for the year ending february 1, 2004 - knotia.ca · using the weighted average cost method and...

Forzani Group Ltd. For the year ending February 1, 2004

TSX/S&P Industry Class = 25 2004 Annual Revenue = Canadian $968.1 million 2004 Year End Assets = Canadian $548.6 million Web Page (October, 2005) = www.forzanigroup.com 2005 Financial Reporting In Canada Survey Company Number 77

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F O R Z A N I A N N U A L R E P O R T F 2 0 0 4

The Annual Report, including the consolidated financial statements, is the responsibility of the management

of the Company. The consolidated financial statements were prepared by management in accordance with

generally accepted accounting principles. The significant accounting policies used are described in Note 2 to

the consolidated financial statements. The integrity of the information presented in the financial statements,

including estimates and judgments relating to matters not concluded by year-end, is the responsibility of

management. Financial information presented elsewhere in this Annual Report has been prepared by

management and is consistent with the information in the consolidated financial statements.

Management is responsible for the development and maintenance of systems of internal accounting and

administrative controls. Such systems are designed to provide reasonable assurance that the financial

information is accurate, relevant and reliable, and that the Company’s assets are appropriately accounted for

and adequately safeguarded. The Board of Directors is responsible for ensuring that management fulfills its

responsibilities for final approval of the annual consolidated financial statements. The Board appoints an

Audit Committee consisting of three directors, none of whom is an officer or employee of the Company or

its subsidiaries. The Audit Committee meets at least four times each year to discharge its responsibilities

under a written mandate from the Board of Directors. The Audit Committee meets with management and

with the independent auditors to satisfy itself that they are properly discharging their responsibilities, reviews

the consolidated financial statements and the Auditors’ Report, and examines other auditing, accounting and

financial reporting matters. The consolidated financial statements have been reviewed by the Audit

Committee and approved by the Board of Directors of The Forzani Group Ltd. The consolidated financial

statements have been examined by the shareholders’ auditors, Deloitte & Touche, LLP, Chartered

Accountants. The Auditors’ Report outlines the nature of their examination and their opinion on the

consolidated financial statements of the Company. The independent auditors have full and unrestricted

access to the Audit Committee, with and without management present.

Calgary, Alberta

March 5, 2004

Bob Sartor, CA Richard Burnet, CA

Chief Executive Officer Vice-President & Chief Financial Officer

Management’s Responsibilities forFinancial Reporting

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To the Shareholders of The Forzani Group Ltd.We have audited the consolidated balance sheets of The Forzani Group Ltd. as at February 1, 2004 and

February 2, 2003 and the consolidated statements of operations and retained earnings and cash flows for the

years then ended. These consolidated financial statements are the responsibility of the Company’s

management. Our responsibility is to express an opinion on these consolidated financial statements based

on our audits.

We conducted our audits in accordance with Canadian generally accepted auditing standards. Those

standards require that we plan and perform an audit to obtain reasonable assurance whether the financial

statements are free of material misstatement. An audit includes examining, on a test basis, evidence

supporting the amounts and disclosures in the financial statements. An audit also includes assessing the

accounting principles used and significant estimates made by management, as well as evaluating the overall

financial statement presentation.

In our opinion, these consolidated financial statements present fairly, in all material respects, the financial

position of the Company as at February 1, 2004 and February 2, 2003 and results of its operations and its

cash flows for the years then ended in accordance with Canadian generally accepted accounting principles.

Calgary, Alberta

March 5, 2004 (except as to Note 19 which is as at March 19, 2004)

Deloitte & Touche LLP

Chartered Accountants

Auditor’s Report

44


THE FORZANI GROUP LTD.

Consolidated Balance Sheets

(in thousands)

(audited)

As at February 1, February 2,

2004 2003

(Note 3)

