A N N U A L R E P O R T ANNUEL T RAPPOR

Transcription

1 ANNUAL REPORT 2006

2 CORPORATE PROFILE Le Château is a leading Canadian specialty retailer offering fashionforward apparel, accessories and footwear to style-conscious women and men. Our brand s success is built on quick identification of and response to fashion trends through our design, product development and vertically integrated operations. Le Château brand name merchan- STORES AND SQUARE FOOTAGE JANUARY 27, 2007 JANUARY 28, 2006 STORES SQUARE STORES SQUARE FOOTAGE FOOTAGE QUÉBEC , ,309 ONTARIO , ,638 BRITISH COLUMBIA , ,139 ALBERTA 20 89, ,916 MANITOBA 7 30, ,050 NOVA SCOTIA 6 19, ,969 SASKATCHEWAN 4 14, ,209 NEW BRUNSWICK 4 14, ,467 NEWFOUNDLAND 2 9, ,203 P.E.I. 1 3, ,480 TOTAL CANADA , ,380 TOTAL UNITED STATES 5 20, ,713 TOTAL LE CHÂTEAU STORES , ,093 dise is sold exclusively through our 195 retail locations. All stores are in Canada, except for five locations in 300, ,000 the New York City area. 250, , ,000 80,000 Le Château, committed to research, 150, ,000 SALES 50,000 (in 000) 0 60,000 SHAREHOLDERS 40,000 EQUITY 20,000 (in 000) 0 design and product development, manufactures approximately 40% of 30,000 40,000 the Company s apparel in its own 25,000 20,000 30,000 Canadian production facilities. NET EARNINGS (in 000) 15,000 10,000 5,000 0 CASH FLOW FROM OPERATIONS (in 000) 20,000 10,

3 FINANCIAL HIGHLIGHTS (in thousands of dollars except per share data and ratios) January 27, January 28, January 29, January 31, January 25, FISCAL YEARS ENDED (53 weeks) RESULTS Sales 303, , , , ,660 Earnings before income taxes 38,406 35,963 24,336 17,123 12,375 Net earnings 24,751 23,513 15,886 10,648 7,562 Per share Dividends per share Ordinary Special 3.00 Average number of shares outstanding (000) 6,045 5,953 5,362 5,134 4,980 FINANCIAL POSITION Working capital 45,928 60,491 47,781 24,987 18,443 Shareholders equity 108, ,245 85,244 61,162 51,492 Total assets 185, , ,198 94,546 80,519 FINANCIAL RATIOS Current ratio :1 2.61:1 1.99:1 1.79:1 Quick ratio :1 1.62:1 0.96:1 0.70:1 Long-term debt to equity (1) 0.14:1 0.20:1 0.16:1 0.11:1 0.08:1 OTHER STATISTICS (units as specified) Cash flow from operations (in 000) 40,374 36,311 25,291 18,311 14,503 Capital expenditures (in 000) 27,701 27,655 16,491 14,438 9,019 Number of stores at year-end Square footage 853, , , , ,815 Sales per square foot (2) SHAREHOLDERS INFORMATION Ticker symbol: CTU.A Listing: TSX Number of participating shares outstanding (as of May 22, 2007): 4,587,941 Class A Subordinate Voting Shares 1,640,000 Class B Voting Shares Float: (3) 3,860,271 Class A Shares held by the public As of May 22, 2007: High/low of Class A Shares (12 months ended May 22, 2007): $65.00 / $36.00 Recent price: $64.99 Dividend yield: 3.1% Price/earnings ratio: 15.9 X Price/book value ratio: 3.7 X Earnings per share: (4) $4.09 Book value per share: (5) $17.39 (1) Including capital leases and current portion of debt. Excluding deferred lease inducements. (2) Excluding Le Château outlet stores. (3) Excluding shares held by officers and directors of the Company. (4) For the year ended January 27, (5) As at January 27, annual report

4 MESSAGE TO SHAREHOLDERS Credit for Le Château s success in 2006 is owed to the commitment and talent of our people in every department of the Company. We thank them for meeting the challenge of furthering our leadership position in the fashion marketplace. Le Château s continued growth derived from our emphasis on doing what we have always done. We gave our customers fashion innovation. We were relentless in finding the right product and putting it in the store at the right time. Fashion remains, and will always remain, the DNA of Le Château. In the course of the year we concluded a process of strategic review. The results endorsed our focus on product and called for staying the course. Le Château s approach will continue to be one of seasonless merchandising. Our delivery of buy now, wear now original collections on a weekly basis will continue to be a central factor in our growth. This strategy will sustain our mission to remain the leading interpreter, creator and merchandiser of global fashion for Canadians. Our strong national network continued to expand in 2006, with the opening of ten new stores. While we are focused on the Canadian marketplace, we continue to increase our global licensing opportunities. In 2006 we raised the annual shareholder dividend from $1.00 to $1.50. In addition, we issued a special dividend of $3.00 per share. Going forward we aim to further increase Le Château s value creation by reaching the full potential of every category in which we operate. (Signed) JANE SILVERSTONE SEGAL, B.A.LLL Vice-Chairman and Chief Executive Officer 2 le château

