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SPCHA > SEC Filings for SPCHA > Form 10-Q on 14-Aug-2013All Recent SEC Filings

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Form 10-Q for SPORT CHALET INC


14-Aug-2013

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

This Quarterly Report on Form 10-Q 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 "- Factors That May Affect Future Results" and "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 the Company's financial statements and related notes thereto provided under "Item 1. Financial Statements" above. 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.

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 offering a broad assortment of brand name sporting goods equipment, apparel, and footwear. As of June 30, 2013, we operated 53 stores, including 34 locations in Southern California, eight in Northern California, seven in Arizona, three in Nevada, and one in Utah, comprising a total of over two million square feet of retail space. These stores average approximately 41,000 square feet in size. Our stores offer over 50 specialty services for the sports enthusiast, including online same day delivery, climbing, backcountry skiing, ski mountaineering, avalanche education, and mountain trekking instruction, car rack installation, snowboard and ski rental and repair, Scuba training and certification, Scuba boat charters, team sales, gait analysis, baseball/softball glove steaming and lacing, racquet stringing, and bicycle tune-up and repair. In addition, we have a Team Sales Division and an online store at sportchalet.com.

In 1959, Norbert Olberz, our founder (the "Founder"), purchased a small ski and tennis shop in La Caņada Flintridge, 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 goal was: to "see things through the eyes of the customer;" to "do a thousand things a little bit better;" to focus on "not being the biggest, but the best;" to "be the image of an athlete;" and to "create ease of shopping."


Recent History

Our stores are located in states that experienced, since the downturn that began in 2007, some of 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 response, we modified our business model to make the Company more efficient, improved our liquidity and reduced operating expenses during the downturn. Additionally, we 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.

While fiscal 2013 began to show signs of improvement, as evidenced by our first annual comparable store sales increase since fiscal 2007, the momentum reversed during the first quarter of fiscal 2014 due to a weaker-than-anticipated retail sales environment. We incurred a net loss of $2.8 million during the first quarter of fiscal 2014. Despite the setback, we continue to implement a number of strategic initiatives to position the Company for improved financial performance, as follows:

? New store prototype/next generation store (one opened at the end of June 2013 in Downtown Los Angeles);

? Online sales growth expected to continue in fiscal 2014;

? Leveraging data to drive geographical expansion efforts;

? Local store marketing and micro-merchandising initiatives to create differentiation and increase recognition in the community; and

? Comprehensive digital strategy to enhance the customer experience.

In response to the results of the first quarter, we are renewing our focus on reducing costs and refining our inventory position and store strategy. We are reducing our costs by decreasing store and corporate office labor expense to align with current sales trends, cutting IT maintenance expenses in non-critical areas, switching to a more cost effective logistics provider, negotiating rent reductions and honing our customer satisfaction initiatives. Through the closure of underperforming stores, selected staff reductions, and the renegotiation of logistics and software contracts, we have reduced our annualized operating expenses by approximately $3.2 million. We continue to refine our inventory position through improvements in merchandise assortments and category adjacencies. We are tailoring merchandise mix to meet the needs of local customers and aggressively managing inventory at both the store and vendor levels. In reviewing our store portfolio, we attempt to identify underperforming trade areas within markets where we have stores. We intend to terminate, modify or renegotiate the leases of underperforming trade area stores that do not meet specific financial criteria, which may reduce our sales and the impact of advertising in those local markets, as well as free up operating resources for more productive stores. During the 13 weeks ended June 30, 2013, we closed two underperforming stores located in Antioch, California and Phoenix, Arizona, and opened one new concept store in Downtown Los Angeles. We will close one underperforming store located in Concord, California in August 2013 and have no planned new store openings.