ASSETS

Current

Cash $ 23,315 $ 523

Accounts receivable 36,319 38,275

Inventory 267,221 268,519

Prepaid and other expenses 11,292 11,123

338,147 318,440

Capital assets (Note 4) 160,625 142,236

Goodwill and other intangibles (Note 5) 39,682 38,684

Other assets (Note 6) 10,105 7,452

$ 548,559 $ 506,812

LIABILITIES

Current

Indebtedness under revolving credit facility (Note 7) $ - $ 4,204

Accounts payable and accrued liabilities 217,777 209,873

Current portion of long-term debt (Note 7) 887 3,638

218,664 217,715

Long-term debt (Note 7) 37,408 32,062

Deferred lease inducements 52,954 52,251

Future income tax liability (Note 10) 1,435 1,061

310,461 303,089

SHAREHOLDERS’ EQUITY

Share capital (Note 9) 128,880 124,866

Contributed surplus (Note 3) 2,888 546

Retained earnings 106,330 78,311

238,098 203,723

$ 548,559 $ 506,812

Approved on behalf of the Board:

Roman Doroniuk John M. Forzani


45


Consolidated Statements of Operations and Retained Earnings

(in thousands, except share data)

(audited, except where otherwise noted)

For the For the

52 weeks ended 53 weeks ended

February 1, 2004 February 2, 2003

(Note 3)

Corporate and Franchise Retail Sales (unaudited – Note 13) $ 1,107,603 $ 1,053,449

Revenue

Corporate $ 732,880 $ 715,003

Franchise 235,198 208,792

968,078 923,795

Cost of sales 635,059 603,326

Gross margin 333,019 320,469

Operating and administrative expenses

Store operating 186,725 177,252

General and administrative 62,739 60,230

Stock-based compensation (Note 3) 2,342 546

251,806 238,028

Operating earnings before undernoted items 81,213 82,441

Amortization 31,183 29,624

Interest 4,838 4,354

Gain on sale of investment (Note 14) - (1,454)

36,021 32,524

Earnings before income taxes 45,192 49,917

Provision for (recovery of) income taxes (Note 10)

Current 16,799 22,133

Future 374 (2,201)

17,173 19,932

Net earnings 28,019 29,985

Retained earnings, opening 78,311 48,326

Retained earnings, closing $ 106,330 $ 78,311

Earnings per share $ 0.90 $ 1.00

Diluted earnings per share $ 0.86 $ 0.95

Total number of common shares outstanding 31,791,327 30,787,179

Weighted average number of common shares outstanding 31,215,081 30,082,408

46



Consolidated Statements of Cash Flows

(in thousands)

(audited)

For the For the

52 weeks ended 53 weeks ended

February 1, 2004 February 2, 2003

(Note 3)

Cash provided by (used in) operating activities

Net earnings $ 28,019 $ 29,985

Items not involving cash


Amortization of deferred finance charges 430 571

Amortization of deferred lease inducements (8,092) (8,767)

Stock-based compensation 2,342 546

Gain on sale of investment - (1,445)

Future income tax expense (recovery) 374 (2,201)

54,256 48,313

Changes in non-cash elements of working capital (Note 8) 10,989 (27,300)

65,245 21,013

Cash provided by (used in) financing activities

Proceeds from issuance of share capital 4,014 40,416

Increase (decrease) of long-term debt 2,595 (13,786)

(Decrease) in revolving credit facility (4,204) (12,890)

Proceeds from deferred lease inducements 8,795 14,395

11,200 28,135

Cash provided by (used in) investing activities

Addition of capital assets (48,394) (50,085)

Net change in other assets (5,727) (1,000)

Sale of investment - 1,690

Disposal of capital assets 468 276

(53,653) (49,119)

Increase in cash 22,792 29

Net cash position, opening 523 494

Net cash position, closing $ 23,315 $ 523

Supplementary cash flow information (Note 8)

1. Nature of Operations

The Forzani Group Ltd. “FGL” or “the Company” is Canada’s largest sporting goods retailer. FGL currently

operates 217 corporate stores under the banners: Sport Chek, Sport Mart and Coast Mountain Sports. The

Company is also the franchisor of 174 stores under the banners: Sports Experts, Intersport, RnR,

Econosports, Atmosphere and Tech Shop. FGL operates two websites, dedicated to the Canadian online

sporting goods market, www.sportchek.ca and www.sportmart.ca.

2. Significant Accounting Policies

The consolidated financial statements have been prepared by management in accordance with Canadian

generally accepted accounting principles (“GAAP”). The financial statements have, in management’s

opinion, been prepared within reasonable limits of materiality and within the framework of the accounting

policies summarized below:

(a) Organization

The consolidated financial statements include the accounts of The Forzani Group Ltd. and its subsidiaries,

all of which are wholly owned.