5 MANAGEMENT S DISCUSSION AND ANALYSIS April 26, 2007 The 2006, 2005 and 2004 years refer, in all cases, to the 52 week period ended January 27, 2007, January 28, 2006 and January 29, 2005, respectively. Management s Discussion and Analysis ( MD&A ) should be read in conjunction with the audited consolidated financial statements and notes to the consolidated financial statements for the 2006 fiscal year of Le Château Inc. SELECTED ANNUAL INFORMATION (IN THOUSANDS OF DOLLARS EXCEPT PER SHARE AMOUNTS) $ $ $ Sales 303, , ,131 Earnings before income taxes 38,406 35,963 24,336 Net earnings 24,751 23,513 15,886 Net earnings per share Basic Diluted Total assets 185, , ,198 Long term debt (1) 8,222 14,665 9,086 Dividends per share Ordinary Special 3.00 Cash flow from operations 40,374 36,311 25,291 Comparable store sales increase % 3.8 % 11.2 % 4.9 % Square footage of gross store space at year-end 853, , ,830 Sales per square foot, excluding fashion outlet stores (in dollars) (1) Including capital lease obligations. Excluding current portion of debt and deferred lease inducements. SALES Sales increased 8.9% in 2006 to reach a record level of $303.9 million, compared to $279.1 million the previous year. Sales per square foot of retail space - excluding fashion outlets decreased to $407 from $416 in 2005, primarily due to the decline in sales of 5.2% in the Accessories division. Although sales per square foot is an important performance indicator, the Company maintains its focus on profit contribution per square foot which remained strong in The goal of the Company in 2006 was to surpass its performance of 2005 with solid gains. In spite of a slow start to the year, that goal was achieved. In the first half of the year sales per square foot, excluding fashion outlets, declined by 8.0%. In the latter half of the year, however, performance improved in this category, posting an increase of 3.2% for the period. Despite a decrease of 2.4% in comparable store sales during the first half of 2006, the Company showed a strong recovery in the second half with a 9.0% increase. In this category we ended the year with an annual increase of 3.8%. annual report

6 Space Re-Alignment: In the first half of 2006 the Company completed the re-alignment of existing real estate to maximize profitability, a process that had begun two years earlier. All remaining space formerly assigned to the JUNIOR GIRL clothing division was allocated principally to the Footwear and Ladies Divisions, with the bulk of the space being assigned to Footwear. With the space rearrangement wholly behind us, this initiative resulted in significantly increased sales in footwear in the latter half of the year. Pilot Licensing: During the third quarter of 2005, Le Château entered into a pilot licensing agreement with a retail developer in the Middle East regarding the opening of Le Château branded stores in the region. As at January 27, 2007, there were four stores under licensee arrangement in this region. The Company will seek to further expand its offering and brand awareness internationally, to accelerate revenue generation through foreign licensing and franchising opportunities. TOTAL SALES BY DIVISION (IN THOUSANDS OF DOLLARS) % CHANGE $ $ $ Ladies Clothing 170, , , % 8.7 % Men s Clothing 45,970 38,019 30, % 24.8 % Accessories 48,870 51,560 37,575 (5.2) % 37.2 % Footwear 36,905 25,128 18, % 39.1 % JUNIOR GIRL Clothing 1,974 10,995 13,892 (82.0) % (20.9) % 303, , , % 15.7 % Stronger in Ladies Wear: The Ladies clothing division posted margin expansion in 2006 and recorded a sales increase of 11.0%; it continues to be the main revenue driver among the Company s divisions, accounting for 56.0% of total sales. Our continued focus on a broader customer base, an extended range of clothing sizes and a continuous flow of unique and quality product all contributed to the sales growth. Footwear Rising: The highest percentage sales increase in 2006 came from the Footwear division with an increase of 46.9%, accounting for 12.1% of total sales as compared to 9.0% the previous year. The footage dedicated to footwear expanded by approximately 30%. Furthermore, we coordinated our footwear offering more closely with our clothing and overall lifestyle brand. We recognize that this division has still further growth potential and we plan on strengthening our product offering to capture a larger market share. Our footwear offering is typically a shop within a shop, but in some larger markets we are introducing full concept shoe stores, adjacent to our ladies store, with their own separate entrance (similar to the separate entrances for Menswear that have proven successful). In the first quarter of 2006, our first full concept shoe store opened in Place Laurier, adjacent to our Quebec City flagship location. We now have seven such footwear operations, all contiguous to existing stores. Accessories Decline and Rebound: Sales in the Accessories division decreased 5.2% in 2006 and accounted for 16.1% of total sales. The Accessories division, which had enjoyed significant growth in the last few years, did not fully capture a shift in the fashion scene during the first nine months. However, performance of the division improved in Q4 with a 9% increase and the trend has continued in Growth and Expansion in Menswear: Revenues in the Men s division increased 20.9% in 2006, making it one of the largest profit contributors among our divisions. During the year eight more existing stores were expanded to provide adjacent, but distinct, premises for menswear, bringing the total number of stores with a separate men s entrance to forty-five. Altogether, 13% more footage was added to this division in le château Annual report

