2nd Quarterly Report To Shareholders 2009 Ended August 2, 2008
Table of Contents President's Message.......................................... 3 Management's Discussion and Analysis....................... 4-12 Consolidated Statements of Earnings and Comprehensive Earnings.... 13 Consolidated Statements of Shareholders Equity.................. 14 Consolidated Balance Sheets.................................. 15 Consolidated Statements of Cash Flows......................... 16 Notes to Interim Consolidated Financial Statements............ 17-23
President s Message To our shareholders, On behalf of the Board of Directors of, I am pleased to present to you our second quarter report. For the second quarter ended August 2, 2008 sales were $41.0 million compared to $41.1 million for the same period last year, a decrease of $0.1 million. The Company reported net earnings of $1.5 million or $0.11 diluted net earnings per share compared to $2.1 million or $0.15 diluted net earnings per share in the same period last year. New stores sales and improved margin were offset by lower same-store sales compared to last year and additional operating costs related to the new stores that opened. For the six-month period ended August 2, 2008, net earnings were $1.5 million or $0.11 diluted net earnings per share compared to $1.8 million or $0.13 diluted net earnings per share for the same period in the previous year. Total sales for the period increased by $974,000 or 1.4% to $72.1 million compared to $71.2 million for the same period in the previous year. The Company recently announced in August, the acquisition of eight new locations from the former SAAN Stores. This addition to our network will provide synergies in distribution logistics, advertising and increase our presence in markets that we have been successful. We have the resources currently working on preparing these stores to be opened this fall in time for the Holiday shopping season. The eight markets are welcoming the change and we are excited with the opportunity of servicing these new customers. In addition to this transaction, we are also adding another location in Quebec to be opened in the same time frame. These openings as well as the five new locations already opened since the beginning of the year will total 14 new stores this year. This will bring the total number of stores in operation to 89. We continue to see the positive impact from our strategic expansion plans and are pleased with the recent expansion plans of the nine new locations which will provide a great synergy and further complement critical mass in many of the new and existing tertiary markets in which we have established a dominant position. On behalf of our Board of Directors, I would like to take this opportunity to thank our shareholders, management team, associates and vendor partners for their continued support. Michael Hart, President and CEO September 11, 2008 3
Management's Discussion and Analysis This Management's Discussion and Analysis ( MD&A ) update is current as of September 11, 2008. This report should be read in conjunction with Hart Stores Inc. ( the Company ) unaudited interim consolidated financial statements for the six months ended August 2, 2008. As well as the MD&A and audited consolidated financial statements for the year ended February 2, 2008, which are available in the Company's 2008 Annual Report, which can be obtained from the Company's website at www.hartstores.com. This information as well as additional information relating to the Company, including the Company's Annual Information Form ( AIF ), is available on-line at www.sedar.com. Forward Looking Statements Certain statements included in this management's discussion and analysis may constitute forward-looking statements within the meaning of the Canadian securities legislation and regulations. Such forward-looking statements involve assumptions and known and unknown risks, uncertainties and other factors, including but not limited to: general economic conditions such as currency exchange rates, interest rates and other factors over which we have no control; the impact of the economy on business conditions, industry trends and other external and political factors in Canada and in other countries where we source products; the intensity of competitive activity; changes in environmental, tax, trade and other laws and regulations; our ability to implement our strategies and plans; changes in customer demand for our products and our ability to grow our business; the seasonality of our business; our ability to attract and retain key personnel; changes in accounting policies; and, disruption to distribution activities due to the impact of weather, natural disasters, system failure and other unforeseen adverse events, which could cause actual results to differ materially from future results expressed or implied by such forward-looking statements. You should not place undue reliance on these forward-looking