(b) Inventory

Inventory is valued at the lower of laid-down cost and net realizable value. Laid-down cost is determined

using the weighted average cost method and includes invoice cost, duties, freight, and distribution costs. Net

realizable value is defined as the expected selling price.

Volume rebates and other supplier discounts are included in income when earned. For volume and

advertising rebates, “earned” is when the Company receives the related product. For all other rebates and

discounts, “earned” is when the related expense is incurred.

(c) Capital assets

Capital assets are recorded at cost and are amortized using the following methods and rates:

Building - 4% declining-balance basis

Building on leased land - straight-line basis over the lesser of the length of the

lease and estimated useful life of the building,

not exceeding 20 years

Furniture, fixtures, equipment

and automotive - straight-line basis over 3-5 years

Leasehold improvements - straight-line basis over the lesser of the length of the lease and

estimated useful life of the improvements,

not exceeding 10 years

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Notes to Consolidated Financial Statements

(tabular amounts in thousands, except share data)

(d) Goodwill and other intangibles

Goodwill represents the excess of the purchase price over the fair market value of the identifiable net assets

acquired. Goodwill and other intangible assets, with indefinite lives, are not amortized, but tested for

impairment at year end, and, if required, asset values are reduced accordingly.

The method used to assess impairment is a review of the fair value of the asset based on its earnings and a

market earnings multiple.

Non-competition agreement costs are being amortized, on a straight-line basis, over the five-year life of the

agreements.

(e) Other assets

Other assets include deferred financing charges, system and interactive development costs, long-term

receivables, and an investment in a wholesale distribution company.

Interactive development costs relate to the development of the sportchek.ca interactive web site, designed as

a part of the Company’s multi-channel retailing and branding strategy. These costs are being amortized over

five years following the commencement of the web site’s operations in June, 2001.

Financing costs represent fees incurred in establishing and renegotiating the Company’s credit facilities.

These costs are being amortized over the term of the facilities.

System development costs relate to the implementation of computer software. Upon activation, costs are

amortized over the estimated useful lives of the systems (3 – 5 years).

Long-term receivables are carried at cost less a valuation allowance, if applicable.

The investment in shares of a wholesale distribution company is carried at cost and periodically reviewed for

impairment based on the market value of the shares.

(f) Deferred lease inducements

Deferred lease inducements represent cash and non-cash benefits that the Company has received from

landlords pursuant to store lease agreements. These lease inducements are amortized against rent expense

over the term of the lease, not exceeding 10 years.

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(g) Revenue recognition

Revenue includes sales to customers through corporate stores operated by the Company and sales to, and

service fees from, franchise stores. Sales to customers through corporate stores operated by the Company

are recognized at the point of sale, net of an estimated allowance for sales returns. Sales of merchandise to

franchise stores are recognized at the time of shipment. Royalties and administration fees are recognized

when earned, in accordance with the terms of the franchise agreements.

(h) Store opening expenses

Operating costs incurred prior to the opening of new stores are expensed as incurred.

(i) Fiscal year

The Company’s fiscal year follows the retail calendar. The fiscal years for the consolidated financial

statements presented are the 52-week period ended February 1, 2004 and the 53-week period ended

February 2, 2003.

(j) Foreign currency translation

Foreign currency accounts are translated to Canadian dollars. At the transaction date, each asset, liability,

revenue or expense is translated into Canadian dollars using the exchange rate in effect at that date. At the

year-end date, monetary assets and liabilities are translated into Canadian dollars using the exchange rate in

effect at that date, or by rates fixed by forward exchange contracts, and the resulting foreign exchange gains

and losses are included in income in the current period, to the extent that the amount is not hedged.

(k) Financial instruments (Note 16)

Accounts receivable, accounts payable and accrued liabilities, long-term debt and derivative transactions,

constitute financial instruments. The Company also, in the normal course of business, enters into leases in

respect of real estate and certain point-of-sale equipment.

The Company enters into forward foreign currency contracts and options, with financial institutions, as

hedges of other financial transactions and not for speculative purposes. The Company’s policies do not

allow leveraged transactions and are designed to minimize foreign currency risk. The Company’s policies

require all hedges be linked with specific liabilities on the balance sheet and be assessed, both at inception,

and on an ongoing basis, as to their effectiveness in offsetting changes in the fair values of the hedged

liabilities.