7 TOTAL SALES BY REGION (IN THOUSANDS OF DOLLARS) % CHANGE $ $ $ Ontario 104,358 98,127 85, % 15.3 % Québec 82,266 75,833 65, % 16.5 % Prairies 53,352 47,746 41, % 14.2 % British Columbia 40,317 36,371 30, % 21.1 % Atlantic 15,316 13,271 11, % 17.4 % United States 8,270 7,716 7, % (0.1) % 303, , , % 15.7 % In 2006, all regions improved in terms of sales performance. The strongest growth came from Atlantic Provinces with an increase of 15.4% in total sales and 12.5% in comparable stores sales. Alberta also had a strong showing with increases of 14.5% in sales and 10.2% in same store sales. Same store sales also increased 4.4% in both British Columbia and Ontario. In Quebec, total sales increased 8.5% while comparable store sales increased 0.4%. The Company s five U.S. stores, all located in the New York City area, reported a total sales increase of 13.8% (in US$) while comparable store sales were flat. During the year, Le Château opened 10 new stores and renovated 32 existing stores. As at January 27, 2007, the Company operated 195 stores (including 19 fashion outlet stores) compared to 185 (including 14 fashion outlets) at the end of the previous year. Total floor space at the end of the year was 854,000 square feet compared to 762,000 square feet at the end of the preceding year, an increase of 92,000 square feet or 12.1%. Of the 92,000 square feet added during year, 58,000 square feet was attributable to new stores and 34,000 square feet to the expansion of 20 existing stores. In 2007, the Company expects to add approximately 80,000 to 100,000 square feet. This footage will result from the addition of 15 to 18 new stores, as well as from the expansion (where possible) of existing stores. EXPENSES Cost of sales and selling, general and administrative expenses totalled $251.1 million for the year or 82.6% of sales, as compared to $230.9 million or 82.7% of sales the previous year. Included in expenses for 2006 were stock-based compensation expense of $929,000 (2005 $458,000) and costs of $732,000 (2005 NIL) relating to the strategic review which was completed during the year. Interest expense increased to $1,079,000 in 2006 from $803,000 in 2005, due to additional long-term financing of $13.0 million obtained during the fourth quarter of Depreciation and amortization increased to $13.8 million from $11.2 million in 2005, due to the additional investments in fixed assets of $27.7 million. The $13.7 million provision for income taxes in 2006 represents an effective income tax rate of 35.6%, compared to 34.6% the previous year. The increase in the effective income rate is attributable to the increase in non-deductible items such as stock-based compensation and U.S. tax losses. annual report

8 EARNINGS Net earnings reached a record level of $24.8 million or $4.09 per share (basic) in 2006 compared to $23.5 million or $3.95 per share in Earnings before interest, income taxes, depreciation and amortization ( EBITDA ) for the year increased 9.5% to $52.8 million or 17.4% of sales, compared to $48.2 million or 17.3% of sales last year. Net earnings attributable to Canadian operations amounted increase to $25.9 million or $4.28 per share (basic) in 2006 compared to $24.4 million or $4.10 per share in The Company s U.S. operations recorded a net loss of $1,161,000 Cdn or $(0.19) Cdn per share in 2006 as compared to $893,000 million or $(0.15) Cdn per share the previous year. LIQUIDITY AND CAPITAL RESOURCES The Company has a high level of liquidity, more than sufficient to cover its operating requirements, as well as a strong financial position. The Company s liquidity follows a seasonal pattern based on the timing of inventory purchases and capital expenditures, with liquidity being at its highest level at year-end and the lowest at the end of the second quarter. The Company s cash position, including short-term investments, increased to $61.6 million or $9.91 per share in 2006 from $61.1 million or $10.13 per share in Cash flows from operating activities (excluding net changes in non-cash working capital items) increased to $40.4 million in 2006, compared to $36.3 million the previous year, mainly as a result of higher net earnings before depreciation. Cash flows from operating activities (including net changes in non-cash working capital items) increased to $38.4 million from $38.1 million in Cash provided by operating and financing activities was used in the following financing and investing activities: Capital expenditures of $27.7 million, of which $27.3 million was attributed to Canadian operations and $0.4 million to U.S. operations, consisting of: CAPITAL EXPENDITURES (IN THOUSANDS OF DOLLARS) $ $ $ New Stores (10 stores; stores; stores) 4,658 5,943 2,828 Renovated Stores (32 stores; stores; stores) 19,234 16,768 9,856 Information Technology 1,657 2,213 2,647 Other 2,152 2,731 1,160 27,701 27,655 16,491 Dividend payments of $6.0 million Capital lease and long-term debt repayments of $6.8 million 6 le château