statements, which are made only as of the date of this management's discussion and analysis. We refer you to the Company's section on risk and uncertainties that may affect the Company's future results. Corporate Overview The Company operates a network of 89 mid-sized department stores under the Hart, Bargain Giant and Géant des Aubaines banners located in secondary and tertiary markets throughout Eastern Canada where it has established a dominant position in many of the communities it serves. The stores offer an extensive and differentiated selection of national and exclusive fashion apparel brands as well as family footwear, home furnishings, housewares, electrical appliances, home electronics, bed & bath, giftware, toys and seasonal goods. The average store size is 25,000 square feet, ranging from the smallest at 15,000 square feet to the largest at 45,000 square feet. 4
Management's Discussion and Analysis Overall Performance A summary of the interim period ended August 2, 2008 follows: Sales decreased by $0.1 million to $41.0 million for the second quarter and increased by 1.3% or $0.9 million to $72.1 million for the 26-week period; Same-store sales decreased by 8.7% for the second quarter and decreased by 7.7% for the 26-week period. After adjusting for a major advertising event that is scheduled in the third quarter this year compared to second quarter last year, the decrease would be 5.5% for the quarter and 5.8% for the 26-week period; Net earnings decreased by $670,000 for the second quarter and decreased by $363,000 the 26-week period; Working capital decreased by $0.1 million from $36.4 million from the same period last year to $36.3 million. Results of Operations Sales: Sales decreased by 0.2% in the second quarter reaching $41.0 million from $41.1 million last year. Same store sales during the quarter decreased by 8.7%. After adjusting for a major advertising event that is scheduled in the third quarter this year compared to second quarter last year, the decrease would be approximately 5.5%. There were 79 stores in operation at the end of this period compared to 76 in the prior year. The new stores sales almost offset the same-store lower volume. The lower consumer spending in the quarter reflects the current market conditions and unseasonable cool summer as well as mainly attributable to an advertising event that is scheduled in early August of this year while the event occurred at the end of the second quarter last year. Based on the comparison of the various sales, we estimated this impact to approximately $1.3 million in timing between the second quarter and the third quarter of this year. Sales for the 26-week period were reaching $72.1 million compared to 71.2 million last year, up 1.3%. The increase is mainly due to additional stores opened at the end of the second quarter last year combined with the new stores opened earlier this year, net of the timing impact on the advertising event at the end of the second quarter and the lower same-store sales. Cost of Sales and Expenses: Cost of sales and expenses increased by 3.2% in the second quarter to 93.2% of sales compared to 90.0% of sales for the comparable period last year. While the expenses were well managed and controlled, the timing impact of the major sales event reduced the absorption of the fixed cost for the quarter. After adjusting for the timing, the amount would represent 92.0% of sales for the second quarter. 5
Management's Discussion and Analysis For the 26-week period ending August 2, 2008, cost of sales and expenses increased by 1.1% to 94.9% of sales compared to 93.8% of sales for the comparable period last year. The favourable benefit of a strong Canadian dollar was more than offset by higher freight cost and lower comparable store sales. After adjusting for the timing of a major advertising event, the amount would represent 94.1% of sales year to date. Net Earnings: For the 13-week period ending August 2, 2008, the Company reported net earnings of $1,470,000 or $0.11 diluted net earnings per share compared to $2,140,000 or $0.15 diluted net earnings per share in the previous year. Earnings are lower than last year for the quarter, following lower sales due to the timing impact of a major advertising event that will occur in the third quarter this year compared to the second quarter of last year, partially offset by other income from the early termination of a store lease. On a year to date basis, net earnings were $1,473,000 or $0.11 diluted net earnings per share compared to $1,836,000 or $0.13 diluted net earnings per share in the previous year. The lower earnings are mainly attributable to the advertising event timing that caused the lower comparable sales volume partially offset by the performance of the new stores opened in the first quarter of this year and the other income from the early termination of a store lease. Balance Sheet: The Company's balance sheet at the end of the second quarter