward-looking statements as predictions of actual results. These statements are not guarantees of future performance and involve risks and uncertainties that are difficult to predict. Further, certain forward-looking statements are based upon assumptions as to future events that may not prove to be accurate. Actual results may differ materially from those suggested by forward-looking statements as a result of risks and uncertainties which are discussed in further detail under "Item 1A. Risk Factors." We do not assume, and specifically disclaim, any obligation to update any forward-looking statements, which speak only as of the date made.

The following should be read in conjunction with "Item 6. Selected Financial Data" and our consolidated financial statements and related notes thereto.

General Overview

Sport Chalet, Inc. (referred to as the "Company," "Sport Chalet," "we," "us," and "our") is a premier, full-service specialty sporting goods retailer of full-service, specialty sporting goods stores offering a broad assortment of brand name sporting goods equipment, apparel, and footwear. Over the last 54 years, Sport Chalet has grown into a chain of 54 specialty sporting goods stores serving California, Nevada, Arizona and Utah, as well as a Team Sales Division and an online store at sportchalet.com.

Our stores are located in states that have experienced, since the downturn that began in 2008, the worst macroeconomic conditions in the nation, including high unemployment rates, foreclosure rates and bankruptcy filings. As a result, our sales, which are largely dependent on the level of consumer spending in the geographic regions surrounding our stores, declined and we incurred substantial losses in fiscal 2009 and fiscal 2010. In response, we have aggressively taken action to modify our business model to make the Company more efficient, improve our liquidity and reduce operating expenses. At the same time, we have reinforced our commitment to be first to market with performance, technology and lifestyle merchandise by expanding our specialty brands and continuing to emphasize the availability and proficiency of our sales staff while many of our competitors emphasized value pricing and severely reduced store staffing. As a result of these efforts, our net loss for fiscal 2013 was $3.3 million (or $0.24 per diluted share) compared to net losses of $5.1 million (or $0.36 per diluted share), $3.0 million (or $0.21 per diluted share), $8.3 million (or $0.59 per diluted share) and $52.2 million (or $3.70 per diluted share) for fiscal years 2012, 2011, 2010 and 2009, respectively. Our comparable store sales, which declined significantly during fiscal 2009 and fiscal 2010, stabilized in the latter part of fiscal 2011 and in fiscal 2012. In fiscal 2013, our comparable store sales increased 3.7%, which is the first increase annually since fiscal 2007. A store's sales are included in the comparable store sales calculation in the quarter following its twelfth full month of operation and excluded from the calculation in the quarter of its closure.

Results of Operations

Fiscal 2013 Compared to Fiscal 2012

The following table sets forth statement of operations data determined in accordance with accounting principles generally accepted in the United States ("GAAP"), the relative percentages of net sales, and the percentage increase or decrease, for fiscal years 2013 and 2012 (in thousands, except per share amounts).


                                             Fiscal year
                                  2013                          2012                 Dollar        Percentage
                         Amount        Percent         Amount        Percent         change          change
Net sales               $ 360,645          100.0 %    $ 349,883          100.0 %    $  10,762              3.1 %
Gross profit               99,240           27.5 %       95,373           27.3 %        3,867              4.1 %
Selling, general and
administrative
expenses                   91,994           25.5 %       89,203           25.5 %        2,791              3.1 %
Depreciation and
amortization                8,455            2.3 %        9,450            2.7 %         (995 )          (10.5 %)
Loss from operations       (1,209 )         (0.3 %)      (3,280 )         (0.9 %)       2,071            (63.1 %)
Interest expense            2,124            0.6 %        1,790            0.5 %          334             18.7 %
Loss before income
taxes                      (3,333 )         (0.9 %)      (5,070 )         (1.4 %)       1,737            (34.3 %)
Income tax provision            2            0.0 %            2            0.0 %            -              0.0 %
Net loss                   (3,335 )         (0.9 %)      (5,072 )         (1.4 %)       1,737            (34.2 %)

Loss per share:
Basic and diluted       $   (0.24 )                   $   (0.36 )                   $    0.12            (34.2 %)

Net sales increased $10.8 million, or 3.1%, to $360.6 million for fiscal 2013 from $349.9 million for fiscal 2012. The increase in sales is primarily due to a comparable store sales increase of $12.2 million, or 3.7%, while sales for Team Sales Division and online increased 19.5% and 21.5%, respectively, partially offset by one store closure which contributed $3.2 million in sales in the prior fiscal year. The comparable store sales increase of 3.7% is an improvement from the 0.6% decrease in fiscal 2012, which was primarily due to the unseasonably warm and dry winter weather experienced in the second half of fiscal 2012.