Results of Operations

13 Weeks Ended June 30, 2013 Compared to July 1, 2012

The following table sets forth statements of operations data and relative percentages of net sales for the 13 weeks ended June 30, 2013 compared to the 13 weeks ended July 1, 2012 (dollar amounts in thousands, except per share amounts):

                                              13 weeks ended
                                                                                   Dollar       Percentage
                                  June 30, 2013             July 1, 2012           change         change
                               Amount      Percent       Amount      Percent
Net sales                     $ 81,525       100.0%     $ 83,849       100.0%     $ (2,324 )          (2.8% )
Gross profit                    21,465        26.3%       23,368        27.9%       (1,903 )          (8.1% )
Selling, general and
administrative expenses         21,604        26.5%       20,738        24.7%          866              4.2 %
Depreciation and
amortization                     2,166         2.7%        2,069         2.5%           97              4.7 %
(Loss) income from
operations                      (2,305 )      (2.8% )        561         0.7%       (2,866 )             *
Interest expense                   541         0.7%          458         0.5%           83             18.1 %
Net (loss) income               (2,846 )      (3.5% )        103         0.1%       (2,949 )              *

(Loss) earnings per share:
Basic                         $  (0.20 )                $   0.01                  $  (0.21 )             *
Diluted                       $  (0.20 )                $   0.01                  $  (0.21 )             *

* Percentage change not meaningful.

Sales decreased $2.3 million, or 2.8%, to $81.5 million for the 13 weeks ended June 30, 2013 from $83.8 million for the 13 weeks ended July 1, 2012. The sales decrease is primarily the result of a sales decrease of $1.1 million from the closure of two underperforming stores, a sales decrease in Team Sales Division of 31.0% due to the departure of several sales representatives, and a comparable store sales decrease of 0.7%, partially offset by a 37.6% increase in online sales. The comparable store sales decrease of 0.7% was primarily due to the general consumer caution from the uneven retail environment. The two underperforming stores were closed in April 2013 and June 2013, while the one new concept store was opened at the end of June 2013.

Gross profit decreased $1.9 million, or 8.1%, and as a percent of sales decreased to 26.3% from 27.9%. The decrease in gross profit is primarily the result of an increase in promotional activity to stimulate sales as well as the decrease in sales. Occupancy costs related to the new store was offset by the savings from the store closures.

Selling, general and administrative ("SG&A") expenses increased $0.9 million, or 4.2%, primarily due to increases of $0.2 million in advertising, $0.2 million in expenses associated with the growth of the online business, and $0.5 million in labor-related expenses, such as salaries, payroll taxes and employee health insurance coverage. This increase combined with the decline in sales resulted in an increase in SG&A as a percent of sales to 26.5% from 24.7%. SG&A related to the new store was offset by the savings from the store closures.

Net loss for the quarter ended June 30, 2013 increased $2.9 million to $2.8 million, or $0.20 per diluted share, from net income of $0.1 million, or $0.01 per diluted share, for the quarter ended July 1, 2012.


Liquidity and Capital Resources

Our primary capital requirements currently are for inventory replenishment and store operations. Since fiscal 2007, we have increasingly relied on bank borrowing 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. As previously announced, we closed two underperforming stores during the first quarter and at the end of the first quarter, opened one new concept store, which we expect will more than offset the sales decrease from the two closures. The following table summarizes the more significant items for the 13 weeks ended June 30, 2013 and July 1, 2012:

                                                                  13 weeks ended
                                                       June 30, 2013          July 1, 2012
                                                                  (in thousands)
Net (loss) income                                     $        (2,846 )      $           103
Depreciation and amortization                                   2,166                  2,069
Merchandise inventories                                        (4,891 )               (8,612 )
Accounts payable                                                4,688                 11,109
Accounts receivable                                              (518 )               (1,997 )
Prepaid expenses and other current assets                      (2,023 )                  109
Other accrued expenses                                          1,523                   (586 )
Deferred rent                                                  (1,478 )                 (716 )
Other                                                             871                  1,197
Net cash (used in) provided by operating activities   $        (2,508 )      $         2,676

Inventory increased $4.9 million for the 13 weeks ended June 30, 2013 compared to an increase of $8.6 million for the same period last year. The difference is due to focused efforts to reduce overall inventory levels in light of lower than expected sales. We had previously made additional investments in merchandise categories that had exhibited the greatest sales growth potential, which combined with the first quarter's overall weak sales, caused the average inventory per store to increase 4.1% to $2.1 million at June 30, 2013 from $2.0 million at July 1, 2012. The increase in average inventory per store is unfavorable and we continue to focus on inventory productivity and expect improvements during the remainder of fiscal 2014.