remained strong. The current ratio at the end of the second quarter stood at 2.0:1 and bank borrowings were $18.6 million mainly as the result of increased inventories and capital expenditures following the addition of five new locations in the past six months. The Company also renovated six locations. Current inventory levels were higher than year-end inventories due to the addition of new stores and the seasonal nature of the business. Compared to the same period in the previous year, inventory levels were $4.4 million higher due to the additional new stores in operation. The inventories were also higher by approximately $0.6 million due to the timing in a major advertising event that will occur in the third quarter this year while the event was in the second quarter last year. Comparable store inventory levels were lower by $0.8 million compared to the previous year. The book value amounted to $3.49 per share compared to $3.44 per share in the comparable period in the previous year. 6
Management's Discussion and Analysis Risk & Uncertainties The Company is exposed to various external risk factors and uncertainties that may affect the performance of the Company. Management has the responsibility of mitigating these risks to the extent possible. The risks and uncertainties faced by the Company are substantially the same as those disclosed in the MD&A section of its 2008 Annual Report. The Company is exposed to fluctuations in interest rate levels. Interest payable under the terms of revolving credit facility is based on a variable rate; as such the Company is exposed to interest rate fluctuations. Each 1% change in interest rate would approximate to $0.002 diluted EPS based on historical borrowing levels. The Company purchases goods mainly in Canadian dollar currency and performs approximately $5 to $10 million in US dollar denominated currency transactions per annum. The foreign exchange direct risk is limited due to the marginal volume of foreign currency transactions in relation to the Company's total volume. evaluates the risk associated with the US currency and may decide to cover some of the risk by using various hedging instruments available with established Canadian financial institutions, as covered by it foreign exchange policy. The Company is also exposed to indirect impact of the US and other currencies worldwide as it source its products from local vendors. Some vendors are exposed to foreign currency fluctuations which may in return impact The Company alleviates this risk by entering into pricing agreements with its vendors. Liquidity & Capital Resources At August 2, 2008, the Company held $0.4 million in cash and cash equivalents compared to $2.7 million in the comparable period the previous year. The Company's primary financial resources have been from operations and from time to time borrowings under the revolving credit agreement with Wachovia Capital Finance of Canada. Under the terms of the credit facility, the Company can borrow up to a maximum of $50 million, dependent on inventory levels. At August 2, 2008, $18.4 million of the available credit facility was utilized compared to $12.9 million in the comparable period the previous year. The principal uses have been to finance inventory requirement, store openings and renovations as well as other working capital requirements. The main reason for the increase in financing needs at the end of the quarter is the result of adding five new stores since the beginning of the year and the fixtures and inventory being paid, representing approximately $5.0M. It is also the timing of an advertising event that caused sales to be a week later into the third quarter compared to the second quarter last year. 7
Management's Discussion and Analysis As at August 2, 2008, the minimum rentals payable under long-term operating leases, exclusive of certain operating costs and the repayments of Mortgage principal for which the Company is responsible, are as follows: (in thousands of dollars) Operating leases Long-term debt $ $ Less than 1 year 8,590 170 1-3 years 13,741 369 4-5 years 8,955 414 After 5 years 10,161 6,711 41,447 7,664 Certain of the lease agreements provide for additional annual rentals based on sales. The Company believes that it has adequate financial resources to meet its contractual obligations. Off-Balance Sheet Arrangements The Company does have off-balance sheet arrangements as at August 2, 2008. It did enter into forward foreign exchange contracts in order to reduce the foreign exchange risk on imported goods denominated in a foreign currency (mainly USD). The Company purchases a portion of its inventory in foreign currency (mainly US dollar). To manage the foreign exchange risk associated, the Company purchases foreign exchange forward contracts to fix exchange rates and has established a foreign exchange policy to manage the process. The foreign exchange forward contracts are not used for speculative purposes. The Company has forward exchange contracts to purchase US$3,990,000 (none in fiscal 2008), with strike dates ranging from August 2008 to December 2008 at an average exchange rate of 1.0138. The Canadian dollar value at the end of the quarter was CA$4,045,227 (none in fiscal 2008). 8