Gross profit increased $3.9 million, or 4.1%, primarily as a result of the increase in sales. As a percent of sales, gross profit improved to 27.5% from 27.3%. In the first three quarters of fiscal 2013 the margin was negatively impacted primarily due to costs related to ongoing customer satisfaction initiatives, changes in merchandise costs and product mix, and a payment received in the prior year from a landlord as part of a store's closing. This negative impact was offset primarily by lower markdowns and increased winter rentals and repairs, which have higher margins, due to an improvement in winter weather in the fourth quarter of fiscal 2013.

Selling, general and administrative expenses ("SG&A") increased $2.8 million, or 3.1%. The increase is primarily due to increases of $1.4 million in advertising and $1.2 million from costs associated with the growth of the Team Sales Division, which include operational issues associated with the new computer systems. As a percent of sales, SG&A remained unchanged at 25.5%.

Depreciation expense decreased $1.0 million, or 10.5%, as a result of the low level of capital expenditures in recent fiscal years with no new store openings or significant remodels.

Net loss decreased $1.7 million to $3.3 million, or $0.24 per diluted share for fiscal 2013, from a net loss of $5.1 million, or $0.36 per diluted share for fiscal 2012.

Fiscal 2012 Compared to Fiscal 2011

The following table sets forth statement of operations data determined in accordance with GAAP, the relative percentages of net sales, and the percentage increase or decrease, for fiscal years 2012 and 2011 (in thousands, except per share amounts). Fiscal 2011 was a 53 week year and thus included one extra week in the fourth quarter and ended on April 3, 2011. The results for the 52 weeks ended April 1, 2012 (fiscal 2012) are compared to the 53 weeks ended April 3, 2011 (fiscal 2011), except for sales comparisons that exclude the extra week in fiscal year 2011 and compare the 52 weeks ended April 1, 2012 to the 52 weeks ended April 3, 2011 (excluding the first week of fiscal 2011).


                                             Fiscal year
                                  2012                          2011                 Dollar        Percentage
                         Amount        Percent         Amount        Percent         change          change
Net sales               $ 349,883          100.0 %    $ 362,483          100.0 %    $ (12,600 )           (3.5 %)
Gross profit               95,373           27.3 %      102,352           28.2 %       (6,979 )           (6.8 %)
Selling, general and
administrative
expenses                   89,203           25.5 %       92,647           25.6 %       (3,444 )           (3.7 %)
Depreciation and
amortization                9,450            2.7 %       10,351            2.9 %         (901 )           (8.7 %)
Loss from operations       (3,280 )         (0.9 %)        (646 )         (0.2 %)      (2,634 )          407.7 %
Interest expense            1,790            0.5 %        2,366            0.7 %         (576 )          (24.3 %)
Loss before income
taxes                      (5,070 )         (1.4 %)      (3,012 )         (0.8 %)      (2,058 )           68.3 %
Income tax provision            2            0.0 %            3            0.0 %           (1 )          (33.3 %)
Net loss                   (5,072 )         (1.4 %)      (3,015 )         (0.8 %)      (2,057 )           68.2 %

Loss per share:
Basic and diluted       $   (0.36 )                   $   (0.21 )                   $   (0.14 )           68.2 %