9 The following table identifies the timing of contractual obligation amounts due after January 27, CONTRACTUAL OBLIGATIONS (IN THOUSANDS OF DOLLARS) Total Less than 1 year 1-3 years 4-5 years After 5 years $ $ $ $ $ Long-term debt 10,326 4,392 5,934 Capital Lease Obligations 4,339 2,051 2,288 Operating leases (1) 197,033 30,541 53,835 42,147 70, ,698 36,984 62,057 42,147 70,510 (1) Minimum rentals payable under long-term operating leases excluding percentage rentals. For 2007, projected capital expenditures are $26.0 million, of which $22.0 million is expected to be used for the opening of 15 to 18 stores and the renovation of 20 to 25 existing stores, with the balance of $4.0 million to be used for investments in information technology and infrastructure. Management expects to be able to continue financing the Company s operations and a portion of its capital expenditure requirements through cash flow from operations. If necessary, it can also draw upon its financial resources, which include cash and cash equivalents (including short-term investments) of $61.6 million at year-end, as well as a revolving line of credit of $16.0 million with its bank. In addition, the Company has a credit facility totalling $25 million available until June 30, 2007 to finance the renovation and re-fixturing of various stores throughout Canada. Drawdowns under this facility are repayable over 60 months and bear interest at a fixed rate based on the three year Government of Canada bond interest rate. The facility is collateralized by the store fixtures and equipment financed. The Company s outstanding debt with this institution, in the amount of $4.3 million, reduces the amount available under this facility thereby leaving a balance available of $20.7 million as at January 27, Subsequent to year end, an additional $16.3 million was drawn under this facility. The Company does not have any off-balance sheet financing arrangements. FINANCIAL POSITION Working capital stood at $45.9 million at the end of the fiscal year, compared to $60.5 million at the end of The decrease is attributable to financing capital expenditures out of operations as well as the special dividend in the amount of $18.7 million declared on November 30, 2006, which was paid in February Inventories increased 15.6% to $41.0 million from $35.4 million a year earlier, due primarily to the addition of 92,000 square feet or 12.1% in the year and the earlier receipts of our spring collections. Long-term debt and capital lease obligations, including the current portions, decreased to $14.7 million from $21.5 million in 2005, after the repayment of $6.8 million during the year. The long-term debt to equity ratio remained conservative at 0.14:1, compared to 0.20:1 the previous year. Shareholders equity increased to $108.2 million at year-end, after deducting $25.5 million in dividends. In spite of these dividends, book value per share only decreased slightly to $17.39 at year-end, compared to $17.46 as at January 28, 2006, and included $9.91 per share in cash and cash equivalents (including short-term investments). annual report

10 DIVIDENDS AND OUTSTANDING SHARE DATA In 2006, Le Château continued for the thirteenth consecutive year its policy of paying quarterly dividends on the Class A subordinate voting and Class B voting shares. Total dividends per Class A and Class B share amounted to $4.13 in 2006 as compared to $0.80 the previous year. On November 30, 2006, the Board of Directors declared two dividends for the holders of Class A subordinate voting shares and Class B voting shares. The Board of Directors increased the regular quarterly dividend by 50% to $0.375 per share and declared a one-time dividend of $3.00 per share. Both dividends were paid on February 13, 2007 to the shareholders of record at the close of business on January 30, On April 12, 2007, the Company announced that it intends to proceed with a four-for-one stock split of its Class A subordinate voting shares and Class B voting shares, subject to approval by the Company's shareholders at the forthcoming meeting of shareholders to be held on June 27, A majority of 66 2 /3 % of the votes attached to the Class A subordinate voting shares and Class B voting shares is required to approve the stock split. Further information on the stock split will be provided in the Company's information circular for the meeting. The Company is undertaking the stock split to further enhance the liquidity of its shares for the benefit of all shareholders. The record date for and the effective date of the split will be announced by the Company at a later date. All share and per share information presented in this MD&A do not reflect the effects of the stock split. On April 12, 2007, the Board of Directors declared a quarterly dividend of $0.50 per Class A subordinate voting share and Class B voting share (on a pre-split basis), representing an increase of 33% from the previous dividend rate of $0.375 per share. The dividend is payable on May 25, 2007 to shareholders of record at the close of business on May 11, The dividend yield, based on the April 23, 2007 closing price of $61.00 per share, was 3.28%. The Company designated the above dividends to be eligible dividends pursuant to subsection 89 (14) of the Income Tax Act and its equivalent in the provincial jurisdictions of Canada. As at April 23, 2007, there were 4,187,141 Class A subordinate voting and 2,040,000 Class B voting shares outstanding. Further, there were 445,400 options outstanding with exercise prices ranging from $7.00 to $60.55, of which 18,300 were exercisable. SUPPLEMENTARY MEASURES In addition to discussing earnings measures in accordance with Canadian generally accepted accounting principles ( GAAP ), this MD&A provides EBITDA as a supplementary earnings measure. Depreciation and amortization include the write-off of fixed assets. EBITDA is provided to assist readers in determining the ability of the Company to generate cash from operations and to cover financial charges. It is also widely used for valuation purposes for public companies in our industry. This MD&A also discloses cash flow from operations as a supplementary measure. Cash flow from operations is defined as cash flow from operating activities before the net change in non-cash working capital items related to operations. This measure provides an indication of the Company s ability to generate cash flows without considering certain timing and other factors causing variations in non-cash items. 8 le château