Management's Discussion and Analysis Transactions with Related Parties H & N Family Subco Inc. is the beneficial holder of the majority of the outstanding common shares of the Company, holding approximately 56.7% of the common shares of the Company. In the ordinary course of business the Company purchases goods and services from companies that are also controlled by H & N Family Subco Inc. Transactions with a common controlled entity occurred within the normal course of business and have been measured at their exchange amount. Total transactions, for the 26-week period, that related to common controlled entities were $16,855. Critical Accounting Estimates The preparation of the financial statements requires the Company to estimate the effect of various matters that are inherently uncertain as of the date of the financial statements. Inherent critical estimates that the Company has recorded include the valuation of merchandise inventory. The Company records a provision to reflect management's best estimate of the net realizable value of its merchandise inventory. Outstanding Share Data and Dividends The Company has authorized an unlimited number of Class A and B preferred shares to be issued in series and common shares. The common shares of the Company are publicly traded on the Toronto Stock Exchange under the symbol HIS. The Company has 13,649,296 common shares issued and outstanding as at August 2, 2008. The Company declared a cash dividend distribution of $0.10 per share, or $1,365,000 to shareholders of record on June 20, 2008 and paid on July 10, 2008. 9
Management's Discussion and Analysis Quarterly Information: (in thousands of dollars, except per share amounts) 2009 2008 2007 Net Sales Earnings Basics Diluted (Loss) EPS EPS $ $ $ $ Q2 40,985 1,470 0.11 0.11 Q1 31,148 3 0.00 0.00 Q4 49,109 (125) (0.01) (0.01) Q3 41,287 1,761 0.13 0.13 Q2 41,080 2,140 0.16 0.15 Q1 30,079 (304) (0.02) (0.02) Q4 Restated 53,251 73 0.01 0.01 Q3 45,028 2,165 0.16 0.16 New accounting standards Inventories Section 3031, Inventories, effective for fiscal years beginning on or after January 1, 2008. This section describes the standards for recognizing and measuring inventory in the balance sheet and the standards for reporting cost of sales in financial statements. Inventory must be valued at cost net of all trade discounts or at net realizable value. The impact of re-measuring our inventory at cost net of all trade discounts or at net realizable value will be recognized in opening retained earnings as appropriate. The impact of the adoption of this new section on the consolidated financial statements reduced opening inventory by $1.2 million, opening retained earnings by approximately $0.8 million (net of income taxes recovery of $0.4 million). The adjustment relates to overhead costs that are excluded from the cost of inventories under the new section. The new Section allows the application to be either retroactively adjusted or prospectively with an adjustment made to retained earnings. The Company decided to apply this new Section prospectively with fiscal year starting February 3, 2008 and updated the opening retained earnings without any prior year restatement. 10
Management's Discussion and Analysis Capital disclosures Section 1535, Capital Disclosures: This Section will be applicable to financial statements relating to fiscal years beginning on or after October 1, 2007. Accordingly, the Company adopted the new standards for its fiscal year beginning February 3, 2008. Section 1535 on capital disclosures requires the disclosure of information about an entity's objectives, policies and processes for managing capital. The Company objectives when managing capital are: Minimizing the cost of capital; and Maintaining sufficient capital structure to provide ongoing ability to execute the growth plan and sustain current operation The Company defines its capital as the shareholders' equity, revolving credit facility, long-term debt and its short-term portion and bank overdraft, net of cash and cash equivalents. The Company monitors its performance through different ratios such as, but not limited to: ROE (Return on equity), RONA (Return on net assets), net debt to total capitalization ratio and interest coverage ratio. Financial Instruments-Disclosure and Presentation In December 2006, the CICA issued Section 3862, Financial Instruments - Disclosures; Section 3863, Financial Instruments - Presentation. Both Sections will be applicable to financial statements relating to fiscal years beginning on or after October 1, 2007. Accordingly, the Company adopted the new standards for its fiscal year beginning February 3, 2008. Section 3862 on financial