The Sport Chalet Acquisition and Their 10K; Some Perspective
Sometimes we just get lucky. I guess that’s you get lucky, and I get to review something like 650 pages of small print- the estimated total (so far) of documents filed by Sport Chalet between their 10K and the deal.
I’m not going to do quite the typical review of a public company’s financials that I usually undertake. I’ll do a brief review of the 10K with the goal of explaining where and how Sport Chalet got to where it got. That will set the stage for a look at the deal and how they made one. I’m not so interested in explaining what the deal is (I imagine you’ve read that) as in talking about the process and dynamics of how they got there. Let’s get going.
A Little History, A Few Numbers
Sport Chalet got its start in 1959, when Norbert Olberz and his wife Irene bought a ski shop in a town North of Los Angeles. A 30,000 square foot store was opened across the street from that first store in 1974. A Huntington Beach store was next in 1981. The company went public in 1992. At the end of March, 2014 (the date of the 10K, which you can review here) it had 51 stores including 34 in Southern California. Average store size is 41,000 square feet (that’s 200 feet by 200 feet).
Unfortunately, for the last seven years, things haven’t gone too well. “The Company has reported losses for each of the last seven fiscal years, has an accumulated deficit of $32.3 million as of March 30, 2014, and has sustained negative comparable store sales for six of the last seven fiscal years. Since fiscal 2007, the Company has increasingly relied on debt for its capital needs, to fund new store openings and to cover losses from operations.”
I won’t inflict seven years of numbers on you, but in its last fiscal year ended March 31, 2014, the company lost $10.1 million on sales of $344 million. In fiscal 2010, sales were $354 million. Comparable store sales fell 3.1% from the previous year.
The balance sheet has a current ratio that’s barely over 1.0, suggesting some liquidity issues. Loses have reduced equity to $5.3 million. That’s left us with a total debt to equity ratio of 22.1 times. That’s a lot of leverage. At that date, they have a loan payable to the bank of $52.5 million, all of which is carried in current assets. The lender is Bank of America and I think it’s a fair assumption that they aren’t real happy with the situation.
The other thing I noted is that some of the risk factors are included in the sections of the 10K to which they relate. Normally, as you know if you’re a regular reader, those are gathered together in one section. That feels like the lawyer’s subtle way of letting you know how tough things are.
The Operating Strategy
In the year ended March 31, 51% of revenues was from what they call hard lines. As you’ll see below, this goes way beyond what the action sports market thinks of as hard goods. Apparel was 28% and footwear 21%.
Here’s how Sport Chalet describes their stores:
“Our typical store is 41,000 square feet in size and showcases under one roof every merchandise and service category with the feel of a specialty shop. The full-service approach to customer service and merchandise knowledge is enhanced by fixtures which feature specific technical, performance and lifestyle brands. Each shop is staffed by trained sales associates with expertise in the merchandise they sell…”
They continue:
“Our typical store format features a natural color scheme reminiscent of the outdoors, clear-coated fixtures, 30-foot clear ceilings, large sport-specific graphics, a training pool for Scuba and water sports instruction and demonstrations, as well as a 100 foot shoe wall, among other features.” It’s not cheap to build out one of their stores I’m guessing.
And finally:
“Our stores offer over 50 specialty services for the sports enthusiast, including online same day delivery, climbing, backcountry skiing, ski mountaineering, avalanche education, mountain trekking instruction, car rack installation, snowboard and ski rental and repair, scuba training and certification, scuba boat charters, team sales, gait analysis, baseball/softball glove steaming and lacing, racquet stringing, and bicycle tune-up and repair. Although the revenues generated by these specialty services are not material, these services further differentiate us from our competitors.”
I’d especially point you to the last sentence above about services not generating material revenue. Bet they cost a bunch to provide.
In their discussion of seasonality, we also find that Sport Chalet says it has “…a reputation as a leading specialty winter merchandise retailer, and our merchandise mix has historically emphasized winter-sports related merchandise. This positioning makes us more dependent upon winter business and the
amount of snowfall at the resorts most frequented by our customers…In recent years, our fiscal third quarter, which includes the holiday season, represented approximately 30% of our annual sales. Winter-related merchandise and services represent approximately 12% of our annual sales and have ranged from approximately 15% to 25% of sales in our fiscal fourth quarter.”
In the discussions of their results for the year, management notes that the decline in comparable store sales was “…primarily due to the unseasonably warm and dry winter weather experienced in the second half of fiscal 2014…”
How do all of you feel about a dependence on winter sports as a retail proposition? Let’s add to that the services they provide that may differentiate them but probably cost money and a very broad range of sports and activities they sell product for trying, it feels, to compete with players like Dicks Sporting Goods which has 558 stores averaging 50,000 square feet and gets 49% of revenue from hard lines.