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.

Accounts receivable increased $0.5 million for the 13 weeks ended June 30, 2013 compared to an increase of $2.0 million for the same period last year. The difference includes a reduction related to our Team Sales Division of $0.7 million due to reduced sales, offset by $1.7 million due from the landlord of our recently opened new concept store for reimbursement of improvements.

Prepaid expenses include rent whose payment timing can fluctuate from the final days to the first days of a fiscal month.


Other accrued expenses include $2.5 million due to a landlord for the early termination of a lease related to an underperforming store approximately five years before the original termination date. The $2.5 million expense will be paid over a three year period.

We made the decision to discontinue operations of three of our underperforming stores, each of which was previously fully impaired, because they were not meeting our specific financial criteria. As a result of the store closings, we recognized a benefit from previously recorded deferred rent of $2.2 million for the 13 weeks ended June 30, 2013, which is offset by the $2.5 million expense incurred for the early termination. There are no additional material losses on the net fixed assets related to the store closings and we do not expect to incur further charges in connection with these locations.

Net cash used in investing activities is primarily for capital expenditures which are expected to remain nominal with no planned new store openings or significant store remodels in the near future. Forecasted capital expenditures for fiscal 2014 are expected to be approximately $5.5 million primarily for new rental equipment, information systems and the concept store that opened at the end of June 2013 in Downtown Los Angeles. Approximately $1.7 million for the new store will be reimbursed by the landlord.

Net cash provided by financing activities reflects advances and repayments of borrowings under our revolving credit facility. In August 2013, we entered into a second amendment to our October 2010 amended and restated credit facility with our existing bank, Bank of America, N.A. (the "Lender"), which was first amended in May 2012. The credit facility provides for advances up to $75.0 million (previously $65.0 million from January 1 of each year through August 31 of each year and $70.0 million from September 1 of each year through December 31 of each year). This facility provides for up to $10.0 million in authorized letters of credit within the $75.0 million facility. The amount we can borrow under this credit facility is limited to fixed percentages of the value of various categories of accounts receivable and fixed percentages of the value of various categories of eligible inventory, minus certain reserves. As amended by the second amendment, eligible inventory now includes food, rental equipment inventory up to $2.5 million of borrowing base, and ski lift ticket inventory from December 1 to March 31 of each year to the extent the lift tickets are subject to a guaranteed buy-back. Our borrowing capacity and thus the adequacy of our working capital would be adversely affected if we experienced a significant decrease in eligible inventory, whether due to our vendors' unwillingness to ship us merchandise, the aging of inventory and/or an unfavorable inventory appraisal. Interest under the amended credit facility accrues at the Lender's prime rate plus a margin of between 1.25% and 1.75% per annum (presently 1.50% per annum), or at our option we can fix the rate for a period of time at LIBOR plus a margin of between 2.25% and 2.75% per annum (presently 2.50% per annum), in each case based on average credit facility utilization. Under the credit facility prior to the current amendment, the margins depended on EBITDA on a trailing 12-month basis. Interest accrued under the credit facility prior to the current amendment at a rate of 5.00% per annum at June 30, 2013. The current amendment is expected to reduce interest expense by approximately $0.1 million on an annualized basis, based on current borrowing forecasts. In addition, there is an unused commitment fee of 0.25% per year, based on a weighted average formula. The credit facility's expiration has been extended to August 2018. 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 of 1.10 to 1.00 (previously 1.25 to 1.00). The covenant would apply only if our availability is equal to or less than the greater of (x) $5.0 million and (y) 10% of the amount of the credit facility (presently $75.0 million) 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.


