Leon's Furniture Limited For the year ending December 31, 2004

Transcription

1 Leon's Furniture Limited For the year ending December 31, 2004 TSX/S&P Industry Class = Annual Revenue = Canadian $504.6 million 2004 Year End Assets = Canadian $368.1 million Web Page (October, 2005) = Financial Reporting In Canada Survey Company Number 107

2 Annual Report Management s responsibility for the financial statement The accompanying consolidated financial statements and all information in this annual report are the responsibility of management and have been approved by the Board of Directors. The accompanying consolidated financial statements have been prepared by management in accordance with Canadian generally accepted accounting principles. Financial statements are not precise since they include certain amounts based upon estimates and judgements. When alternative methods exist, management has chosen those it deems to be the most appropriate in the circumstances. The financial information presented elsewhere in this Annual Report is consistent with that in the financial statements. Leon s Furniture Limited (Leon s) maintains systems of internal accounting and administrative controls of high quality, consistent with reasonable costs. Such systems are designed to provide reasonable assurance that the financial information is relevant and reliable and that Leon s assets are appropriately accounted for and adequately safeguarded. The Board of Directors is responsible for ensuring that management fulfils its responsibilities for financial reporting and is ultimately responsible for reviewing and approving the financial statements. The Board carries out this responsibility principally through its Audit Committee. The Audit Committee is appointed by the Board and reviews the financial statements and annual report; considers the report of the external auditors; assesses the adequacy of the internal controls of the company; examines the fees and expenses for audit services; and recommends to the Board the independent auditors for appointment by the shareholders. The Committee reports its findings to the Board of Directors for consideration when approving the financial statements for issuance to the shareholders. These consolidated financial statements have been audited by Ernst & Young, the external auditors, in accordance with Canadian generally accepted auditing standards on behalf of the shareholders. Ernst & Young has full and free access to the Audit Committee. (signed) (signed) Mark J. Leon Vice Chairman and CEO Dominic Scarangella Vice President and CFO Auditors report To the Shareholders of Leon s Furniture Limited Meubles Leon Ltée We have audited the consolidated balance sheets of Leon s Furniture Limited Meubles Leon Ltée as at December 31, 2004 and 2003 and the consolidated statements of income and retained 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 December 31, 2004 and 2003 and the results of its operations and its cash flows for the years then ended in accordance with Canadian generally accepted accounting principles. Toronto, Canada, February 14, 2005 (signed) Ernst & Young LLP Chartered Accountants

3 14 Leon s Furniture Limited Consolidated balance sheets As at December Assets Current Cash and cash equivalents $ 14,995 $ 12,649 Marketable securities [note 5(d)] 84,000 90,185 Accounts receivable 17,763 20,116 Inventory 71,279 58,841 Income taxes recoverable 3,472 Future tax assets [note 4] Total current assets 191, ,569 Future tax assets [note 4] 6,285 7,056 Capital assets, net [note 3] 170, ,468 $ 368,121 $ 340,093 Liabilities and shareholders equity Current Accounts payable and accrued liabilities $ 79,451 $ 67,422 Income taxes payable 8,559 Customers deposits 9,896 7,217 Dividends payable 3,907 2,823 Deferred warranty plan revenue 7,722 7,401 Total current liabilities 100,976 93,422 Deferred warranty plan revenue 17,079 16,075 Redeemable share liability [note 8] Total liabilities 118, ,599 Shareholders equity Common shares [note 9] 10,532 9,602 Retained earnings 239, ,892 Total shareholders equity 249, ,494 $ 368,121 $ 340,093 See accompanying notes On behalf of the Board: (signed) Anthony T. Leon Director (signed) Mark J. Leon Director

4 Annual Report Consolidated statements of income and retained earnings Years ended December ($ in thousands, except shares outstanding and earnings per share) [restated note 2] Sales $ 504,591 $ 455,702 Cost of sales 295, ,323 Gross profit 209, ,379 Operating expenses (income) Salaries and commissions 75,394 69,433 Advertising 29,492 27,193 Rent and property taxes 9,579 9,213 Amortization 10,412 9,881 Employee profit-sharing plan 2,870 2,441 Other operating expenses 30,558 26,993 Interest income (3,083) (3,390) Other income (16,609) (13,737) 138, ,027 Income before income taxes 70,737 60,352 Provision for income taxes [note 4] 24,633 21,914 Net income for the year 46,104 38,438 Retained earnings, beginning of year, as previously reported 220, ,100 Adjustment [note 2] (6,701) Retained earnings, beginning of year, as restated 220, ,399 Dividends declared (13,915) (9,800) Excess of cost of share repurchase over carrying value of related shares [note 9] (13,746) (24,145) Retained earnings, end of year $ 239,335 $ 220,892 Weighted average number of common shares outstanding Basic 18,485,248 19,278,344 Diluted 19,112,388 19,977,041 Earnings per share Basic $ 2.49 $ 1.99 Diluted $ 2.41 $ 1.92 See accompanying notes