instruments disclosures, requires the disclosure of information about: i) the significance of financial instruments for the entity's financial position and performance and ii) the nature and extent of risks arising from financial instruments to which the entity is exposed during the period and at the balance sheet date, and how the entity manages those risks. Section 3863 on the presentation of financial instruments is unchanged from the presentation requirements included in Section 3861. The Company does not expect that the adoption of these new Sections will have a material impact on its consolidated financial statements, but requires additional disclosure. In the normal course of business, the Company is exposed to financial risks that have the potential to negatively impact its financial performance. The Company may use derivative financial instruments to manage certain of these risks. The Company does not use derivative financial instruments for trading or speculative purposes. These risks are discussed in more detail under the Risks and uncertainties - Financial Instruments discussion on page 7 of the Company's Management Discussion and Analysis for the second quarter ended August 2, 2008 and in note 8. 11
Management's Discussion and Analysis Recent accounting pronouncements International Financial Reporting Standards On February 13, 2008, the Canadian Accounting Standards Board (AcSB) officially announced that Canadian GAAP would require to be transitioned to International Financial Reporting Standards (IFRS) for fiscal years starting on or after January 1, 2011, which would represent fiscal year ending January 28, 2012 for Even though the IFRS and Canadian GAAP use a similar framework, many accounting policies have some significant differences that must be reviewed by management in order to assess the impact of the new standards on our consolidated financial statements. Management is currently evaluating the impact of this transition on the Company's consolidated financial statements. Goodwill and Intangible Assets In February 2008, the CICA issued CICA HB 3064 - Goodwill and Intangible Assets, which replaces CICA HB 3062 - Goodwill and Other Intangible Assets. This new standard provides guidance on the recognition, measurement, presentation and disclosure of goodwill and intangible assets. As this standard applies to interim and annual financial statements for fiscal years beginning on or after October 1, 2008, the Company will adopt this new standard effective February 1, 2009 the first day of the Company's 2010 fiscal year. The Company is evaluating the potential impact of this new standard on the financial statements, but does not expect any material impact on its consolidated financial statements. 12
Consolidated Statements of Earnings and Comprehensive Income (unaudited) (in thousands of dollars, except per share amounts) For the 13 weeks ended: For the 26 weeks ended: August 2, August 4, August 2, August 4, 2008 2007 2008 2007 $ $ $ $ Sales 40,985 41,080 72,133 71,159 Cost of sales and expenses excluding the undernoted items 38,216 36,990 68,463 66,751 Earnings before the undernoted items 2,769 4,090 3,670 4,408 Other income (note 3) 350-350 - Financial charges 213 213 434 369 Amortization 678 635 1,354 1,257 Earnings before income taxes 2,228 3,242 2,232 2,782 Income taxes 758 1,102 759 946 Net earnings and comprehensive income 1,470 2,140 1,473 1,836 Net earnings per share: Basic 0.11 0.16 0.11 0.14 Diluted 0.11 0.15 0.11 0.13 13
Consolidated Statements of Shareholders Equity (unaudited) (in thousands of dollars) For the 13 weeks ended: For the 26 weeks ended: August 2, August 4, August 2, August 4, 2008 2007 2008 2007 restated restated $ $ $ $ Capital stock Balance, beginning of period 24,771 24,731 24,771 24,714 Share issued pursuant to exercise of stock options 16 27 16 44 Ascribed value credited to share capital from exercise of stock options - 13-13 Balance, end of period 24,787 24,771 24,787 24,771 Contributed Surplus Balance, beginning of period 798 536 719 465 Stock-based compensation related to stock options plan 64 72 143 143 Ascribed value credited to to share capital from exercise of stock option - (13) - (13) Balance, end of period 862 595 862 595 Retained Earnings Balance, beginning of period 21,860 20,669 23,087 20,973 Transitional adjustment on adoption of new accounting policies Inventory (note 2) - - (1,230 ) - Balance, beginning of period as restated 21,860 20,669 21,857 20,973 Net earnings and comprehensive income 1,470 2,140 1,473 1,836 Dividends (1,365 ) (1,358 ) (1,365 ) (1,358 ) Balance, end of period 21,965 21,451 21,965 21,451 14