11 The following table reconciles EBITDA to GAAP measures disclosed in the audited consolidated statements of earnings for the years ended January 27, 2007 and January 28, 2006: (IN THOUSANDS OF DOLLARS) $ $ Earnings before income taxes 38,406 35,963 Depreciation and amortization 13,798 11,238 Write-off of fixed assets 1,244 1,164 Interest on long-term debt and capital lease obligations 1, Interest income (1,738) (976) EBITDA 52,789 48,192 The above measures do not have a standardized meaning prescribed by GAAP and may not be comparable to similar measures presented by other companies. RECENTLY ISSUED ACCOUNTING STANDARDS During 2005, the CICA issued Handbook section 3855, Financial Instruments Recognition and Measurement, Handbook section 3865, Hedges and Handbook section 1530, Comprehensive Income. Section 3855 puts forward comprehensive requirements for recognition and measurement of financial instruments. An entity should recognize a financial asset or financial liability only when the entity becomes a party to the contractual provisions of the financial instrument. Financial assets and liabilities should, with certain exceptions, be initially measured at fair value. For financial assets and liabilities not classified as held for trading, the initial value recorded should include transaction costs that are directly attributable to the acquisition or issuance of the financial asset or liability. After initial recognition, the measurement of financial assets will vary depending on the category of the asset: financial assets held for trading, held-to-maturity investments, loans and receivables, and available-for-sale financial assets. Section 3865 introduces requirements for hedge accounting. Requirements for identifying hedging relationships, previously included in CICA Accounting Guideline 13, Hedging Relationships ( AcG 13 ), are now incorporated into this new standard. However, certain hedging relationships will no longer qualify for special hedge accounting under these new rules, even though they qualify under AcG 13. Section 1530 establishes standards for reporting and display of comprehensive income. Comprehensive income includes net income as well as all changes in equity during a period, from transactions and events from non-owner sources. Comprehensive income and its components should be presented in a financial statement with the same prominence as other financial statements. These new standards will be effective for the Company on January 28, 2007.The Company is currently evaluating the impact of these new standards. annual report

12 DISCLOSURE CONTROLS AND PROCEDURES As of January 27, 2007, an evaluation of the effectiveness of the issuer s disclosure controls and procedures (as such term is defined under the rules adopted by the Canadian securities regulatory authorities) was carried out by our management, under supervision of, and with the participation of, our Chief Executive Officer ( CEO ) and Chief Financial Officer ( CFO ). Based upon the evaluation, the CEO and CFO concluded that as of such date our disclosure controls and procedures were effective, such that information relating to the Company required to be disclosed by us in the reports we file or submit to such regulatory authorities (a) is recorded, processed, summarized and reported within the time periods specified under applicable securities laws and (b) is accumulated and communicated to our management, including our CEO and CFO, to allow timely decisions regarding disclosure. INTERNAL CONTROL OVER FINANCIAL REPORTING Internal control over financial reporting ( ICFR ) is designed to provide reasonable assurance regarding the reliability of the Company s financial reporting and its compliance with GAAP in its financial statements. The Chief Executive Officer and Chief Financial Officer have evaluated whether there were changes to its ICFR during the year ended January 27, 2007 that have materially affected, or are reasonably likely to materially affect, its ICFR. No such changes were identified through their evaluation. CRITICAL ACCOUNTING ESTIMATES The preparation of financial statements requires the Company to estimate the effect of various matters that are inherently uncertain as of the date of the financial statements. Each of these required estimates varies in regard to the level of judgement involved and its potential impact on the Company s reported financial results. Estimates are deemed critical when a different estimate could have reasonably been used or where changes in the estimates are reasonably likely to occur from period to period, and would materially impact the Company s financial condition, changes in financial condition or results of operations. The Company s significant accounting policies are discussed in note 1 of the Notes to Consolidated Financial Statements ; critical estimates inherent in these accounting policies are discussed in the following paragraphs. Inventory Valuation The Company records a provision to reflect management s best estimate of the net realizable value less normal profit margin on its finished goods inventory. In addition, a provision for shrinkage and obsolescence is calculated based on historical experience. Management continually reviews the entire provision, to assess whether it is adequate, based on economic conditions and an assessment of past sales trends. Fixed Asset Impairment Management evaluates the ongoing value of assets associated with retail stores. Impairment is assessed by comparing the carrying amount of an asset with its expected future net undiscounted cash flows from use. If such assets are considered impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds their fair value, generally determined on a discounted expected cash flow basis. Stock-based Compensation A stock based compensation expense for stock options is calculated based on the fair value method using the Black-Scholes model and is recorded for all options granted after January 25, In order to establish fair value, the Company uses estimates and assumptions to determine risk-free interest rate, expected term, anticipated volatility and anticipated dividend yield. The use of different assumptions could result in different stock-based compensation amounts. RISKS AND UNCERTAINTIES Competitive and Economic Environment Fashion is a highly competitive global business that is subject to rapidly changing consumer demands. In addition, there are several external factors that affect the economic climate and consumer confidence over which the Company has no influence. 10 le château