5 16 Leon s Furniture Limited Consolidated statements of cash flows Years ended December Operating activities Net income for the year $ 46,104 $ 38,438 Add (deduct) items not involving an outlay of cash Amortization of capital assets 10,412 9,881 Amortization of deferred warranty plan revenue (9,008) (9,033) Gain on sale of capital assets (916) (67) Future income taxes 1,244 (4,627) Loss (gain) on sale of marketable securities (897) 134 Cash received on warranty sales 10,333 9,769 57,272 44,495 Net change in non-cash working capital balances related to operations [note 7[a]] (7,090) 30,649 Cash provided by operating activities 50,182 75,144 Investing activities Purchase of capital assets (31,273) (24,643) Proceeds on sale of capital assets 1, Purchase of marketable securities (1,793,639) (1,818,718) Proceeds on sale of marketable securities 1,800,721 1,785,084 Decrease in employee share purchase loans [note 8] 1, Cash used in investing activities (21,221) (57,950) Financing activities Dividends paid (12,663) (9,320) Repurchase of capital stock [note 9] (13,952) (24,554) Cash used in financing activities (26,615) (33,874) Net increase (decrease) in cash and cash equivalents during the year 2,346 (16,680) Cash and cash equivalents, beginning of year 12,649 29,329 Cash and cash equivalents, end of year $ 14,995 $ 12,649 See accompanying notes

6 Annual Report Notes to consolidated financial statements [ 1 ] Summary of significant accounting policies These consolidated financial statements of Leon's Furniture Limited Meubles Leon Ltée [the Company ] have been prepared by management in accordance with Canadian generally accepted accounting principles. The more significant of these accounting policies are summarized as follows: Principles of consolidation The consolidated financial statements include the accounts of the Company and its subsidiaries, Murlee Holdings Limited, Leon Holdings (1967) Limited and Ablan Insurance Corporation, all of which are wholly owned. Revenue recognition Sales are recognized as revenue for accounting purposes upon the customer either picking up the merchandise ordered or when merchandise is delivered to the customer s home. The Company defers warranty revenue received and recognizes it in income over the contract period. Foreign exchange translation Merchandise imported from the United States and South East Asia, paid for in United States dollars, is recorded at its equivalent Canadian dollar value upon receipt. United States dollar accounts payable are translated at the year-end exchange rate. Gains and losses resulting from translation of United States dollar accounts payable are included in income. Cash and cash equivalents Cash includes cash on hand and balances with banks from the date of purchase. Marketable securities Marketable securities, which consist primarily of bonds with maturities not exceeding six years and an interest rate range of 2.5% to 6.75%, are stated at the lower of cost and market value. Marketable securities and equity instruments are valued at the lower of cost and market value on an aggregate basis. The market value of the portfolio at December 31, 2004 is $85,439,000 [2003 $91,122,000]. Inventory Inventory is valued at the lower of cost, determined on a first-in, first-out basis, and net realizable value. Capital assets Capital assets are initially recorded at cost. Normal maintenance and repair expenditures are expensed as incurred. Amortization is provided over the estimated useful lives of the assets using the following annual rates and methods: Buildings Equipment Vehicles Computer hardware Computer software Leasehold improvements 5% straight-line 20% to 30% declining balance 30% declining balance 20% straight-line 14% straight-line over the terms of the leases to a maximum of 15 years No amortization is provided for assets under construction.

7 18 Leon s Furniture Limited Notes to consolidated financial statements (cont d) Store pre-opening costs Store pre-opening costs are expensed as incurred. Income taxes The Company follows the liability method for accounting for income taxes. Under the liability method, future tax assets and liabilities are determined based on differences between the financial reporting and tax bases of assets and liabilities and are measured using the substantively enacted tax rates and laws that will be in effect when the differences are expected to reverse. Earnings per share Basic earnings per share have been calculated using the weighted average number of common shares outstanding during the year. Diluted earnings per share are calculated using the if converted method. The dividends declared on the special series shares under the Company s Management Share Purchase Plan [the Plan ] were deducted from net income. The shares convertible under the Plan were included in the calculation of diluted number of common shares to the extent the redemption price was less than the average annual market price of the Company s common shares. Fair value of financial instruments The fair value of financial instruments held by the Company, comprising cash and cash equivalents, marketable securities, accounts receivable, accounts payable and accrued liabilities, customers deposits and redeemable share liability approximates their carrying values in these consolidated financial statements. Stock-based compensation The Plan represents a compensatory plan under the CICA guidance [note 8]. Effective January 1, 2003, the Company elected to adopt on a prospective basis the fair value method of accounting for stock-based compensation with respect to redeemable shares issued under the Plan after December 31, Under the fair value method, compensation expense for stock-based compensation is measured at the grant date using an option pricing model and recognized in income on a straight-line basis over the expected service life. No compensation expense for redeemable shares issued before January 1, 2003 has been recorded in the accounts. [ 2 ] Change in accounting policy The Company has adopted on a retroactive basis, with restatement of prior periods, the new standard of the CICA with respect to accounting for separately priced extended warranty and product maintenance contracts [the contracts ]. The Company now defers warranty revenue received and recognizes it in income over the contract period. Costs directly related to the acquisition of the contracts are also deferred and charged to expense over the contract period. All other costs, including costs of services performed under the contracts, are charged to expense as incurred.

