ANNUAL REPORT 2012
CORPORATE PROFILE Le Château is a leading Canadian specialty retailer offering contemporary fashion 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 merchandise is sold exclusively through our 235 retail locations, of which 234 are located in Canada. In addition, the Company has 5 stores under license in the Middle East and Asia. Le Château s webbased marketing is further broadening the Company s customer base among Internet shoppers in both Canada and the United States. Le Château, committed to research, design and product development, manufactures approximately 40% of the Company s apparel in its own Canadian production facilities. 2012 annual report 1
TORONTO - ShERway GARdENS QUEBEC - ST-BRUNO TORONTO - ShERway GARdENS QUEBEC - ST-BRUNO
STORES AND SQUARE FOOTAGE JANUARY 26, 2013 JANUARY 28, 2012 STORES SQUARE FOOTAGE STORES SQUARE FOOTAGE ONTARIO 79 430,890 79 414,175 QUEBEC 68 380,934 71 385,944 ALBERTA 29 174,118 30 179,530 BRITISH COLUMBIA 26 140,300 27 143,339 MANITOBA 9 42,571 9 42,571 NOVA SCOTIA 7 38,625 9 39,570 SASKATCHEWAN 7 29,957 7 29,957 NEW BRUNSWICK 5 20,738 5 19,441 NEWFOUNDLAND 3 15,314 3 15,314 P.E.I. 1 3,480 1 3,480 TOTAL CANADA 234 1,276,927 241 1,273,321 TOTAL UNITED STATES 1 5,027 2 10,927 TOTAL LE CHÂTEAU STORES 235 1,281,954 243 1,284,248 SALES (in 000) SHAREHOLDERS EQUITY (in 000) NET EARNINGS (LOSS) (in 000) CASH FLOW FROM OPERATIONS (in 000) 350,000 300,000 250,000 200,000 150,000 100,000 50,000 0 10 11 12 200,000 160,000 120,000 80,000 40,000 0 10 11 12 35,000 30,000 25,000 20,000 15,000 10,000 5,000 0-5,000 10 11 12 50,000 40,000 30,000 20,000 10,000 0-10,000 10 11 12 2012 annual report 3
FINANCIAL HIGHLIGHTS FISCAL YEARS ENDED January 26, 2013 January 28, 2012 January 29, 2011 January 30, 2010 (1) January 31, 2009 (1) RESULTS (52 weeks) (52 weeks) (52 weeks) (52 weeks) (53 weeks) Sales 274,827 302,707 319,039 321,733 345,614 Earnings (loss) before income taxes (12,186) (2,982) 27,566 43,246 57,706 Net earnings (loss) (8,717) (2,386) 19,557 29,837 38,621 Per share - basic (0.34) (0.10) 0.79 1.23 1.56 Per share - diluted (0.34) (0.10) 0.79 1.22 1.55 Dividends per share Ordinary 0.43 0.70 0.70 0.625 Special 0.25 Average number of shares outstanding (000) 25,659 24,789 24,668 24,339 24,796 FINANCIAL POSITION Working capital 84,841 90,345 96,381 91,853 85,620 Shareholders equity 139,798 143,105 155,653 157,221 142,414 Total assets 220,210 233,794 246,146 236,032 216,431 FINANCIAL RATIOS Current ratio 2.79 3.13 2.89 3.13 3.03 Quick ratio 0.19 0.32 1.09 1.71 1.75 Long-term debt to equity (2) 0.17:1 0.32:1 0.23:1 0.21:1 0.20:1 OTHER STATISTICS (units as specified) Cash flow from operations (in 000) 6,602 (11,304) 8,074 41,643 41,821 Capital expenditures (in 000) 9,237 23,755 26,969 20,075 21,467 Number of stores at year-end 235 243 238 230 221 Square footage 1,281,954 1,284,248 1,221,795 1,145,992 1,047,529 Sales per square foot (3) 252 277 311 335 385 SHAREHOLDERS INFORMATION TICKER symbol: CTU.A LISTING: TSX Number of participating shares outstanding (AS of May 30, 2013): 22,682,961 Class A Subordinate Voting Shares 4,560,000 Class B Voting Shares FLOAT: (4) 14,203,884 Class A Shares held by the public As of May 30, 2013: High/low of Class A Shares (12 months ended May 30, 2013): $4.30 / $1.10 Recent price: $2.60 dividend yield: % Price/book value ratio: 0.49X Earnings (loss) per share (diluted): (5) $(0.34) Book value per share: (6) $ 5.13 (1) The selected information presented for the years ended January 30, 2010 and (4) Excluding shares held by officers and directors of the Company. January 31, 2009 do not reflect the impact of the adoption of IFRS. (5) For the year ended January 26, 2013. (2) Including capital leases and current portion of debt. (6) As at January 26, 2013. (3) Excluding Le Château outlet stores. 2012 annual report 5
MESSAGE TO SHAREHOLDERS The retail clothing market remained challenging in 2012. Le Château continued to be affected by lingering recessionary conditions, as consumers were cautious with their discretionary spending. In addition, with the emphasis placed on inventory reduction, Le Château was impacted by lower average selling prices. The Company also rationalized operations with a net closing of eight stores. Sales for the fiscal year ended January 26, 2013 totaled $274.8 million, a decrease of 9.2% from the previous year. Comparable store sales declined by 9.1%. Le Château s EBITDA amounted to $12.7 million or 4.6% of sales, compared to $20.2 million or 6.7% of sales in 2011. Net loss for the year came to $8.7 million or $(0.34) per share, compared to a net loss of $2.4 million or $(0.10) per share in 2011. During the year, in response to continuing uncertainty in the economy, the Company focused on efficiency enhancement in every aspect of its operations. We implemented a cost saving plan that yielded more than $16.5 million in expense reductions. During the second half of 2012 the Company saw an increasing number of its stores posting positive comparable sales figures, and this momentum has been sustained in the early months of 2013. Several factors contributed to the positive shift in comparable sales in upwards of 40% of our stores. They include product assortment improvements, some regional strengths, the performance of new concept stores, and steady gains in the performance of top-tier performing stores. Le Château s new concept stores are consistent with the brand repositioning which we set in motion several years ago. Our brand now emphasizes superior quality, European-style fashion designed to appeal to a wider demographic and support a higher price point. The new stores provide an enhanced, more elegant experience for the customer through use of more sophisticated materials, furniture and fixtures. Le Château is looking ahead with confidence. We believe renewed growth will follow two principal