13 This environment intensifies the importance of in-store differentiation, quality of service and continually exceeding customer expectations, thereby delivering an outstanding total customer experience. With this view, Le Château believes that its distinctive edge in fashion, its innovative store design and merchandising, its strong financial position and its winning team of vibrant employees dedicated to providing the best whole store experience will facilitate continued success. Leases All of the Company s stores are held under long-term leases, except for the Company owned St. Jean street store in Quebec City. Any increase in retail rental rates would adversely impact the Company. Foreign Exchange The Company s foreign exchange risk is limited to currency fluctuations between the Canadian and U.S. dollar. The Company uses forward contracts to fix the exchange rate of its expected requirements for U.S. dollars. The Company is party to foreign exchange contracts used to manage currency rate risks. Realized gains and losses on foreign exchange contracts entered into to hedge future transactions are included in the measurement of the related foreign currency transaction. As at January 27, 2007, the Company had $6.7 million of contracts outstanding to buy US dollars (2005 $8.2 million). The Company enters into foreign exchange forward contracts that oblige it to purchase specific amounts of foreign currencies at set future dates at forward predetermined exchange rates. The contracts are matched with anticipated foreign currency purchases. The Company enters into the foreign exchange forward contracts to hedge itself from the risk of losses should the value of the Canadian dollar decline compared to the foreign currency. The Company only enters into foreign exchange contracts with Canadian chartered banks to minimize risk. Seasonality The Company offers many seasonal goods. The Company sets budgeted inventory levels and promotional activity in accordance with its strategic initiatives and expected consumer spending changes. Businesses that generate revenue from the sale of seasonal merchandise are subject to the risk of changes in consumer spending behaviour as a result of unseasonable weather patterns. QUARTERLY RESULTS (IN THOUSANDS OF DOLLARS EXCEPT PER SHARE AMOUNTS) FIRST QUARTER SECOND QUARTER THIRD QUARTER FOURTH QUARTER TOTAL $ $ $ $ $ $ $ $ $ $ Sales 61,187 60,601 71,892 69,007 77,841 69,231 92,959 80, , ,064 Earnings before income taxes 4,219 7,218 8,482 9,660 12,847 9,505 12,858 9,580 38,406 35,963 Net earnings 2,719 4,638 5,432 6,240 8,352 6,143 8,248 6,492 24,751 23,513 Net earnings per share Basic Diluted annual report

14 The Company s business follows a seasonal pattern, with retail sales traditionally being higher in the third and fourth quarters due to the back-to-school period and the Christmas season, respectively. In addition, fourth quarter earnings results are usually reduced by post Christmas sale promotions. Fourth Quarter Results The Company recorded a sales increase of 15.9% to $93.0 million for the 13 week period ended January 27, 2007, compared with sales of $80.2 million for the same period ended last year. Comparable stores sales increased by 11.0% over the same period a year ago. Fourth quarter results reflect a continuation of the trend set in the third quarter. Net earnings rose 27.0% to $8.2 million or $1.35 per share for the fourth quarter, as compared with $6.5 million or $1.08 per share last year. STRATEGIC REVIEW On March 14, 2006, the Company announced that it was evaluating various strategic alternatives for enhancing shareholder value. The options included, but were not limited to: a sale of the Company; a business combination; or a capital reorganization. On January 5, 2007, the Company disclosed that its comprehensive review of operations, positioning and strategic alternatives had come to a conclusion. The Board had determined that shareholders would be best rewarded by the Company staying the course. OUTLOOK Based on the Company s expectations for a stable economy and retail environment, Le Château anticipates steady growth in sales and earnings to continue in The Company remains committed to enhancing the customer experience by elevating our service standards and by focusing on product innovation. We will remain centered on improving all aspects of our business through ongoing brand-building efforts, better inventory management, tighter cost controls, and continued investments in research, design and development, renovations, and new technologies. The Company will also continue to study and draw on opportunities for revenue generation through foreign licensing of its offering and brand. Additional information relating to the Company, including the Company s Annual Information Form, is available online at FORWARD-LOOKING STATEMENTS This MD&A along with the Annual Report may contain forward-looking statements relating to the Company and/or the environment in which it operates that are based on the Company's expectations, estimates and forecasts. These statements are not guarantees of future performance and involve risks and uncertainties that are difficult to predict and/or are beyond the Company's control. A number of factors may cause actual outcomes and results to differ materially from those expressed. These factors include those set forth in other public filings of the Company. Therefore, readers should not place undue reliance on these forward-looking statements. In addition, these forward-looking statements speak only as of the date made and the Company disavows any intention or obligation to update or revise any such statements as a result of any event, circumstance or otherwise. Factors which could cause actual results or events to differ materially from current expectations include, among other things: the ability of the Company to successfully implement its strategic initiatives and whether such strategic initiatives will yield the expected benefits; competitive conditions in the businesses in which the Company participates; changes in consumer spending; general economic conditions and normal business uncertainty; customer preferences towards product offerings; seasonal weather patterns; fluctuations in foreign currency exchange rates; changes in the Company s relationship with its suppliers; interest rate fluctuations and other changes in borrowing costs; and changes in laws, rules and regulations applicable to the Company. 12 le château