8 Annual Report The increase (decrease) in the amounts for the years ended December 31, 2004 and 2003 resulting from the adoption of the new accounting standard is summarized below: ($ in thousands) Sales $ (692) $ (650) Provision for income taxes Net income for the year (450) (414) Earnings per share - basic $ (0.02) $ (0.02) - diluted $ (0.02) $ (0.02) The effect of the change in accounting policy for the opening retained earnings as of January 1, 2004 and 2003 and the related balance sheet accounts is summarized below: ($ in thousands) Opening retained earnings $ (7,115) $ (6,701) Accounts receivable 1,514 1,428 Future income tax assets 4,703 4,467 Accounts payable and accrued liabilities (10,144) (10,144) Deferred warranty plan revenue $ 23,476 $ 22,740 [ 3 ] Capital assets Capital assets consist of the following: Accumulated Net book Accumulated Net book ($ in thousands) Cost amortization value Cost amortization value Land $ 52,559 $ $ 52,559 $ 47,934 $ $ 47,934 Buildings 138,687 61,935 76, ,175 56,690 65,485 Equipment 22,329 13,429 8,900 19,822 12,812 7,010 Vehicles 15,689 12,361 3,328 14,026 11,891 2,135 Computer hardware and software 8,506 6,454 2,052 8,296 5,534 2,762 Leasehold improvements 37,422 10,991 26,431 34,148 9,006 25,142 $ 275,192 $ 105,170 $ 170,022 $ 246,401 $ 95,933 $ 150,468 Included in the above balances are assets not being amortized with book values of approximately $7,079,000 [2003 $9,240,500] due to construction in progress.

9 20 Leon s Furniture Limited Notes to consolidated financial statements (cont d) [ 4 ] Income taxes Significant components of the Company's future tax assets are as follows: Current future tax assets Deferred warranty plan revenue $ 1,464 $ 1,480 Inventory (1,159) (702) Net current future tax assets Non-current future tax assets Deferred warranty plan revenue 3,239 3,223 Capital assets 3,046 3,833 Non-current future tax assets $ 6,285 $ 7,056 Significant components of the provision for income taxes are as follows: Current tax expense $ 23,389 $ 26,541 Future income tax expense (benefit) relating to origination and reversal of temporary differences 1,053 (4,079) Future income tax expense (benefit) relating to tax rate reduction (increases) 191 (548) Provision for income taxes $ 24,633 $ 21,914 The total provision for income taxes in the consolidated financial statements is at a rate different than the combined federal and provincial statutory income tax rate of the current year for the following reasons: Tax at combined federal and provincial tax rate $ 24, % $ 21, % Tax effect of expenses that are not deductible for income tax purposes (8) 19 Tax effect of non-taxable portion of gain on disposal of capital assets (302) (0.5) 10 Future tax effect of rate reduction (increases) (547) (0.9) Future tax effect of arising temporary differences Federal Large Corporations Tax Other, net (79) (0.1) Provision for income taxes $ 24, % $ 21, %

10 Annual Report [ 5 ] Commitments [a] The estimated cost to complete construction in progress at two locations [four locations in 2003] amounted to approximately $2,901,000 as at December 31, 2004 [2003 $14,471,000]. [b] The Company is obligated under operating leases to future minimum annual rental payments for certain land and buildings as follows: ($ in thousands) Thereafter 75 2,031 [c] [d] The Company has issued approximately $2,400,000 in letters of credit primarily with respect to buildings under construction. Pursuant to a reinsurance agreement, the Company has pledged marketable securities amounting to $9,641,000 [2003 $9,280,000] and provided a letter of credit of $1,500,000 [2003 1,500,000] for the benefit of the insurance company. [ 6 ] Franchise operations As at December 31, 2004, a total of twenty-six franchises [2003 twenty-four] were in operation representing twenty-seven [2003 twenty-five] stores. Sales by franchise stores during the year ended December 31, 2004, on which the Company earns royalty income, amounted to approximately $165,252,000 [2003 $133,422,000]. [ 7 ] Consolidated statements of cash flows [a] The net change in non-cash working capital balances related to operations consists of the following: Accounts receivable $ 2,353 $ 12,533 Inventory (12,438) (3,794) Income taxes recoverable/payable (12,031) 16,122 Accounts payable and accrued liabilities 12,347 5,235 Customers deposits 2, $ (7,090) $ 30,649