paths. First, it should resume in tandem with improvements in the general economy. Additionally, we expect to widen our market base and secure many new customers as we realize the full potential of our brand repositioning and new concept stores. In 2012, growth in sales from e-commerce surpassed expectations and should continue to expand in 2013. Accordingly, our e-commerce initiative represents an ongoing opportunity to profitably expand the Company s activities well beyond Canada, and well beyond the traditional brick and mortar business model. As well, the Company remains committed to the licensing model abroad, and expects to add four new stores this year under licensee arrangements for a total of eight franchise stores. We believe all of Le Château s current initiatives will stimulate increased sales and contribute to shareholder value. My sincere thanks to all employees of Le Château for their dedication to the Company, and to all our shareholders for their confidence and support. JANE SILVERSTONE SEGAL, B.A.LLL Chairman and Chief Executive Officer 2012 annual report 7
MANAGEMENT S DISCUSSION AND ANALYSIS April 12, 2013 The 2012, 2011 and 2010 years refer, in all cases, to the 52-week periods ended January 26, 2013, January 28, 2012 and January 29, 2011, 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 2012 fiscal year of Le Château Inc. All amounts in this report and in the tables are expressed in Canadian dollars, unless otherwise indicated. The audited consolidated financial statements have been prepared in accordance with International Financial Reporting Standards ( IFRS ), as issued by the International Accounting Standards Board ( IASB ), and with the accounting policies included in the notes to the audited consolidated financial statements for the year ended January 26, 2013. Additional information relating to the Company, including the Company s Annual Information Form, is available online at www.sedar.com. SELECTED ANNUAL INFORMATION (IN THOUSANDS OF DOLLARS EXCEPT PER SHARE AMOUNTS) 2012 2011 2010 $ $ $ (52 weeks) (52 weeks) (52 weeks) Sales 274,827 302,707 319,039 Earnings (loss) before income taxes (12,186) (2,982) 27,566 Net earnings (loss) (8,717) (2,386) 19,557 Net earnings (loss) per share Basic (0.34) (0.10) 0.79 Diluted (0.34) (0.10) 0.79 Total assets 220,210 233,794 246,146 Long term debt (1) 24,134 45,468 36,180 Dividends per share 0.43 0.70 Cash flow from (used for) operations (2) 6,602 (11,304) 8,074 Comparable store sales decrease % (9.1)% (7.9)% (4.2)% Square footage of gross store space at year end Regular stores 861,771 868,383 878,416 Outlet stores 420,183 415,865 343,379 Total 1,281,954 1,284,248 1,221,795 Number of stores at year end Regular stores 187 194 198 Outlet stores 48 49 40 Total 235 243 238 Sales per square foot (in dollars) Regular stores 252 277 311 Outlet stores 125 139 152 (1) Includes current and long-term portion of long-term debt. (2) After net change in non-cash working capital items related to operations. 2012 annual report 9
SALES Comparable store sales, which are defined as sales generated by stores that have been open for at least one year, decreased 9.1% based on the year ended January 26, 2013. Taking into account the 2 new stores and 10 closures, total sales for the year ended January 26, 2013 decreased 9.2% to $274.8 million, compared to $302.7 million for the year ended January 28, 2012. Sales were negatively impacted throughout 2012 by several factors including: reduced store traffic as consumers remained cautious on discretionary spending within a soft retail environment, lower average selling prices as a result of the emphasis on inventory reduction and the net closure of eight stores when compared to 2011. A positive trend was observed in the second of half of 2012 as an increasing number of regular stores presented positive comparable sales over last year. This reflects product assortment improvements, some regional strengths, the performance of new concept stores and momentum of top-tier performing stores. In October 2011, the Company introduced the first new concept store in St-Bruno, Quebec. New concept stores are designed to provide an elevated experience consistent with the evolving brand through more sophisticated materials, furniture and fixtures. A more spacious feel showcases collections more compellingly and more comfortably. The new concept has now been rolled out to seven stores. During the year, Le Château opened 2 new stores, and, as planned, closed 10 stores. As at January 26, 2013, the Company operated 235 stores (including 48 fashion outlet stores) compared to 243 stores (including 49 fashion outlets) at the end of the previous year. Total floor space at the end of the year was 1,282,000 square feet compared to 1,284,000 square feet at the end of the preceding year. Le Château s vertically integrated approach makes it unique, as a major Canadian retailer that not only designs and develops, but also manufactures its own brand name clothing. The Company currently manufactures approximately 40% of the Company s apparel (excluding footwear and accessories) in its state-of-the-art production facilities located in Montreal, which have long provided it with several key competitive advantages short lead times and flexibility; improved cost control; the ability to give its customers what they want, when they want it; and allowing the Company to remain connected to the market throughout changing times. TOTAL SALES BY DIVISION (IN THOUSANDS OF DOLLARS) % CHANGE 2012 2011 2010 2012-2011 2011-2010 $ $ $ % % (52 weeks) (52 weeks) (52 weeks) Ladies Clothing 158,609 172,221 185,490 (7.9) (7.2) Men s Clothing 50,386 53,360 53,128 (5.6) 0.4 Footwear 27,422 31,480 32,865 (12.9) (4.2) Accessories 38,410 45,646 47,556 (15.9) (4.0) 274,827 302,707 319,039 (9.2) (5.1) Ladies wear: The Ladies clothing division posted a sales decrease of 7.9%, accounting for 57.7% of total sales as compared to 56.9% the previous year. Sales in the second half of the year point to strengthening consumer response to our improved product assortment with the fourth quarter reporting an increase of 3.5% in comparable store sales. This improvement includes gains from the evolution of the casual offering into a well-priced, higher quality coordinates business consistent with the new brand. 10