Net sales decreased $12.6 million, or 3.5%, to $349.9 million for fiscal 2012 from $362.5 million for fiscal 2011. The decrease in sales is primarily due to the extra week in fiscal 2011 that contributed $5.8 million to sales in that fiscal year. Excluding the extra week in fiscal year 2011, net sales decreased $6.8 million, or 1.9%, primarily due to a store closure decrease of $4.1 million, a comparable store sales decrease of $1.9 million, or 0.6%, and an increase in the usage of our customer relationship management program, Action Pass, which requires sales be reduced as points are earned, partially offset by an increase in online business of 22.0%. The comparable store sales decrease was due to the unseasonably warm and dry winter weather experienced in the second half of the year, which significantly affected snowfall at the resorts most frequented by our customers. This resulted in a 25.9% sales decrease in winter related merchandise, which was partially offset by a 4.6% sales increase in non-winter categories in the second half of the year. Online sales of winter related merchandise decreased 18.7% while online sales of non-winter categories increased 41.3% in the second half of the year. In October 2011, one store was closed to complete this store's relocation to a larger store in an area with more appealing customer demographics, which opened in June 2008.

Gross profit decreased $7.0 million, or 6.8%, primarily as a result of the decrease in sales. Additionally, a decrease in winter rentals and repairs, which have higher margins, and an increase in the usage of Action Pass, negatively impacted gross profit as a percent of sales, which decreased to 27.3% from 28.2%.

SG&A decreased $3.4 million, or 3.7%. The decrease is primarily due to savings of $1.9 million in labor to align to the lower sales trends, $1.6 million in insurance costs as a result of self-insuring for a significant portion of employee health insurance coverage, and the extra week in fiscal 2011. As a percent of sales, SG&A slightly decreased to 25.5% from 25.6%.

Depreciation expense decreased $0.9 million, or 8.7%, as a result of the low level of capital expenditures in recent fiscal years with no new store openings or significant remodels.

Net loss increased by $2.1 million, primarily due to the unseasonably warm and dry winter weather, to $5.1 million, or $0.36 per diluted share for fiscal 2012, from a net loss of $3.0 million, or $0.21 per diluted share for fiscal 2011.

Liquidity and Capital Resources

Our primary capital requirements currently are for inventory replenishment, store operations and new store openings. Since fiscal 2007, we have increasingly relied on bank borrowings for our capital needs to fund new store openings and losses from operations. For the foreseeable future our ability to continue our operations and business is dependent on credit terms from vendors and bank borrowing.


Net cash provided by operating activities has generally been the result of net loss, adjusted for depreciation and amortization, and changes in inventory along with related accounts payable. The following table summarizes the more significant items for fiscal years ended March 31, 2013 and April 1, 2012:

                                                                Fiscal year
                                                             2013         2012
                                                              (in thousands)
      Net loss                                             $ (3,335 )   $ (5,072 )
      Depreciation and amortization                           8,455        9,450
      Merchandise inventories                                (6,074 )     (4,592 )
      Accounts payable                                        4,771        5,533
      Prepaid expenses and other current assets                (227 )      2,939
      Deferred rent                                          (3,265 )     (2,684 )
      Other                                                    (840 )       (277 )
      Net cash (used in) provided by operating activites   $   (515 )   $  5,297

Inventory increased $6.1 million as average inventory per store increased 6.2% to $1.9 million from $1.8 million at the end of fiscal 2013 and fiscal 2012, respectively. The inventory increase is primarily due to additional investments in merchandise categories that have exhibited the greatest sales growth potential and the lower than planned holiday season sales during the third quarter of fiscal 2013.

Accounts payable changes are generally related to inventory changes. However, the timing of vendor payments or receipt of merchandise near the end of the period influences this relationship.

Prepaid expenses and other current assets can include approximately one month's rent, depending on the timing of our fiscal month end, as most leases require payment at the beginning of each calendar month.

We will not record income tax benefits until it is determined that is it more likely than not that we will generate sufficient taxable income to realize our deferred income tax assets. Our valuation allowance is equal to all of the net deferred tax assets, $26.4 million. We have federal and state net operating loss carryforwards of $18.6 million and $47.7 million, respectively, which can be carried forward for a period ranging from 15 to 20 years.

Purchases of fixed assets summarized below:

                                                  Fiscal year
                                         2013        2012        2011
                                                (in thousands)
                  Existing stores       $   869     $ 1,064     $   166
                  New stores              1,382           -           -
                  Information systems     1,228       1,859       1,485
                  Rental equipment        1,233       1,903         661
                  Total                 $ 4,712     $ 4,826     $ 2,312

Forecasted capital expenditures for fiscal 2014 are expected to be approximately $5.5 million primarily for new rental equipment, information systems and one new store. Approximately $1.8 million for the new store will be reimbursed by the landlord upon opening in early fiscal 2014. We have not opened new stores since fiscal 2009 and currently do not anticipate opening new stores in fiscal 2015.