Consolidated Balance Sheets (unaudited) (in thousands of dollars) As at As at As at August 2, February 2, August 4, 2008 2008 2007 restated $ $ $ Assets Current assets Cash and cash equivalents 400 24 2,748 Accounts receivable 2,724 1,057 2,168 Inventory 65,507 46,130 60,738 Income taxes receivable 1,823 1,397 2,218 Prepaid expenses 3,811 3,001 3,957 Other Assets 47 - - 74,312 51,609 71,829 Capital Assets 19,040 18,811 18,360 Future income taxes 153 153 178 93,505 70,573 90,367 Liabilities Current liabilities Bank overdraft 176 - - Indebtedness under revolving credit facility 18,431 453 12,855 Accounts payable and accrued liabilities 19,225 13,361 22,397 Current portion of long-term debt 170 164 160 38,002 13,978 35,412 Deferred lease credits 396 424 462 Long-term debt 7,494 7,594 7,677 Commitments and contingent liabilities (Notes 7 and 9) Shareholders' equity Capital stock 24,787 24,771 24,771 Contributed surplus 861 719 594 Retained earnings 21,965 23,087 21,451 47,613 48,577 46,816 93,505 70,573 90,367 15
Consolidated Statements of Cash Flows (unaudited) (in thousands of dollars) For the 13 weeks ended: For the 26 weeks ended: August 2, August 4, August 2, August 4, 2008 2007 2008 2007 Cash flows provided by $ $ $ $ (used in): Operating activities Net earnings 1,470 2,140 1,473 1,836 Adjustments for: Amortization 678 787 1,354 1,257 Compensation expense relating to stock options 63 71 142 142 Compensation expense relating to Deferred Share Units (54) - (103) - Deferred lease credits (20) (19) (28) (38) Unrealized foreign exchange gain (34) - (47) - 2,103 2,979 2,791 3,197 Change in non-cash working capital items (10,873) (4,826) (17,450) (9,109) (8,770) (1,847) (14,659) (5,912) Financing activities Increase in bank indebtedness 176-176 - Change in indebtedness under revolving credit facility 10,390 6,254 17,978 11,990 Repayment of long-term debt (41) (38) (94) (76) Dividends paid (1,365) (1,358) (1,365) (1,358) Issuance of shares for employee stock options exercised 16 27 16 44 9,176 4,885 16,711 10,600 Investing activities Acquisitions of capital assets (723) (863) (1,676) (1,699) Net change in cash (317) 2,175 376 2,989 Cash (bank indebtedness) and cash equivalents, beginning of period 717 573 24 (241) Cash and cash equivalents, end of period 400 2,748 400 2,748 16
Notes to Interim Consolidated Financial Statements (unaudited) for the 26 weeks ended August 2, 2008 and August 4, 2007 1. Description of business and seasonal nature of operations The unaudited interim consolidated financial statements presented herein follow the same accounting policies and their method of application as the audited annual financial statements, except for the new accounting standards described in note 2. Under generally accepted accounting principles additional disclosure is required in annual financial statements and accordingly these unaudited interim consolidated financial statements should be read in conjunction with the audited annual consolidated financial statements and accompanying notes contained in the Company's annual report for the year ended February 2, 2008. The consolidated financial statements have been prepared by the management of and have not been reviewed by the auditors of Due to the seasonal nature of the retail business, the results of operations for the thirteen week period ended August 2, 2008 and August 4, 2007 are not necessarily indicative of the earnings to be expected for the fiscal year. Sales by quarter closely follow the general merchandise consumer shopping patterns that are affected by holidays and changes in season. 2. New accounting standards Inventories Section 3031, Inventories, effective for fiscal years beginning on or after January 1, 2008. This section describes the standards for recognizing and measuring inventory in the balance sheet and the standards for reporting cost of sales in financial statements. Inventory must be valued at cost net of all trade discounts or at net realizable value. The impact of re-measuring our inventory at cost net of all trade discounts or at net realizable value will be recognized in opening retained earnings. The impact of the adoption of this new section on the consolidated financial statements reduced the opening inventory by $1.2 million, opening retained earnings by approximately $0.8 million (net of income taxes recovery of $0.4 million). The adjustment relates to overhead costs that are excluded from the cost of inventories under the new section. The new Section allows the application to be either retroactively adjusted or prospectively with an adjustment made to retained earnings. The Company decided to apply this new Section prospectively with fiscal year starting February 3, 2008 and updated the opening retained earnings without any prior year restatement. 17