Menswear: Sales in the Men s division decreased 5.6% and accounted for 18.3% of total sales compared to 17.6% last year. Despite softness in the men s market in the first part of the year, comparable store sales edged positively in the fourth quarter during the important holiday period. The brand remains well positioned in its mission to become one of Canada s leading provider of well-priced fashion suiting. Footwear: Sales decreased 12.9% in 2012, accounting for 10.0% of total sales as compared to 10.4% the previous year. The fourth quarter similarly witnessed an improving trend in this division as the deficit was reduced to a decline of 4.4% in comparable store sales. We remain poised to benefit from the marketplace changes, and consumers demonstrating an increasing interest in the footwear offering of integrated lifestyle brands. Accessories: Sales in the Accessories division decreased 15.9% in 2012 and accounted for 14.0% of total sales compared to 15.1% last year. Performance was affected by deliberate purchasing reduction as this division went through a year of re-alignment and re-adjustment. Licensing: The Company is currently involved in several licensing arrangements with retail developers in the Middle East and in Asia to expand the number of Le Château branded stores in the region. As at January 26, 2013, there were 11 stores under licensee arrangement of which 8 are expected to be closed in the first half of 2013 based on a mutual agreement to terminate a master licensing agreement with a partner. In March 2013, a second store was opened in Vietnam and the plan is to open another 4 stores in the Middle East and in Asia before the end of the current fiscal year. E-commerce: The e-commerce business with its cross channel capabilities exceeded expectations in 2012. While the contribution from online sales remains a relatively small percentage of overall sales, the e-commerce platform continues to gain traction and is expanding customer reach. Included in comparable store sales for the year ended January 26, 2013, online sales increased 93% compared to the same period last year. TOTAL SALES BY REGION (IN THOUSANDS OF DOLLARS) % CHANGE 2012 2011 2010 2012-2011 2011-2010 $ $ $ % % (52 weeks) (52weeks) (52weeks) Ontario 93,182 104,597 109,774 (10.9) (4.7) Quebec 72,244 80,990 85,401 (10.8) (5.2) Prairies 61,482 62,064 65,202 (0.9) (4.8) British Columbia 32,370 36,851 38,908 (12.2) (5.3) Atlantic 14,401 16,340 16,872 (11.9) (3.2) United States 1,148 1,865 2,882 (38.4) (35.3) 274,827 302,707 319,039 (9.2) (5.1) 2012 annual report 11
EARNINGS Net loss for the 2012 year amounted to $8.7 million or $(0.34) per share (diluted), compared to a net loss of $2.4 million or $(0.10) per share in 2011. Earnings before interest, income taxes, depreciation and amortization ( EBITDA ) for the year amounted to $12.7 million or 4.6% of sales, compared to $20.2 million or 6.7% of sales last year. The decrease of $7.5 million in EBITDA for the 2012 year was primarily attributable to a decline of $24.3 million in gross margin dollars offset by cost reduction initiatives in selling, general and administrative expenses of $16.8 million. The decrease in gross margin dollars was the result of a 9.2% reduction in sales in 2012, combined with a decrease in the Company s gross margin percentage from 68.2% to 66.3%, due to increased promotional activity. The decrease in selling, general and administrative expenses was mainly due to (a) a decrease of $8.3 million in store compensation costs resulting from operational improvements, and (b) $5.8 million in non-recurring expenses incurred in 2011 associated with the temporary ramp-up in marketing expenses to accelerate the brand repositioning efforts and start-up costs related to the e-commerce initiative, and offset by (c) an increase in store occupancy costs of $1.4 million as a result of increases in occupancy rates. Depreciation and amortization increased to $19.6 million from $19.4 million in 2011. Write-off and impairment of property and equipment relating to store closures, store renovations and underperforming stores increased slightly to $2.1 million in 2012 from $2.0 million last year. Finance income for 2012 decreased to $23,000 from $217,000 in 2011, primarily the result of lower balances in cash and cash equivalents held by the Company as compared to last year. Finance costs increased to $3.1 million in 2012 from $2.0 million in 2011, due to the increased use of the Company s asset based credit facility in 2012. The income tax recovery of $3.5 million in 2012 represents an effective income tax recovery rate of 28.5%, compared to an income tax recovery of $596,000 or 20.0% the previous year. LIQUIDITY AND CAPITAL RESOURCES The Company s liquidity follows a seasonal pattern based on the timing of inventory purchases and capital expenditures. The Company s bank indebtedness, net of cash and cash equivalents, amounted to $11.3 million as at January 26, 2013, compared with cash and cash equivalents of $7.2 million as at January 28, 2012. Cash flows from operating activities amounted to $6.6 million in 2012, compared with cash flow used for operating activities of $11.3 million the previous year. The increase of $17.9 million was primarily the result of a decrease of $26.2 million in non-cash working capital requirements for the year, offset by (a) the higher net loss of $6.3 million for 2012 compared to 