Net cash provided by financing activities reflects advances and repayments of borrowings under our revolving credit facility.


Our revolving credit facility with Bank of America, N.A. (the "Lender") provides for advances up to $65.0 million, increasing to $70.0 million from September 1st of each year through December 31st of each year. This facility also provides for up to $10.0 million in authorized letters of credit. The amount we may borrow under this credit facility (the "Line Amount") is limited to a percentage of the value of accounts receivable and eligible inventory, minus certain reserves. A significant decrease in eligible inventory due to our vendors' unwillingness to ship us merchandise, the aging of inventory and/or an unfavorable inventory appraisal could have an adverse effect on our borrowing capacity under our credit facility, which may adversely affect the adequacy of our working capital. Interest accrues at the Lender's prime rate plus 1.75% (5.00% at March 31, 2013), or at our option we can fix the rate for a period of time at LIBOR plus 2.75%. In addition, there is an unused commitment fee of 0.25% per year, based on a weighted average formula. This credit facility expires in October 2014, and we expect to renegotiate and extend the term of this agreement or obtain another form of financing before that date. Our obligation to the Lender is presently secured by a first priority lien on substantially all of our non-real estate assets, and we are subject to, among others, a covenant that we maintain a Fixed Charge Coverage Ratio measured monthly on a trailing 12-month basis between 0.80 to 1.00 and 1.25 to 1.00 (varying from quarter to quarter). The covenant would only apply if our availability falls below the greater of (x) $5.0 million and (y) 10% of the Line Amount or the borrowing base, whichever is less. In the event of a significant decrease in availability under our credit facility, it is highly likely that the covenant would be violated.

In fiscal 2013, our peak borrowing occurred during the week ended December 9, 2012, at which time our credit facility had a borrowing capacity of $70.0 million, of which we utilized $68.6 million (including a letter of credit of $3.6 million) and had $1.4 million in availability. On March 31, 2013, our credit facility had a borrowing capacity of $65.0 million, of which we utilized $49.9 million (including a letter of credit of $3.6 million) and had $14.4 million in availability, $7.9 million above the availability requirement of $6.5 million. The amount of availability fluctuates due to seasonal changes in sales and inventory purchases throughout the year.

Contractual obligations and commitments related to operating lease obligations, employment contracts and letters of credit are excluded from the balance sheet in accordance with accounting principles generally accepted in the United States.

The following table summarizes our contractual obligations as of March 31, 2013:

                                                          Payment due by period
Contractual Obligations                         Less than                                       More than
(in thousands)                    Total          1 year         2-3 years       4-5 years        5 years
Operating leases (1)            $  145,733     $    30,824     $    49,867     $    33,649     $    31,393
Capital leases                       1,241             752             429              60               -
Revolving credit facility (2)       46,324          46,324               -               -               -
Letters of credit                    3,550           3,550               -               -               -
Employment contracts (3)                75              75               -               -               -
Total contractual obligations   $  196,923     $    81,525     $    50,296     $    33,709     $    31,393

(1) Amounts include the direct lease obligations. Other obligations required by the lease agreements such as contingent rent based on sales, common area maintenance, property taxes and insurance are not fixed amounts and, therefore, are not included. The amounts of the excluded expenses are: $10.4 million, $9.6 million and $10.0 million for the fiscal years 2013, 2012 and 2011, respectively. Operating lease obligations reflect savings from lease modifications, assume "kick-out clauses" will be exercised and do not reflect potential renewals or replacements of expiring leases.

(2) Periodic interest payments on the credit facility are not included in the preceding table because interest expense is based on variable indices, and the balance of our credit facility fluctuates daily depending on operating, investing and financing cash flows. The credit facility expires in October 2014 and is shown as less than 1 year due to a "lock box arrangement" per ASC 470-10-45-5A, Debt.