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(l) Measurement uncertainty

The preparation of the financial statements, in conformity with GAAP, requires management to make

estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of

contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts

of revenue and expenses during the reporting period. Actual results could differ from these estimates.

Estimates are used when accounting for items such as product warranties, inventory provisions,

amortization, uncollectible receivables and the liability for the Company’s loyalty program.

(m) Stock-Based Compensation (see Notes 3, 9 (d))

The Company accounts for stock-based compensation using the fair value method. The fair value of the

options granted are estimated at the date of grant using the Black-Scholes valuation model and recognized

as an expense over the option vesting period.

(n) Income taxes (see Note 10)

The Company follows the liability method under which future income taxes and obligations are determined

based on differences between the financial reporting and tax basis of assets and liabilities, measured using tax

rates substantively enacted at the balance sheet date.

(o) Comparative Figures

Certain 2003 comparative figures have been reclassified to conform with the presentation adopted for the

current year ending February 1, 2004.

3. Adoption of New Accounting Policies

Effective February 3, 2003, the Company changed its accounting policy on accounting for stock-based

compensation. In accordance with the Canadian Institute of Chartered Accountants (“CICA”) standard on

“Stock-based Compensation and Other Stock-based Payments”, the Company has changed its accounting

policy to account for stock-based compensation using the fair value method. This change in accounting

policy has been adopted retroactively to January 28, 2002. In accordance with the CICA handbook, section

3870, only stock options issued on, or after, the initial adoption date of section 3870 are recognized in the

financial statements. No compensation expense is recorded for stock options awarded and outstanding prior

to January 28, 2002.

Previously, the Company elected to account for stock-based compensation by measuring compensation

expense as the excess, if any, of the quoted market value of the stock, at the date of grant, over the exercise

price. This change in accounting policy has been treated retroactively with restatement of the prior period

comparative values. The net impact of the change in accounting policy created a $546,000 decrease to

retained earnings as at February 2, 2003. Stock-based compensation is amortized into earnings over the

vesting period of the related options. As the expense is incurred, an offset is created in contributed surplus

(2004 - $2,342,000, 2003 - $546,000) in shareholders’ equity, which is converted into share capital when the

related options are exercised.

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The following is a summary of the impact of the change in accounting policy, for the years ended February 1,

2004 and February 2, 2003, on net earnings and basic and diluted earnings per share.

For the 52 For the 52 For the 53 For the 53

weeks ended weeks ended weeks ended weeks ended

February 1, 2004 February 1, 2004 February 2, 2003 February 2, 2003

(before policy change) (as reported)(previously reported) (restated)