2011, and (b) an increase of $2.9 million in income tax recovery. Long-term debt, including the current portion, decreased to $24.1 million in 2012 from $45.4 million in 2011, due to the repayment of $16.3 million during 2012 and the conversion into share capital of a $5.0 million loan payable to a company directly controlled by a director. As at January 26, 2013, the long-term debt to equity ratio decreased to 0.17:1 from 0.32:1 the previous year. On April 25, 2012, the Company entered into a Credit Agreement for an asset based credit facility of $70.0 million, replacing its previous credit facility of $22.0 million. The revolving credit facility is collateralized by the Company s credit card accounts receivable and inventories, as defined in the agreement. The facility has a term of 3 years and consists of revolving credit loans, which include both a swing line loan facility limited to $15.0 million and a letter of credit facility limited to $15.0 million. The available borrowings bear interest at a rate based on the Canadian prime rate, plus an applicable margin ranging from 0.75% to 1.50%, or a banker s acceptance rate, plus an applicable margin ranging from 2.0% to 2.75%. The Company is required to pay a standby fee ranging from 0.25% to 0.375% on the unused portion of the revolving credit. The Credit Agreement requires the Company to comply with certain covenants, including restrictions with respect to the payment of dividends and the purchase of the Company s shares under certain circumstances. As at January 26, 2013, the Company had drawn $13.6 million under this credit facility and in addition had an outstanding standby letter of credit totaling $500,000 which reduced the availability under this credit facility. Financing costs related to obtaining the above facility have been deferred and netted against the amounts drawn under the facility, and are being amortized over the term of the facility. 12
In addition, in September 2012, the Company renewed its import line of credit of $25.0 million which includes a $1.0 million loan facility. The import line is for letters of credit which guarantee the payment of purchases from foreign suppliers. Amounts drawn under these facilities are payable on demand and bear interest at rates based on the bank s prime rate plus 0.50% for loans in Canadian and U.S. dollars. As at January 26, 2013, the Company had outstanding letters of credit totaling $7.5 million. Aside from the outstanding letters of credit, no other amounts were drawn under this loan facility. Cash provided by operating activities was used in the following financing and investing activities: 1. Capital expenditures of $9.2 million, consisting of: CAPITAL EXPENDITURES (IN THOUSANDS OF DOLLARS) 2012 2011 2010 $ $ $ New Stores (2 stores; 2011 6 stores; 2010 13 stores) 1,102 3,853 5,195 Renovated Stores (8 stores; 2011 19 stores; 2010 22 stores) 6,102 12,896 13,584 Information Technology 1,276 2,660 5,196 Warehousing Equipment 396 2,534 1,582 Other 361 1,812 1,412 9,237 23,755 26,969 2. Long-term debt repayments of $16.3 million The following table identifies the timing of contractual obligation amounts due after January 26, 2013: CONTRACTUAL OBLIGATIONS (IN THOUSANDS OF DOLLARS) Less than 1-3 4-5 After Total 1 year years years 5 years $ $ $ $ $ Long-term debt and finance lease obligations 24,134 9,844 13,442 848 Operating leases (1) 229,680 45,314 78,695 53,212 52,459 253,814 55,158 92,137 54,060 52,459 (1) Minimum rentals payable under long-term operating leases excluding percentage rentals. For 2013, the projected capital expenditures are between $10.0 to $10.5 million, of which $5.0 to $5.5 million is expected to be used for the opening of 1 store and the renovation of 5 to 8 existing stores, with $5.0 million to be used for investments in information technology as well as manufacturing and distribution centre enhancements. In 2013, the Company is planning to close 2 to 5 stores in Canada and expects its total square footage to decline slightly to 1,265,000 square feet. 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 and long-term debt as well as the asset backed credit facility of up to $70.0 million. 2012 annual report 13
Aside from the letters of credit outstanding, the Company did not have any other off-balance sheet financing arrangements as at January 26, 2013. FINANCIAL POSITION Working capital amounted to $84.8 million as at January 26, 2013, compared to $90.3 million as at January 28, 2012. Total inventories as at January 26, 2013 increased 3.3% to $123.2 million from $119.3 million as at January 28, 2012. Total finished goods inventory at year end was up 3.3% in dollars and down 3.1% on a unit basis, year over year. The increase in carrying value is primarily attributable to (a) higher average unit costs due to changes in product mix as a result of the Company s investments in the higher value men s and ladies suiting and footwear categories, (b) weaker than expected sales experienced during 2012, and (c) an earlier Chinese New Year resulted in the acceleration of import spring receipts by $1.8 million. For the year ended January 26, 2013, the Company recorded net write-downs of inventory totalling $4.3 million, compared to $6.9 million the previous year. As part of the Company s inventory reduction plan, the Company continues to use 48 outlets (420,000 square feet) in its network to sell prior season discounted merchandise. On-line selling of these goods was enabled in the first quarter of 2012 through an on-line outlet division. Shareholders equity amounted to $139.8 million at year-end compared to $143.1 million the previous year. Book value per share amounted to $5.13 as at January 26, 2013, compared to a book value per share of $5.77 as at January 28, 2012. DIVIDENDS AND OUTSTANDING SHARE DATA In 2012, the Company did not declare any dividends on the Class A