Notes to Interim Consolidated Financial Statements (unaudited) for the 26 weeks ended August 2, 2008 and August 4, 2007 The cost of sales and expenses for the second quarter and 26 week period include $23,355,000 ($22,503,000 for fiscal 2008) and $37,054,000 ($39,252,000 for fiscal 2008) respectively for products sold, comprise of cost of goods, duties, freight and net of all trade discounts and rebates. The Company applies the retail method for valuation of inventories which approximate cost. The cost of sales and expenses also include for the second quarter $714,000 ($719,000 in fiscal 2008) and year to date $1,259,000 ($1,245,000 in fiscal 2008) expensed and recorded as a reserve for write-down. Capital disclosures Section 1535, Capital Disclosures: This Section will be applicable to financial statements relating to fiscal years beginning on or after October 1, 2007. Accordingly, the Company adopted the new standards for is fiscal year beginning February 3, 2008. Section 1535 on capital disclosures requires the disclosure of information about an entity's objectives, policies and processes for managing capital. The Company objectives when managing capital are: Minimizing the cost of capital; and Maintaining sufficient capital structure to provide ongoing ability to execute the growth plan and sustain current operation. The Company defines its capital as the shareholders' equity, revolving credit facility, long-term debt and its short-term portion and bank overdraft, net of cash and cash equivalents. The Company monitors its performance through different ratios such as, but not limited to: ROE (Return on equity), RONA (Return on net assets), net debt to total capitalization ratio and interest coverage ratio. 18
Notes to Interim Consolidated Financial Statements (unaudited) for the 26 weeks ended August 2, 2008 and August 4, 2007 Financial Instruments-Disclosure and Presentation In December 2006, the CICA issued Section 3862, Financial Instruments - Disclosures; Section 3863, Financial Instruments - Presentation. Both Sections will be applicable to financial statements relating to fiscal years beginning on or after October 1, 2007. Accordingly, the Company adopted the new standards for its fiscal year beginning February 3, 2008. Section 3862 on financial instruments disclosures, requires the disclosure of information about: i) the significance of financial instruments for the entity's financial position and performance and ii) the nature and extent of risks arising from financial instruments to which the entity is exposed during the period and at the balance sheet date, and how the entity manages those risks. Section 3863 on the presentation of financial instruments is unchanged from the presentation requirements included in Section 3861. The Company does not expect that the adoption of these new Sections will have a material impact on its consolidated financial statements, but requires additional disclosure. In the normal course of business, the Company is exposed to financial risks that have the potential to negatively impact its financial performance. The Company may use derivative financial instruments to manage certain of these risks. The Company does not use derivative financial instruments for trading or speculative purposes. These risks are discussed in more detail under the Risks and uncertainties - Financial Instruments discussion on page 7 of the Company's Management Discussion and Analysis for the second quarter ended August 2, 2008 and in note 8. Recent accounting pronouncements International Financial Reporting Standards On February 13, 2008, the Canadian Accounting Standards Board (AcSB) officially announced that Canadian GAAP would require to be transitioned to International Financial Reporting Standards (IFRS) for fiscal years starting on or after January 1, 2011, which would represent fiscal year ending January 28, 2012 for Even though the IFRS and Canadian GAAP use a similar framework, many accounting policies have some significant differences that must be reviewed by management in order to assess the impact of the new standards on our consolidated financial statements. Management is currently evaluating the impact of this transition on the Company's consolidated financial statements. 19
Notes to Interim Consolidated Financial Statements (unaudited) for the 26 weeks ended August 2, 2008 and August 4, 2007 Goodwill and Intangible Assets In February 2008, the CICA issued CICA HB 3064 - Goodwill and Intangible Assets, which replaces CICA HB 3062 - Goodwill and Other Intangible Assets. This new standard provides guidance on the recognition, measurement, presentation and disclosure of goodwill and intangible assets. As this standard applies to interim and annual financial statements for fiscal years beginning on or after October 1, 2008, the Company will adopt this new standard effective February 1, 2009 the first day of the Company's 2010 fiscal year. The Company is evaluating the potential impact of this new standard on the financial statements, but does not expect any material impact on its consolidated financial statements. 3. Other Income The Company received compensation for early termination of one of their store lease. The total other income pre-tax was $350,000. 