(3) On July 15, 2011, Norbert Olberz passed away. Pursuant to his amended employment contract dated April 1, 2000, upon his death, Irene Olberz, his wife will be paid a base salary of $0.1 million per year until March 31, 2014.

We lease all of our existing store locations. The leases for most of the existing stores are for approximately ten-year terms plus multiple option periods under non-cancelable operating leases with scheduled rent increases. Some of the leases provide for contingent rent based upon a percentage of sales in excess of specified minimums. Additionally, some of the leases contain kick-out clauses, which allow us to terminate the lease at our option at a specified date if contractually specified minimum sales volumes are not exceeded. Many of the leases obligate us to pay costs of maintenance, utilities, and property taxes.

We currently plan to close two existing stores, which are located in Antioch, California and Phoenix, Arizona, in fiscal 2014.


Generally, our purchase obligations are cancelable 45 days prior to shipment from our vendors. Letters of credit amounting to approximately $3.6 million were outstanding as of March 31, 2013 and expire within one year.

No cash dividends have been declared on Class A Common Stock and Class B Common Stock as we intend to retain earnings, if any, for use in the operation of our business and, therefore, do not anticipate paying any cash dividends in the foreseeable future.

Critical Accounting Policies and Use of Estimates

Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States. In connection with the preparation of our financial statements, we are required to make assumptions and estimates about future events, and apply judgments that affect the reported amounts of assets, liabilities, revenue, expenses and the related disclosures. We base our assumptions, estimates and judgments on historical experience, current trends and other factors that management believes to be relevant at the time our consolidated financial statements are prepared. On a regular basis, management reviews the accounting policies, assumptions, estimates and judgments to ensure that our financial statements are presented fairly and in accordance with accounting principles generally accepted in the United States. However, because future events and their effects cannot be determined with certainty, actual results could differ from our assumptions and estimates, and such differences could be material.

Our significant accounting policies are discussed in Note 2, Summary of Significant Accounting Policies, of the Notes to Consolidated Financial Statements, included in Item 8, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K. Management believes that the following accounting estimates are the most critical to aid in fully understanding and evaluating our reported financial results, and they require management's most difficult, subjective or complex judgments, resulting from the need to make estimates about the effect of matters that are inherently uncertain. Management has reviewed these critical accounting estimates and related disclosures with the Audit Committee of our Board.

Inventory Valuation. We value our inventory based on weighted-average cost, using the retail method at the item level.

We consider cost to include direct cost of merchandise and inbound freight, plus internal costs associated with merchandise procurement, storage and handling. The retail method is widely used in the retail industry due to its practicality. Current owned retail represents the retail price for which merchandise is offered for sale on a regular basis reduced for any permanent or clearance markdowns. As a result, the retail method normally results in an inventory valuation that is lower than the cost basis method.

Inherent in the retail method calculation are certain significant management judgments and estimates including markdowns and shrinkage, which can significantly impact the owned retail and, therefore, the ending inventory valuation at cost. Specifically, the failure to take permanent or clearance markdowns on a timely basis can result in an overstatement of carrying cost under the retail method. Management believes that its application of the retail method reasonably states inventory at the lower of cost or market.

We regularly review aged and excess inventories to determine if the carrying value of such inventories exceeds market value. The carrying value of inventory is reduced to market value as necessary. A determination of market value requires estimates and judgment based on our historical markdown experience and anticipated markdowns based on future merchandising and advertising plans, seasonal considerations, expected business trends and other factors.

Shrinkage is accrued as a percentage of sales based on historical shrinkage trends. We perform physical inventories twice per year at our stores, near the end of our second quarter and near the end of our fiscal year. The reserve for shrinkage represents an estimate since the last physical inventory date through the reporting date and actual results can vary from this reserve based on internal and external factors. The shrinkage accrual at fiscal year-end is immaterial.


We have not made any material changes in the accounting methodology used to establish our inventory valuation during the past three fiscal years. We do not believe there is a reasonable likelihood that there will be a material change in future estimates or assumptions we use to calculate our inventory. However, if estimates regarding consumer demand are inaccurate or our ability to maintain our cost complement percentages for certain merchandise changes in an unforeseen manner, we may be exposed to losses or gains that could be material. A 10% . . .

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