subordinate voting and Class B voting shares (2011 - $0.43 per share). The Company designated the dividends paid in 2011 to be eligible dividends pursuant to the Income Tax Act (Canada) and its provincial equivalents. As at April 12, 2013, there were 22,682,961 Class A subordinate voting and 4,560,000 Class B voting shares outstanding. Furthermore, there were 2,255,700 options outstanding with exercise prices ranging from $1.44 to $13.25, of which 178,900 options were exercisable. On September 20, 2012, a $5.0 million loan payable to a company that is directly controlled by a director was converted into 2,454,097 Class A subordinate voting shares. The Company did not purchase any Class A subordinate voting shares in 2012 pursuant to the normal course issuer bid announced on July 7, 2011. NON-GAAP MEASURES In addition to discussing earnings measures in accordance with IFRS, this MD&A provides EBITDA as a supplementary earnings measure. Depreciation and amortization includes write-off and impairment of property and equipment. 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. 14
The following table reconciles EBITDA to loss before income tax recovery for the years ended January 26, 2013 and January 28, 2012: 2012 2011 (In thousands of dollars) $ $ Loss before income tax recovery (12,186) (2,982) Depreciation and amortization 19,574 19,364 Write-off and impairment of property and equipment 2,142 2,033 Loss on disposal of property and equipment 108 Finance costs 3,063 1,974 Finance income (23) (217) EBITDA 12,678 20,172 The Company also discloses comparable store sales which are defined as sales generated by stores that have been open for at least one year. The above measures do not have a standardized meaning prescribed by IFRS and may not be comparable to similar measures presented by other companies. RELATED PARTY TRANSACTIONS The consolidated financial statements include the financial statements of Le Château Inc. and its wholly-owned U.S. subsidiary, Château Stores Inc, incorporated under the laws of the State of Delaware. Key management of the Company includes the Chief Executive Officer, President and Vice-Presidents, as well as the non-executive Directors. The compensation earned by key management in aggregate was as follows: 2012 2011 (In thousands of dollars) $ $ Salaries and short-term benefits 3,067 2,814 Stock-based compensation 161 211 Termination benefits 142 3,370 3,025 Companies that are directly or indirectly controlled by a director sublease real estate from the Company. Total amounts earned under the sublease during the year amounted to $259,000 (2011 $176,000). Goods purchased during the year on behalf of companies that are directly or indirectly controlled by a director amounted to $85,000 (2011 $94,000). During the year ended January 28, 2012, the Company borrowed $10.0 million from a company that is directly controlled by a director of the Company. During the third quarter of 2012, $5.0 million of the loan was converted into 2,454,097 Class A subordinate voting shares. The loan amount outstanding as at January 26, 2013 was $5.0 million. For the year ended January 26, 2013, the Company recorded interest expense of $614,000 (2011 $56,000). Amounts payable to related parties as at January 26, 2013 totalled $31,000 (2011 $56,000). These amounts are recorded at their exchange value and are made at terms equivalent to those that prevail in arms length transactions. There are no guarantees provided or received with respect to these transactions. 2012 annual report 15
NEW STANDARDS NOT YET EFFECTIVE IAS 1, Presentation of Financial Statements, has been amended to require entities to separate items presented in other comprehensive income ( OCI ) into two groups, based on whether or not items may be recycled in the future. Entities that choose to present OCI items before tax will be required to show the amount of tax related to the two groups separately. The amendment is effective for annual periods beginning on or after July 1, 2012 with earlier application permitted. The Company does not believe that this new standard will have a material impact on the consolidated financial statements. IFRS 9, Financial Instruments, partially replaces the requirements of IAS 39, Financial Instruments: Recognition and Measurement. This standard is the first step in the project to replace IAS 39. The IASB intends to expand IFRS 9 to add new requirements for the classification and measurement of financial liabilities, derecognition of financial instruments, impairment and hedge accounting to become a complete replacement of IAS 39. These changes are applicable for annual periods beginning on or after January 1, 2015, with earlier application permitted. The Company has not yet assessed the future impact of this new standard on its consolidated financial statements. IFRS 13, Fair Value Measurement, is a comprehensive standard for fair value measurement and disclosure requirements for use across all IFRS standards. The new standard clarifies that fair value is the price that would be received to sell an asset, or paid to transfer a liability in an orderly transaction between market participants, at the measurement date. It also establishes disclosures about fair value measurement. Under existing IFRS, guidance on measuring and disclosing fair value is dispersed among the specific standards requiring fair value measurements and in many cases does not reflect a clear measurement basis or consistent disclosures. The Company does not believe that this new standard will have a material impact on the consolidated financial statements. CONTROLS AND PROCEDURES In compliance with the Canadian Securities Administrators National Instrument 52-109 ( NI 52-109 ), Certification of Disclosure in Issuers Annual and Interim Filings, the Company will file certificates signed by the Chief Executive Officer ( CEO ) and Chief Financial Officer ( CFO ) that, among other things, report on the design and effectiveness of disclosure controls and procedures ( DC&P ) and the design and effectiveness of internal controls over financial reporting ( ICFR ). Disclosure controls and procedures The CEO and the CFO have designed DC&P, or have caused them to be designed under their supervision, to provide reasonable assurance that material information relating to the Company has been made known to them and has been properly disclosed in the annual regulatory filings. As of January 26, 2013, an evaluation of the effectiveness of the Company s DC&P, as defined in NI 52-109, was carried out under the supervision of the CEO and CFO. Based on this evaluation, the CEO and the CFO concluded that the design and operation of these DC&P were effective. Internal controls over financial reporting The CEO and CFO have designed ICFR, or have caused them to be designed under their supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the financial statements for external purposes in accordance with IFRS. The CEO and CFO have evaluated whether there were changes to its ICFR during the year ended January 26, 2013 that have materially affected, or are reasonably likely to materially affect, its ICFR. No such changes were identified through their evaluation. As of January 26, 2013, an evaluation of the effectiveness of the Company s ICFR, as defined in NI 52-109, was carried out under the supervision of the CEO and CFO. Based on this evaluation, the CEO and the CFO concluded that the design and operation of these ICFR were effective. The evaluations were conducted in accordance with the framework and criteria established in Internal Control - Integrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission ( COSO ), a recognized control model, and the requirements of NI 52-109. 16
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 judgment 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 notes 3 and 4 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 of inventory which includes assumptions and estimates for future sell-through of units, selling prices, as well as disposal costs, where appropriate, based on historical experience. Management continually reviews the provision, to assess whether it is adequate, based on current economic conditions and an assessment of sales trends. Impairment of non-financial assets Non-financial assets are reviewed for impairment if events or changes in circumstances indicate that the carrying amount may not be recoverable. A review for impairment is conducted by comparing the carrying amount of the cash generating unit s ( CGU ) assets with their respective recoverable amounts based on value in use. Value in use is determined based on management s best estimate of expected future cash flows, which includes estimates of growth rates, from use over the remaining lease term and discounted using a pre-tax weighted average cost of capital. Management is required to make significant judgments in determining if individual commercial premises in which it carries out its activities are individual CGUs, or if these units should be aggregated at a district or regional level to form a CGU. Deferred revenue The Company measures the gift card liability and breakage income by estimating the value of gift cards that are not expected to be redeemed by customers, based on historical redemption patterns. Provisions When a provision for onerous contracts is recorded, the provision is determined based on management s best estimate of the present value of the lower of the expected cost of terminating the contract and the expected net cost of operating under the contract. Assumptions and estimates are made in relation to discount rates, the expected cost to terminate a contract and the related timing of those costs. Stock-based compensation The Company measures the cost of equity-settled transactions with employees by reference to the fair value of the equity instruments at the date on which they are granted. Estimating fair value for share-based payments requires determining the most appropriate valuation model for a grant of equity instruments, which is dependent on the terms and conditions of the grant. This also requires determining the most appropriate inputs to the valuation model including the assumptions with respect to the expected life of the option, volatility and dividend yield. RISKS AND UNCERTAINTIES The risks presented below are not exhaustive and are in addition to other risks mentioned herein or in Le Château s publicly filed documents. A more complete list of the risks and uncertainties can be found in the Company s most recent Annual Information Form. Le Château operates in a competitive and rapidly changing environment. New risk factors may emerge from time to time and it is not possible for management to predict all such risk factors, nor can it assess the impact of all such risk factors on Le Château s business. 2012 annual report 17