15 CONSOLIDATED FINANCIAL STATEMENTS MANAGEMENT S RESPONSIBILITY For Financial Information The accompanying consolidated financial statements of Le Château Inc. and all the information in this annual report are the responsibility of management. The financial statements have been prepared by management in accordance with Canadian generally accepted accounting principles. When alternative accounting methods exist, management has chosen those it deems most appropriate in the circumstances. Financial statements are not precise since they include certain amounts based on estimates and judgement. Management has determined such amounts on a reasonable basis in order to ensure that the financial statements are presented fairly, in all material respects. Management has prepared the financial information presented elsewhere in the Annual Report and has ensured that it is consistent with that in the financial statements. The Company maintains systems of internal accounting and administrative controls of high quality, consistent with reasonable cost. Such systems are designed to provide reasonable assurance that the financial information is relevant, reliable and accurate and 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 financial reporting and is ultimately responsible for reviewing and approving the financial statements. The Board carries out this responsibility principally through the Audit Committee which consists of three outside directors appointed by the Board. The Committee meets quarterly with management as well as with the independent external auditors to discuss internal controls over the financial reporting process, auditing matters and financial reporting issues. The Committee reviews the consolidated financial statements and the external auditors report thereon and reports its findings to the Board for consideration when the Board approves the financial statements for issuance to the Company s shareholders. The Committee also considers, for review by the Board and approval by the shareholders, the engagement or re-appointment of the external auditors. The external auditors have full and free access to the Audit Committee. On behalf of the shareholders, the financial statements have been audited by Ernst & Young LLP, the external auditors, in accordance with Canadian generally accepted auditing standards. (Signed) Jane Silverstone Segal, B.A.LLL Vice-Chairman and Chief Executive Officer (Signed) Emilia Di Raddo, CA President and Secretary AUDITORS REPORT To the Shareholders of Le Château Inc. We have audited the consolidated balance sheets of Le Château Inc., as at January 27, 2007 and January 28, 2006 and the consolidated statements of retained earnings, earnings, and cash flows for the years then ended. These financial statements are the responsibility of the Company s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with 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 January 27, 2007 and January 28, 2006 and the results of its operations and its cash flows for the years then ended in accordance with Canadian generally accepted accounting principles. Montréal, Canada April 3, 2007 [except for note 17, which is as of April 12, 2007] Chartered Accountants annual report

16 Le Château Inc. Incorporated under the Canada Business Corporations Act CONSOLIDATED BALANCE SHEETS As at January 27, 2007 and January 28, 2006 (In thousands of dollars) $ $ ASSETS [note 2] Current Cash and cash equivalents [note 3] 2,743 17,979 Short-term investments [note 4] 58,899 43,083 Accounts receivable and prepaid expenses 4,457 3,746 Inventories [note 5] 40,967 35,444 Total current assets 107, ,252 Fixed assets [notes 6, 7 and 8] 78,643 65, , ,236 LIABILITIES AND SHAREHOLDERS EQUITY Current Accounts payable and accrued liabilities 32,870 27,668 Dividend payable 20,992 1,507 Income taxes payable 833 3,740 Current portion of capital lease obligations [note 7] 2,051 2,634 Current portion of long-term debt [note 8] 4,392 4,212 Total current liabilities 61,138 39,761 Capital lease obligations [note 7] 2,288 4,339 Long-term debt [note 8] 5,934 10,326 Future income taxes [note 10] 2,891 2,365 Deferred lease inducements 5,284 4,200 Total liabilities 77,535 60,991 Shareholders equity Capital stock [note 9] 30,221 27,210 Contributed surplus [note 9] 1, Retained earnings 76,814 77,577 Total shareholders equity 108, , , ,236 Commitments, contingencies and guarantees [notes 12 and 16] See accompanying notes On behalf of the Board: (Signed) Herschel H. Segal Director (Signed) Jane Silverstone Segal, B.A.LLL Director 14 le château

17 CONSOLIDATED STATEMENTS OF RETAINED EARNINGS Years ended January 27, 2007 and January 28, 2006 (In thousands of dollars) $ $ Balance, beginning of year 77,577 58,851 Net earnings 24,751 23, ,328 82,364 Dividends declared [note 9] 25,514 4,787 Balance, end of year 76,814 77,577 See accompanying notes CONSOLIDATED STATEMENTS OF EARNINGS Years ended January 27, 2007 and January 28, 2006 (In thousands of dollars, except per share data) $ $ Sales 303, ,064 Cost of sales and expenses Cost of sales and selling, general and administrative 251, ,872 Depreciation and amortization 13,798 11,238 Write-off of fixed assets 1,244 1,164 Interest on long-term debt and capital lease obligations 1, Interest income (1,738) (976) 265, ,101 Earnings before income taxes 38,406 35,963 Provision for income taxes [note 10] 13,655 12,450 Net earnings 24,751 23,513 Net earnings per share [note 11] Basic Diluted Weighted average number of shares outstanding 6,045,342 5,952,567 See accompanying notes annual report