11 22 Leon s Furniture Limited Notes to consolidated financial statements (cont d) [b] Supplemental cash flow information: Income taxes paid $ 35,996 $ 21,583 Interest paid $ 13 $ 1 [c] During the year, capital assets were acquired at an aggregate cost of $30,955,000 [2003 $23,825,000], of which $2,772,000 [2003 $3,090,000] is included in accounts payable and accrued liabilities as at December 31, [ 8 ] Redeemable share liability Redeemable share liability consists of the following: ($ in thousands) Authorized 89,400 convertible, non-voting, series 1994 shares 350,000 convertible, non-voting, series 1998 shares 571,000 convertible, non-voting, series 2002 shares Issued Nil series 1994 shares [2003 9,180] $ $ ,518 series 1998 shares [ ,468] 3,863 4, ,623 series 2002 shares [ ,049] 11,719 11,846 Less employee share purchase loans (15,383) (16,744) $ 199 $ 102 Under the terms of its Management Share Purchase Plan, the Company advanced non-interest bearing loans to certain of its employees in 1994, 1998 and 2002 to allow them to acquire convertible, nonvoting, series 1994 shares, series 1998 shares and series 2002 shares, respectively, of the Company. These loans are repayable through the application against the loans of any dividends on the shares, with any remaining balance repayable on the date the shares are converted to common shares. Each issued and fully paid for series 1994, 1998 and 2002 share may be converted into one common share at any time after the fifth anniversary date of the issue of these shares and prior to the tenth anniversary of such issue. Each share may also be redeemed at the option of the holder or by the Company at any time after the fifth anniversary date of the issue of these shares and prior to the tenth anniversary of such issue. The redemption price is equal to the original issue price of the shares adjusted for subsequent subdivisions of shares plus accrued and unpaid dividends. The purchase prices of the shares are $12.73 per series 1994 share, $17.60 per series 1998 share and $28.75 per series 2002 share.

12 Annual Report Dividends paid to series 1994 to 2002 shareholders of approximately $168,000 [2003 $177,000] have been used to reduce the respective shareholder loans. During the year ended December 31, 2004, 9,180 series 1994 shares and 57,950 series 1998 shares were converted into common shares with a stated value of approximately $117,000 [2003 $111,000] and $1,019,000 [2003 $363,000], respectively. During the year ended December 31, 2004, the Company cancelled 4,426 convertible, non-voting series 2002 shares in the amount of $128,000. During the year ended December 31, 2003, the Company cancelled 1,424 convertible, non-voting, series 1998 shares and 8,926 convertible, non-voting series 2002 shares in the amounts of $25,000 and $257,000, respectively. Employee share purchase loans have been netted against the redeemable share liability based upon their terms. The Plan represents a compensatory plan under the new CICA guidance as the terms of the series 2002 shares and related employee share purchase loans collectively give the employees the ability, but not the obligation, to acquire common shares of the Company. The Company did not issue any special shares during fiscal 2003 and 2004, and therefore did not recognize compensation costs relating to the Plan. [ 9 ] Common shares The Company s common shares consist of the following: ($ in thousands) Authorized Unlimited common shares Issued 18,281,268 common shares [ ,652,638] $ 10,532 9,602 During the year ended December 31, 2004, 9,180 convertible, non-voting, series 1994 shares [2003 8,694] and 57,950 convertible, non-voting, series 1998 shares [ ,674] were converted into common shares with a stated value of approximately $117,000 [2003 $111,000] and $1,019,000 [2003 $363,000], respectively. During the year ended December 31, 2004, the Company repurchased 438,500 [ ,900] of its common shares on the open market pursuant to the terms and conditions of Normal Course Issuer Bids at a net cost of approximately $13,952,000 [2003 $24,554,000]. All shares repurchased by the Company pursuant to its Normal Course Issuer Bids have been cancelled. The repurchase of common shares resulted in a reduction of share capital in the amount of approximately $207,000 [2003 $409,000]. The excess net cost over the average carrying value of the shares of approximately $13,746,000 [2003 $24,145,000] has been recorded as a reduction in retained earnings.