Business initiatives The Company is implementing a re-alignment of all of its product categories under one clear, focused lifestyle brand targeting contemporary fashion for today s modern man and woman. There can be no guarantee that the business initiatives the Company is implementing to improve its results will be successful, and if they do, there can be no guarantee as to the timing, duration or significance of such improvements. 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. This environment intensifies the importance of in-store differentiation, quality of service and continually exceeding customer expectations, thereby delivering a total customer experience. There is no effective barrier to entry into the Canadian apparel retailing marketplace by any potential competitor, foreign or domestic, and in fact the Company has witnessed the arrival over the past few years of a number of foreign-based competitors in virtually all of the Company s Canadian retail sectors. Changes in customer spending The Company must anticipate and respond to changing customer preferences and merchandising trends in a timely manner. Although the Company attempts to stay abreast of emerging lifestyle and consumer preferences affecting its merchandise, failure by the Company to identify and respond to such trends could have a material effect on the Company s business. Changes in customer shopping patterns could also affect sales. The majority of the Company s stores are located in enclosed shopping malls. The ability to sustain or increase the level of sales depends in part on the continued popularity of malls as shopping destinations and the ability of malls, tenants and other attractions to generate a high volume of customer traffic. Many factors that are beyond the control of the Company may decrease mall traffic, including, economic downturns, closing of anchor department stores, weather, concerns of terrorist attacks, construction and accessibility, alternative shopping formats such as e-commerce, discount stores and lifestyle centres, among other factors. Any changes in consumer shopping patterns could adversely affect the Company s financial condition and operating results. General economic conditions and normal business uncertainty Shifts in the economic health of the environment in which the Company operates such as economic growth, inflation, exchange rates and levels of taxation can impact consumer confidence and spending and could also impact the Company s ability to source products at a competitive cost. Increases in the cost of raw materials (including cotton and other fabrics) could also impact the Company s profitability. Some other external factors over which the Company exercises no influence, including interest rates, personal debt levels, unemployment rates and levels of personal disposable income, may also affect economic variables and consumer confidence. Seasonality and other factors The Company s business is seasonal, as are most retail businesses. The Company s results of operations depend significantly upon the sales generated during some specific periods. Any material decrease in sales for such periods could have a material adverse effect upon the Company s profitability. The Company s results of operations may also fluctuate as a result of a variety of other factors, including the timing of new store openings and net sales contributed by new stores, the impact of new stores on existing stores within the same trade area, changes in general traffic levels in its shopping centers, new store concepts, other retail channels, merchandise mix and the timing and level of markdowns and promotions by competitors, as well as consumer shopping patterns and preferences. Weather Extreme changes in weather can affect the timing of consumer spending and may have an adverse effect upon the Company s results of operations. 18
Changes in the Company s relationship with its suppliers The Company is dependant, to a certain extent, on its suppliers support of the Company s operations. The Company has no guaranteed supply arrangements with its principal merchandising sources. Accordingly, there can be no assurance that such sources will continue to meet the Company s quality, style and volume requirements. In addition, should suppliers refuse or be unable to extend normal credit terms, refuse to ship manufactured goods within a reasonable period of time or refuse to purchase goods to fill orders made by the Company, the Company would have insufficient inventory for future seasons. The inability of the Company to obtain quality and fashionable merchandise in a timely manner could have a material adverse effect on the Company s business and the results of its operations. 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. In connection with the expiration of leases, the Company will have to renegotiate new leases, which could result in higher rental rates. Any increase in retail rental rates would adversely impact the Company. Foreign exchange The Company s foreign exchange risk mainly relates to currency fluctuations between the Canadian and U.S. dollar. In order to protect itself from the risk of losses should the value of the Canadian dollar decline compared to the foreign currency, the Company uses forward contracts to fix the exchange rate of a substantial portion of expected U.S. dollar requirements. The contracts are matched with anticipated foreign currency purchases. As at January 26, 2013 the Company had $9.9 million of contracts outstanding to buy U.S. dollars (2011 $14.9 million). The Company only enters into foreign exchange contracts with Canadian chartered banks to minimize credit risk. QUARTERLY RESULTS (IN THOUSANDS OF DOLLARS EXCEPT PER SHARE AMOUNTS) The table below presents selected financial data for the eight most recently reported quarters. This unaudited quarterly information has been prepared under IFRS. The operating results for any quarter are not necessarily indicative of the results to be expected for any future period. FIRST QUARTER SECOND QUARTER THIRD QUARTER FOURTH QUARTER TOTAL 2012 2011 2012 2011 2012 2011 2012 2011 2012 2011 $ $ $ $ $ $ $ $ $ $ (13 weeks) (13 weeks) (13 weeks) (13 weeks) (13 weeks) (13 weeks) (13 weeks) (13 weeks) (52 weeks) (52 weeks) Sales 57,777 64,959 72,514 84,810 63,736 70,412 80,800 82,526 274,827 302,707 Earnings (loss) before income taxes (9,072) (4,039) 2,042 4,904 (5,565) (5,833) 409 1,986 (12,186) (2,982) Net earnings (loss) (6,532) (2,869) 1,282 3,484 (3,625) (4,143) 158 1,142 (8,717) (2,386) Net earnings (loss) per share Basic (0.26) (0.12) 0.05 0.14 (0.14) (0.17) 0.01 0.05 (0.34) (0.10) diluted (0.26) (0.12) 0.05 0.14 (0.14) (0.17) 0.01 0.05 (0.34) (0.10) Retail sales are traditionally higher in the fourth quarter due to the holiday season. In addition, fourth quarter earnings results are usually reduced by post holiday sale promotions. Fourth quarter results The Company recorded a sales decrease of 2.1% to $80.8 million for the fourth quarter ended January 26, 2013, compared with sales of $82.5 million for the fourth quarter ended January 28, 2012. Comparable store sales decreased by 0.6% versus the same period a year ago. Although the comparable store sales trend improved significantly in the fourth quarter when compared to the first nine months of 2012, store traffic continued to be impacted by consumers remaining cautious with discretionary spending. 2012 annual report 19