4. Cash and Cash Equivalents The components of cash and cash equivalents are: As at As at As at August 2, February 2, August 4, 2008 2008 2007 $ $ $ Cash - 24 2,748 Short-term investments 400 - - Cash and cash equivalents 400 24 2,748 Short term investments are used to guarantee financial transactions such as letter of credit and foreign exchange forward contracts. They consist of low risk investment with no restriction in converting to cash at any given time. 5. Capital stock and diluted earnings per share As at August 2, 2008, there were 13,649,296 common shares issued and outstanding (13,599,296 as at August 4, 2007). As at August 2, 2008, 837,600 stock options (767,600 as at August 4, 2007) had been granted to certain employees to acquire common shares of the Corporation at exercise prices ranging from $0.31 to $5.25, ($0.31 to $5.25 as at August 4, 2007), with expiry dates up to 2018. Of these stock options, 570,000 could be exercised for an average weighted exercise price of $2.76 (497,760 at $1.87 as at August 4, 2007). 20
Notes to Interim Consolidated Financial Statements (unaudited) for the 26 weeks ended August 2, 2008 and August 4, 2007 The following table provides a reconciliation between the weighted average number of shares used in the calculation of basic and diluted earnings per share: For the 13 weeks ended: For the 26 weeks ended: August 2, August 4, August 2, August 4, 2008 2007 2008 2007 Weighted average number of common shares outstanding 13,632,629 13,585,763 13,615,963 13,571,879 Effect of dilutive stock options 165,800 294,789 182,711 317,206 Weighted average number of diluted common shares outstanding 13,798,429 13,880,552 13,798,674 13,889,085 6. Segment information Management has determined that the Company operates in one industry and geographic segment. Specifically, the Company operates in the mid-sized department store industry and in the geographic region of Eastern Canada. 7. Commitments As at August 2, 2008, the minimum rentals payable under long-term operating leases, exclusive of certain operating costs for which the Company is responsible are $41,447,000. 21
Notes to Interim Consolidated Financial Statements (unaudited) for the 26 weeks ended August 2, 2008 and August 4, 2007 8. Financial instruments The Company, through its financial assets and liabilities, is exposed to various risks. The following analysis provides a measurement of risks as at the balance sheet date of August 2, 2008. i) Foreign exchange risk The Company purchases goods mainly in Canadian dollar currency and performs approximately $5 to $10 million in US dollar denominated currency transactions per annum. The foreign exchange direct risk is limited due to the marginal volume of foreign currency transactions in relation to the Company's total volume. evaluates the risk associated with the US currency and may decide to cover some of the risk by using various hedging instruments available with established Canadian financial institutions, as covered by it foreign exchange policy. The Company is also exposed to indirect impact of the US and other currencies worldwide as it source its products from local vendors. Some vendors are exposed to foreign currency fluctuations which may in return impact The Company alleviates this risk by entering into pricing agreements with its vendors. The Company purchases a portion of its inventory in foreign currency (mainly US dollar). To manage the foreign exchange risk associated, the Company purchases foreign exchange forward contracts to fix exchange rates and has established a foreign exchange policy to manage the process. The foreign exchange forward contracts are not used for speculative purposes. The Company has forward exchange contracts to purchase US$3,990,000 (none in fiscal 2008), with strike dates ranging from August 2008 to December 2008 at an average exchange rate of 1.0138. The Canadian dollar value at the end of the quarter was CA$4,045,227 (none in fiscal 2008). At the end of the second quarter, $47,316 was recognized as an unrealized gain in cost of sales on the above forward contracts, and the asset as part of accounts receivable. 22
Notes to Interim Consolidated Financial Statements (unaudited) for the 26 weeks ended August 2, 2008 and August 4, 2007 ii) Interest rate risk The Company is exposed to interest rate risk with regard to the cash and cash equivalents and to the credit facility that are subject to variable rates. 9. Contingent liabilities The Company is party to claims and lawsuits in the normal course of business. Management believes that the resolution of these claims and lawsuits will not have a material adverse effect on the Company's financial condition, earnings or cash flows. 10. Subsequent events On August 19, 2008, the Company acquired eight new stores by purchasing the leases and fixtures, of which seven stores are located in Quebec and one in Ontario. The total cost of the transaction is estimated at $1.5 million. 11. Comparative figures Certain of last year's figures have been reclassified to conform to the current year's presentation. 23
900 Place Paul-Kane, Laval, Québec H7C 2T2 www.hartstores.com