18 CONSOLIDATED STATEMENTS OF CASH FLOWS Years ended January 27, 2007 and January 28, 2006 (In thousands of dollars) $ $ OPERATING ACTIVITIES Net earnings 24,751 23,513 Adjustments to determine net cash from operating activities Depreciation and amortization 13,798 11,238 Write-off of fixed assets 1,244 1,164 Amortization of deferred lease inducements (874) (732) Future income taxes Stock-based compensation ,374 36,311 Net change in non-cash working capital items related to operations [note 14] (3,939) (620) Deferred lease inducements 1,958 2,445 Cash flows from operating activities 38,393 38,136 FINANCING ACTIVITIES Proceeds of capital leases 4,943 Repayment of capital lease obligations (2,634) (1,698) Proceeds of long-term debt 8,081 Repayment of long-term debt (4,212) (3,240) Issue of capital stock 2, Dividends paid (6,029) (4,307) Cash flows from financing activities (10,112) 4,596 INVESTING ACTIVITIES Increase in short-term investments (15,816) (43,083) Additions to fixed assets (27,701) (27,655) Cash flows from investing activities (43,517) (70,738) Decrease in cash and cash equivalents (15,236) (28,006) Cash and cash equivalents, beginning of year 17,979 45,985 Cash and cash equivalents, end of year 2,743 17,979 Supplementary information: Interest paid during the year 1, Income taxes paid during the year 15,437 9,930 See accompanying notes 16 le château

19 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JANUARY 27, 2007 AND JANUARY 28, 2006 [Tabular amounts in thousands of dollars except per share amounts and where otherwise indicated] 1. SIGNIFICANT ACCOUNTING POLICIES Use of estimates The consolidated financial statements of Le Chateau Inc. [the Company ] have been prepared by Management in accordance with Canadian generally accepted accounting principles (GAAP). The preparation of financial statements in conformity with GAAP requires Management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. The financial statements have, in Management s opinion, been properly prepared within reasonable limits of materiality and within the framework of the accounting policies summarized below. Principles of consolidation The consolidated financial statements include the accounts of the Company and its wholly owned subsidiary. Foreign currency translation Transactions denominated in foreign currencies and those of an integrated foreign operation are translated using the temporal method. Monetary assets and liabilities are translated into Canadian dollars at the rates in effect at the balance sheet date. Other assets and liabilities are translated at the rates prevailing at the transaction dates. Revenues and expenses are translated at the average exchange rates prevailing during the year, except for the cost of inventory used and depreciation and amortization, which are translated at exchange rates prevailing when the related assets were acquired. Gains and losses arising from the fluctuations in exchange rates are reflected in earnings. Revenue recognition Revenue from merchandise sales are net of estimated returns and allowances, exclude sales taxes and are recorded upon delivery to the customer. Revenue from gift cards or gift certificates (collectively referred to as gift cards ) is recognized at the time of redemption or in accordance with the Company s accounting policy for breakage. Breakage income is included in other income and represents the estimated value of gift cards that are not expected to be redeemed by customers and is estimated based on the terms of the gift cards and historical redemption patterns, including available industry data. Cash and cash equivalents Cash consists of cash on hand and balances with banks. Cash equivalents are restricted to investments that are readily convertible into a known amount of cash, that are subject to minimal risk of changes in value and which have a maturity of three months or less at acquisition. Cash equivalents are carried at cost, which approximates market value. Short-term investments Short-term investments include investments with original maturity terms of 90 days or more. Short-term investments are carried at the lower of cost and market value. All short-term investments are denominated in Canadian dollars. Inventories Raw materials and work-in process are valued at the lower of average cost and net realizable value. Finished goods are valued, using the retail inventory method, at the lower of average cost and net realizable value less normal profit margin. annual report

20 1. SIGNIFICANT ACCOUNTING POLICIES [Cont d] Fixed assets, depreciation and amortization Fixed assets are recorded at cost. Depreciation and amortization are charged to earnings on the following bases: Building Furniture and equipment Automobiles 10% diminishing balance 5 to 10 years straight-line 30% diminishing balance Leasehold improvements are amortized on the straight-line basis over the initial term of the leases, plus one renewal period, not to exceed 10 years. Impairment of long lived assets Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Impairment is assessed by comparing the carrying amount of an asset with its expected future net undiscounted cash flows from use together with its residual value [net recoverable value]. If such assets are considered impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds their fair value, generally determined on a discounted expected cash flow basis. Any impairment results in a write-down of the asset and a charge to earnings during the year. Deferred lease inducements Deferred lease inducements are amortized on the straight-line basis over the initial term of the leases, plus one renewal period, not to exceed 10 years. Stock-based compensation All awards granted or modified after January 25, 2003, are accounted for under the fair value method. Under this method, the value of the compensation is measured at the grant date using an option pricing model. The value of the compensation expense is recognized over the vesting period of the stock options as an expense included in cost of sales and selling, general and administrative expenses, with a corresponding increase to contributed surplus in shareholders equity. All awards granted or modified prior to January 26, 2003 are accounted for as capital transactions. No compensation expense is recorded in the consolidated financial statements for these awards. Had the Company used the fair value method, the earnings would not have been materially different. Any consideration paid by plan participants on the exercise of stock options is credited to share capital. Store opening costs Store opening costs are expensed as incurred. Income taxes The Company uses the liability method of accounting for income taxes, which requires the establishment of future tax assets and liabilities, as measured by enacted or substantively enacted tax rates, for all temporary differences caused when the tax bases of assets and liabilities differ from those reported in the financial statements. A valuation allowance is recorded to the extent that it is more likely than not that future income tax assets will not be realized. 18 le château