Net earnings for the fourth quarter of 2012 amounted to $158,000 or $0.01 per share (diluted), compared to net earnings of $1.1 million or $0.05 per share the previous year. EBITDA for the fourth quarter amounted to $7.1 million or 8.8% of sales, compared to $8.8 million or 10.6% of sales last year. The decrease of $1.7 million in EBITDA for the fourth quarter was primarily attributable to the decrease of $6.8 million in gross margin offset by cost reduction initiatives in selling, general and administrative expenses of $5.1 million. The Company s gross margin for the fourth quarter of 2012 decreased to 62.0% from 68.9% in 2011, due to increased promotional activity during the quarter and due to the higher gross margin achieved in 2011 as a result of a larger proportion of sales from prior season goods at better than expected recoveries. Depreciation and amortization for the fourth quarter decreased to $4.8 million from $5.0 million last year, due to the reduced investments in non-financial assets of $9.2 million in 2012 compared to $23.8 million in 2011. Write-off and impairment of property and equipment relating to store closures, store renovations and underperforming stores amounted to $1.2 million in the fourth quarter of 2012, compared to $1.3 million in 2011. Cash flows from operating activities amounted to $19.2 million for the fourth quarter of 2012, compared to $6.3 million in 2011, mainly the result of a decrease of $17.8 million in non-cash working capital requirements, offset by a decrease in income taxes refunded of $3.3 million. OUTLOOK The Company enters 2013 with confidence following the implementation of an important cost saving plan in 2012, which yielded more than $16.5 million in expense reductions. Furthermore, in the second half of 2012, an increasing number of stores reported positive comparable same store results. In the fourth quarter of 2012, approximately 40% of the Company s regular stores reported positive comparable same store results over the same period last year. Over the years, Le Château has undergone several shifts in brand positioning and strategy to adapt to changes in demographics and evolving competitive and market conditions. The most recent shift was set in motion more than five years ago with a clear and unwavering focus on contemporary fashion for today s modern man and woman. With the consumer responding well to our well-priced and better quality fashion offering, our efforts must now be extended to enhance the omni-channel brand experience for our customer in-store, on-line and in social media. These include continued roll out of new concept stores and investments in technology that enable full optimization of all aspects of today s marketplace. The higher inventory levels remain one of the key issues still being addressed. As indicated last year, the retail outlet network footprint was temporarily expanded to facilitate a reduction of inventory. Once the inventory returns to more normal levels, the retail outlet network will be realigned to address more modest needs in terms of inventory clearance. Throughout 2013 the Company will continue to carefully evaluate and monitor the performance of its network of stores. The Company is planning to close 2 to 5 stores during the year. For 2013, the projected capital expenditures are between $10.0 to $10.5 million, of which $5.0 to $5.5 million is expected to be used for the opening of 1 store and the renovation of 5 to 8 existing stores, with $5.0 million to be used for investments in information technology as well as manufacturing and distribution centre enhancements. In terms of new business opportunities, Le Château remains committed to the licensing model despite the setback involving a partner in the Middle East (see the Licensing section). In March 2013, a second store was opened in Vietnam and the plan is to open another 4 stores in the Middle East and in Asia by the end of 2013. At the end of the current fiscal year, the Company expects to have under licensee arrangements a total of eight franchised stores. In October 2011, the Company introduced the first new concept store in St-Bruno, Quebec and has since rolled out this new concept to seven stores. The Company expects to integrate the new concept into four additional stores this year. Le Château s e-commerce initiative represents a significant opportunity to profitably expand the Company s activities well beyond Canada, and well beyond a traditional business model that relied exclusively on brick and mortar locations. Growth in sales from e-commerce surpassed expectations in 2012 and should remain healthy in 2013. 20
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 except to the extent required under applicable securities law. 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 business initiatives and whether such business 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; seasonal weather patterns; fluctuations in foreign currency exchange rates; changes in the Company s relationship with its suppliers; interest rate fluctuations; and changes in laws, rules and regulations applicable to the Company. 2012 annual report 21