Earnings before stock-based

compensation and income taxes $47,534 $47,534 $50,463 $50,463

Stock-based compensation - 2,342 - 546

Earnings before income taxes 47,534 45,192 50,463 49,917

Provision for income taxes 17,173 17,173 19,932 19,932

Net earnings $30,361 $28,019 $30,531 $29,985

Basic earnings per share $0.97 $0.90 $1.01 $1.00

Diluted earnings per share $0.94 $0.86 $0.96 $0.95

4. Capital Assets

2004 2003

Accumulated Net Book Accumulated Net Book

Cost Amortization Value Cost Amortization Value

Land $ 1,994 $ - $ 1,994 $ 638 $ - $ 638

Buildings 16,501 1,877 14,624 6,280 1,637 4,643

Building on leased land 3,159 1,996 1,163 3,159 1,659 1,500

Furniture, fixtures,

equipment and

automotive 113,495 65,490 48,005 97,117 52,438 44,679

Leasehold

improvements 160,790 68,618 92,172 142,605 54,374 88,231

Construction in progress 2,667 - 2,667 2,545 - 2,545

$ 298,606 $ 137,981 $ 160,625 $ 252,344 $ 110,108 $142,236

5. Goodwill and Other Intangibles

2004 2003

Accumulated Net Book Accumulated Net Book

Cost Amortization Value Cost Amortization Value

Goodwill $ 21,319 $ 1,187 $ 20,132 $ 21,319 $ 1,187 $ 20,132

Trademarks/Tradenames 18,309 259 18,050 16,702 250 16,452

Non-competition agreements 3,000 1,500 1,500 3,000 900 2,100

$ 42,628 $ 2,946 $ 39,682 $ 41,021 $ 2,337 $ 38,684

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6. Other Assets2004 2003

Interactive development $ 2,649 $ 2,649

Deferred financing charges 2,851 2,124

System development 1,601 1,471

Other deferred charges 789 -

7,890 6,244

Less accumulated amortization 3,745 2,246

4,145 3,998

Long-term receivables 3,726 950

Investment in shares of a wholesale distribution company

(Market value February 1, 2004 – $1,278 (2003 – $2,250)) 2,234 2,504

$ 10,105 $ 7,452

7. Credit Facility and Long-term Debt

2004 2003

G.E. term loan $ 25,000 $ 25,000

Vendor take-back re: Sport Mart acquisition, unsecured with interest rate of

prime plus 1% due August 1, 2006 3,984 7,039

Vendor take-back re: trademark purchase ($550 USD) 730 -

Mortgages, with monthly blended payments of $52,611, including interest at rates

from approximately 7% to 10%, compounded semi-annually, secured by land and

buildings, renewable July 1, 2004 and August 1, 2005. The Company’s intention

is to renew the July 1, 2004 mortgage for an additional 5 years 3,176 3,631

Construction facility re: franchise office building, with interest at prime +0.5% 5,375 -

Security deposits 30 30

38,295 35,700

Less current portion 887 3,638

$ 37,408 $ 32,062

Principal payments on the above, due in the next five years, are as follows:

2005 $ 850

2006 844

2007 29,205

2008 727

2009 569

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The Company has a $175 million credit facility with General Electric Capital Canada Inc. (“G.E.”), National

Bank of Canada and The Royal Bank of Canada, comprised of a $115 million revolving loan, with an option

to increase the maximum revolving credit commitment by $35 million, to $150 million, via the exercising of

a single, irreversible option, and a $25 million term loan repayable at maturity. Under the terms of the credit

agreement, the interest rate payable on both the revolving and term loans is based on the Company's

financial performance as determined by its interest coverage ratio. As at February 1, 2004, the interest rate

paid was 4.05%. The facility is secured by general security agreements against all existing and future

acquired assets of the Company. On February 3, 2003 the Company extended its previous credit facility to

February 3, 2006 and amended it to: assign a pro rata share of the revolving credit facility to each of National

Bank of Canada and The Royal Bank of Canada and; grant the above noted option to increase the maximum

revolving credit commitment. As at February 1, 2004, the Company is in compliance with all covenants and

has not used the credit extension.

On September 15, 2003, the Company entered into an agreement to purchase a trademark. A portion of the

purchase price is repayable over a four year period by means of a vendor-take-back loan. The vendor-take-

back loan (in USD) bears no interest and is unsecured.

Based on estimated interest rates currently available to the Company for mortgages with similar terms and

maturities, the fair value of the mortgages at February 1, 2004 amounted to approximately $3,176,000 (2003

- $3,600,000). Interest costs incurred for the 52-week period ended February 1, 2004 on long-term debt

amounted to $1,696,000 (2003 - $2,331,000). The fair value of the other long-term debt components above,

approximates book value given their short terms to maturity.

On August 27, 2003, the Company entered into a credit agreement with National Bank of Canada for an

interim construction line of credit for a new office building located in Laval, Quebec. This interim

borrowing facility will automatically transfer into a 5-year mortgage when the office is completed and all

construction costs are paid. The mortgage will bear interest at Banker’s Acceptance plus 1 3/4% with a

15-year amortization period.

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8. Supplementary Cash Flow Information

2004 2003

Changes in non-cash elements of working capital

Accounts receivable $ 1,956 $ (2,287)

Inventory 1,298 (39,249)

Prepaid and other expenses (169) (6,642)

Accounts payable and accrued liabilities 7,904 20,878

$ 10,989 $ (27,300)

Cash interest paid $ 4,158 $ 5,195

Cash taxes paid $ 31,376 $ 14,897

9. Share Capital

(a) Authorized

An unlimited number of Class A shares

An unlimited number of Preferred shares, issuable in series

(b) Issued

Class A shares

Number Consideration

Balance, January 27, 2002 27,622,447 $ 83,719

Shares issued upon employees exercising stock options 664,732 2,817

Shares issued March 26, 2002 upon public stock offer

(net of issuance costs and related future income tax) 2,500,000 38,330

Balance, February 2, 2003 30,787,179 $ 124,866

Shares issued upon employees exercising stock options 1,004,148 4,014

Balance, February 1, 2004 31,791,327 $ 128,880

(c) Earnings Per Share

2004 2003

(Note 3)