At June 30, 2013, our credit facility had a borrowing capacity of $65.0 million, of which we utilized $56.2 million (including a letter of credit of $4.5 million) and had $8.8 million in availability, $2.3 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. If cash generated by operations does not result in a sufficient level of unused borrowing capacity, our current operations could be constrained by our ability to obtain funds under the terms of our revolving credit facility. In such a case, we would need to seek other financing alternatives with our bank or other sources. Additional financing may not be available at terms acceptable to us, or at all. Failure to obtain financing in such circumstances may require us to significantly curtail our operations.

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.

Off-Balance Sheet Arrangements, Contractual Obligations and Commitments

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 such obligations as of June 30, 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)    $  135,978     $    30,211     $    48,108     $    29,441     $    28,218
Capital leases               1,038             666             326              46               -
Revolving credit
facility (2)                51,702          51,702               -               -               -
Letters of credit            4,475           4,475               -               -               -
Employment contracts
(3)                             56              56               -               -               -
Total contractual
obligations             $  193,251     $    87,112     $    48,434     $    29,487     $    28,218

(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 included. The amounts of such costs incurred in the fiscal years 2013, 2012 and 2011, were $10.4 million, $9.6 million and 10.0 million, 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.


Generally, our purchase obligations are cancelable 45 days prior to shipment from our vendors. Letters of credit amounting to approximately $4.5 million were outstanding as of June 30, 2013 and expire within one year.

Critical Accounting Policies and Use of Estimates

In preparing our consolidated 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. Actual results may differ from these estimates. As discussed in "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" in our Annual Report on Form 10-K for the fiscal year ended March 31, 2013, we consider our policies on inventory valuation, revenue recognition, gift card redemption, self-insurance reserves, impairment of long-lived assets and estimation of net deferred income tax asset valuation allowance to be the most critical in understanding the significant estimates and judgments that are involved in preparing our consolidated financial statements.

Factors That May Affect Future Results

Our short-term and long-term success is subject to many factors that are beyond our control. Stockholders and prospective stockholders in the Company should carefully consider the following risk factors, in addition to the information contained elsewhere in this Report. This Quarterly Report on Form 10-Q contains forward-looking statements, which are subject to a variety of risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors including, but are not limited to, those set forth below.

For a more detailed discussion of these factors, see "Item 1A. Risk Factors" in our Annual Report on Form 10-K for the fiscal year ended March 31, 2013. The forward-looking statements included in this Quarterly Report on Form 10-Q are made only as of the date of this report, and we undertake no obligation to update the forward-looking statements to reflect subsequent events or circumstances.

Risks Related To Our Business:

? We have a history of losses which could continue in the future.

? A downturn in the economy has affected consumer purchases of discretionary items, significantly reducing our net sales and profitability.

? The limited availability under our revolving credit facility may result in insufficient working capital.


? If our vendors do not provide sufficient quantities of merchandise, our net sales may suffer and hinder our return to profitability.

? If we are unable to effectively manage and expand our alliances and relationships with selected suppliers of brand name merchandise, we may be unable to effectively execute our strategy to differentiate ourselves from our competitors.

? Intense competition in the sporting goods industry could limit our growth and reduce our profitability.

? Because our stores are concentrated in the western portion of the United States, we are subject to regional risks.

? No assurance can be given that we will be successful in managing the growth of our Team Sales Division and online business.

? If we are unable to predict or react to changes in consumer demand, we may lose customers and our sales may decline.

? Our future operations may be dependent on the availability of additional financing.

? Seasonal fluctuations in the sales of our merchandise and services could cause our annual operating results to suffer.

? If we lose key management or are unable to attract and retain talent, our operating results could suffer.

? Declines in the effectiveness of marketing could cause our operating results to suffer.

? Problems with our information systems could disrupt our operations and negatively impact our financial results.

? Failure to protect the integrity and security of our customers' information could expose us to litigation and materially damage our standing with our customers.

? We may not be able to renew the leases of existing store locations.

? We may not be able to terminate or modify the leases of existing store locations.

. . .

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