Basic $0.90 $1.00

Diluted $0.86 $0.95

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The Company uses the treasury stock method to calculate diluted earnings per share. Under the treasury

stock method, the numerator remains unchanged from the basic earnings per share calculation, as the

assumed exercise of the Company's stock options does not result in an adjustment to earnings. Diluted

calculations assume that options under the stock option plan have been exercised at the later of the

beginning of the year or date of issuance, and that the funds derived therefrom would have been used to

repurchase shares at the average market value of the Company’s stock, 2004 - $17.73 (2003 - $19.55). Anti-

dilutive options, 2004 – 377,478 (2003 – 32,749) are excluded from the effect of dilutive securities. The

reconciliation of the denominator in calculating diluted earnings per share is as follows:

2004 2003

Weighted average number of class A shares outstanding (basic) 31,215,081 30,082,408

Effect of dilutive options 1,206,359 1,595,636

Weighted average number of common shares outstanding (diluted) 32,421,440 31,678,044

(d) Stock Option Plan

The Company has granted stock options to directors, officers and employees to purchase 2,808,821 Class A

shares at prices between $3.00 and $22.06 per share. These options expire on dates between February 19,

2004 and September 1, 2008.

During the 52-weeks ended February 1, 2004, the following options were granted:

1,425,000 $7.26 4.05% 4.4 years 43% nil

A summary of the status of the Company’s stock option plan as of February 1, 2004 and February 2, 2003,

and any changes during the year ending on those dates is presented below:

2004 2003

Stock Options Options Weighted Options Weighted

Average Exercise Average Exercise

Outstanding, beginning of year 2,437,968 $6.81 1,997,700 $4.84

Granted 1,425,000 $18.12 1,105,000 $8.88

Exercised 1,004,148 $4.00 664,732 $4.24

Forfeited 49,999 $18.49 - -

Outstanding, end of year 2,808,821 $13.34 2,437,968 $6.81

Options exercisable at year end 597,650 1,103,482

Options

issued

Weighted

average fair value

per option

Weighted

average

risk-free rate

Weighted

average expected

option life

Weighted

average expected

volatility

Weighted

average expected

dividend yield

55


The following table summarizes information about stock options outstanding at February 1, 2004:

Options Outstanding Options Exercisable

Range of Exercise Number Weighted Average Weighted Number Weighted

Prices Outstanding Remaining Average of Shares Average

Contractual Life Exercise Price Exerciseable Exercise Price

$3.00 - $4.26 612,002 0.3 years $3.37 412,000 $3.25$6.18 - $9.39 27,834 2.5 years $8.43 - -$11.36 - $16.49 817,317 3.0 years $12.70 185,650 $11.36$17.55 - $22.06 1,351,668 4.2 years $18.34 - -

2,808,821 $13.34 597,650 $5.76

10. Income Taxes

The components of the future income tax liability amounts as at February 1, 2004 and February 2, 2003, are

as follows:

2004 2003

Current assets $ (3,547) $ (4,610)

Capital and other assets (17,231) (14,776)

Tax benefit of share issuance and financing costs 395 556

Deferred lease inducements 18,948 17,769

Future income tax liability $ (1,435) $ (1,061)

A reconciliation of income taxes, at the combined statutory federal and provincial tax rate to the actual

income tax rate, is as follows:

2004 2003

Federal and provincial income taxes $ 16,324 36.1% $ 19,013 38.1%

Increase (decrease) resulting from:

Effect of substantively enacted tax rate changes (64) (0.1) 451 0.9

Permanent differences:

Stock-based compensation 848 1.9 209 0.4

Other permanent differences 281 0.6 (60) (0.1)

Other, net (216) (0.5) 319 0.6

Provision for income taxes $ 17,173 38.0% $ 19,932 39.9%

Federal Part I.3 tax and provincial capital tax expense in the amount of $961,000 (2003 - $960,000) is

included in operating expenses.

56


11. Commitments

(a) The Company is committed, at February 1, 2004, to minimum payments under long-term real property

and data processing hardware and software equipment leases for the next five years as follows:

Gross

2005 $62,869

2006 59,722

2007 54,578

2008 51,930

2009 49,341

In addition, the Company may be obligated to pay percentage rent under certain of the real property leases.

(b) As at February 1, 2004, the Company has open letters of credit for purchases of inventory of

approximately $5,823,000 (2003 - $3,031,000).

12. Employee Benefit Plans

The Company has a defined contribution plan and a deferred profit sharing plan. Deferred profit sharing

contributions are paid to a Trustee for the purchase of shares of the Company and are distributed to

participating employees on a predetermined basis, upon retirement from the Company. Contributions are

subject to board approval and recognized as an expense when incurred. Defined contributions are paid to

employee retirement savings plan and are expensed when incurred.

The Company has accrued $ nil (2003 - $1,000,000) to the employee deferred profit sharing plan and

$677,000 (2003 - $537,000) to the defined contribution plan.

13. Corporate and Franchise Retail Sales

Total corporate and franchise retail sales have been shown on the Consolidated Statements of Operations

and Retained Earnings to indicate the size of the Company’s total retail sales level (on an unaudited basis).

Only revenue from corporately owned stores, wholesale sales to, and fees from, franchisees are included in

the Consolidated Statements of Operations and Retained Earnings.

14. Sale of Investment

During fiscal 2003, the Company sold its investment in a wholesale distribution operation. The Company

held 668,668 common and 334,334 series “C” preferred shares, which were valued at $2,899,800. The

Company received consideration of $1,690,100 and 234,771 shares in a publicly traded wholesale

distribution company, resulting in a pre-tax gain of $1,445,000. Subsequent to the initial transaction, 13,400

shares of the 234,771 received were sold, for a gain of $9,000, resulting in an overall pre-tax gain on sale of

investments, of $1,454,000.

57


15. Contingencies and Guarantees

Effective February 3, 2003, the Company implemented the CICA’s Accounting Guideline 14 (AcG-14)

“Disclosure of Guarantees”, which expands previously issued accounting guidance and requires additional

disclosure, by a guarantor, in its interim and annual financial statements, for fiscal periods beginning on or

after January 1, 2003, for certain guarantees.

In the normal course of business, the Company enters into numerous agreements that may contain features

that meet the AcG-14 definition of a guarantee. AcG-14 defines a guarantee to be a contract (including an

indemnity) that contingently requires the Company to make payments to the guaranteed party based on (i)

changes in an underlying interest rate, foreign exchange rate, equity or commodity instrument, index or

other variable, that is related to an asset, a liability or an equity security of the counterparty, (ii) failure of

another party to perform under an obligating agreement or (iii) failure of a third party to pay its

indebtedness when due.

The Company has provided the following guarantees to third parties:

(a) The Company has provided guarantees to certain franchisees’ banks pursuant to which it has agreed to

buy back inventory from the franchisee in the event that the bank realizes on the related security. The

Company has provided securitization guarantees for certain franchisees to repay equity loans in the

event of franchisee default. The terms of the guarantees range from 0.5 years to the lifetime of the

particular underlying franchise agreement, with an average guarantee term of 5.6 years. Should a

franchisee default on its bank loan, the Company would be required to purchase between 50% – 100%,

with a weighted average of 65%, of the franchisee’s inventory up to the value of the franchisee’s bank

indebtedness. As at February 1, 2004, the Company’s maximum exposure is $30,855,000. Should the

Company be required to purchase the inventory, it is expected that the full value of the inventory would

be recovered. Historically, the Company has not had to repurchase significant inventory from

franchisees pursuant to these guarantees. The Company has not recognized the guarantee in its

financial statements.

(b) In the ordinary course of business, the Company has agreed to indemnify its lenders under its credit

facilities against certain costs or losses resulting from changes in laws and regulations and from any legal

action brought against the lenders related to the use, by the Company, of the loan proceeds, or to the

lenders having extended credit thereunder. These indemnifications extend for the term of the credit

facilities and do not provide any limit on the maximum potential liability. Historically, the Company

has not made any indemnification payments under such agreements and no amount has been accrued

in the financial statements with respect to these indemnification agreements.

(c) In the ordinary course of business, the Company has provided indemnification commitments to certain

counterparties in matters such as real estate leasing transactions, securitization agreements, director and

officer indemnification agreements and certain purchases of assets (not inventory in the normal course).

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These indemnification agreements generally require the Company to compensate the counterparties for

costs or losses resulting from any legal action brought against the counterparties related to the actions

of the Company or any of the obligors under any of the aforementioned matters or failure of the

obligors under any of the aforementioned matters to fulfill contractual obligations thereunder. The

terms of these indemnification agreements will vary based on the contract and generally do not provide

any limit on the maximum potential liability. Historically, the Company has not made any payments

under such indemnifications and no amount has been accrued in the financial statements with respect

to these indemnification commitments.

(d) Claims and suits have been brought against the Company in the ordinary course of business. In the

opinion of management, all such claims and suits are adequately covered by insurance, or if not so

covered, the results are not expected to materially affect the Company’s financial position.

16. Financial Instruments

The carrying value of the Company’s accounts receivable and accounts payable and accrued liabilities

approximates, based on available information, fair value as at February 1, 2004, based on their terms to

maturity.

The Company is exposed to credit risk on its accounts receivable from franchisees. The accounts receivable

are net of applicable allowances for doubtful accounts, which are established based on the specific credit risks

associated with individual franchisees and other relevant information. Concentration of credit risk with

respect to receivables is limited, due to the large number of franchisees.

The Company purchases a portion of its inventory from foreign vendors with payment terms in foreign

currencies. To manage the foreign exchange risk associated with these purchases, the Company hedges its

exposure to foreign currency by purchasing foreign exchange options and forward contracts to fix exchange

rates and protect planned margins. The Company has the following derivative instruments outstanding at

February 1, 2004 and February 2, 2003:

Notional amounts maturing in

Less than 1 year Over 1 year 2004 Total 2003 Total

Foreign exchange contracts ($CAD)

United States dollar contracts $1,599 - $1,599 $12,712

EURO contracts - - - 367

Total $1,599 - $1,599 $13,079

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As at February 1, 2004, these instruments had unrealized losses of $10,000 (2003 - $200,000 loss).

The Company is exposed to interest rate risk on its credit facility, construction facility and the term loan.

Interest rate risk reflects the sensitivity of the Company’s financial condition to movements in interest rates.

For fiscal year 2004, a +/-1% change in interest rates would change interest expense by +/- $995,000 (2003

+/– $1,093,000).

17. Segmented Financial Information

The Company operates principally in two business segments: corporately-owned and operated retail stores

and as franchisor of retail stores. Identifiable assets, depreciation and amortization, interest expense and

capital expenditures are not disclosed by segment as they are substantially corporate in nature.

2004 2003

Revenues:

Corporate $ 732,880 $ 715,003

Franchise 235,198 208,792

968,078 923,795

Operating Profit:

Corporate 86,121 87,201

Franchise 21,621 16,163

107,742 103,364

Non-segment specific administrative expenses 26,529 20,923


Interest expense 4,838 4,354

Gain on sale of investments - (1,454)

62,550 53,447

Earnings before income taxes 45,192 49,917

Income tax expense 17,173 19,932

Net Earnings $ 28,019 $ 29,985

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18. Related Party Transactions

(a) The Company has advanced $202,944 (2003 – $320,567) to an officer for housing purchase assistance.

The advance is being repaid over a four-year term commencing on January 28, 2002 and bears interest

at bank prime rate.

(b) An officer of the Company holds an interest in a franchise store operation. During the year, that

franchise operation transacted business with the Company, in the normal course and at fair market

value, purchasing product in the amount of $6,896,000 (2003 - $5,495,000). At the end of the year,

accounts receivable from the franchise operation were $634,000 (2003 - $689,000).

(c) The Company is related to The Forzani Group Foundation (“Foundation”) with three of five

Foundation board members being related to the Company. There were no significant transactions

between the Company and the Foundation during the year.

19. Subsequent Event

On March 19, 2004, the Company entered into an agreement to purchase the shares of Gen-X Sports Inc., a

wholesale distribution company. Total consideration for the transaction was $14,172,000, comprised of

inventory of $6,072,000, trademarks of $3,300,000 and goodwill and other intangible assets of $4,800,000.

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for the year ending february 1, 2004 - knotia.ca · using the weighted average cost method and...

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