Then I see the mention of scuba pools and 100 foot shoe walls. As a certified diver, I kind of like the idea of a pool in the store, but I can’t help but wonder about the sales per square foot it generates.
Sport Chalet has closed underperforming stores and in June, 2013, opening a new concept store in Los Angeles. “This 27,300 square foot store incorporates a new design template featuring enhanced displays, fixtures, and graphics, which are intended to reinforce the Sport Chalet brand and its market positioning as a destination for premium brands, technical merchandise and high quality service offerings.” Like other retailers, they’ve been working to improve their systems, and have focused on integrating the customer’s online and in store shopping experience.
My sense is that they were trying to be too many things to too many people, and that their financial model just didn’t work once the economy went south. Some of the things they are trying to do better or differently seem right, but it looks like they were late getting around to them.
Evolution of a Deal
You’ve read, of course, that Versa Capital’s Vestis Retail Group is going to acquire Sport Chalet. The deal was announced June 30. They already own Bob’s Stores and Eastern Mountain Sports. When combined with Sports Chalet, the group will have 150 stores in the U.S. and $800 million in annual sales.
There will be a tender offer for the outstanding shares at $1.20 per share. The Olberz family has agreed to sell their shares for $0.75 per share. There are some added complexities, but you get the picture. Now, how did we get here?
As you can see from the discussion above, things weren’t working out for Sport Chalet. Bluntly, they had gotten to the point where they had to have a deal after things going south for seven years. Sport Chalet was not going to survive as an independent retail chain.
There is a wonderful SEC form called SC 14D9 (Statement of Ownership: Solicitation). You can read it here. Now, I know that most of you are perfectly content to leave reading these things to me, but you just might want to take a look at this one.
Starting on page 10 (as numbered on the document) is a section called Background of the Offer and the Merger. It’s a chronological itemization of how the company got to the point of accepting and recommending to shareholders Versa’s offer. Because of the company’s deteriorating financial condition, it comes across a bit like a soap opera written by lawyers. Maybe that’s not quite a compelling way to describe something I’d like you to take a look at.
The discussion gives you insight into how Sport Chalet’s management team and board of directors went about the process of finding a deal for the company. The first entry is for May 1, 2013 and the last June 30, 2014. It’s 18 pages long.
If there’s one thing I’d like you take away from reading my short description, or from reading the relevant part of the document, it’s the price you pay for waiting too long to deal with difficult issues. Sport Chalet was left with no good choices, got a lower price than they could have received earlier, and damaged the business’ prospects not just due to financial constraints but because of the distraction and uncertainty getting the deal done imposed on management and employees.
There were other potential buyers. But those deals didn’t work out either because the financing wasn’t secure or because the deterioration of the company gave some buyers pause and probably for other reasons as well. Sport Chalet retained Cappelo Capital Corporation on August 12, 2013 to find a partner. Between that date and February 12, 2014, Cappelo “…contacted 84 financial parties and 35 strategic parties to participate in the Company’s strategic review process. Of the parties contacted by Cappello Capital Corp., 44 parties entered into confidentiality and non-disclosure agreement and Cappello Capital Corp. sent confidential information memorandums to 45 process participants. During this time period, representatives of Cappello Capital Corp. and Company management engaged in in-person meetings, conducted facility tours, and engaged in substantive discussions with seven parties (other than Parties A-E), consisting of two strategic parties and five financial parties. However, all seven of these parties determined to not proceed with their review of the Company or submit a proposal.”
The Olberz family, because they owned so much stock, obviously had a lot to say about the deal. They expressed a preference for a cash deal (rather than a merger where they received equity in another consolidated company) because they had borrowed money against their stock and needed to pay that loan back. That may have contributed to their willingness to take a lower price for their shares in exchange for a cash deal. At one point, there’s some discussion about the price they receive having to be high enough to pay off the loan.
There are various discussions about the company’s prospects including, among other things, the possibility of a qualified opinion from the company’s auditor, the possibility that loan covenants would be violated, difficulties with cash flow, and the possibility that vendors wouldn’t be willing to ship them. In May 23, 2014, the company retained Kibel Green as its restructuring advisor on the chance a deal to sell the company didn’t get done. A bankruptcy filing was not out of the question.
The deal isn’t done until the tender offer is completed. You can probably imagine just from my exceptionally brief summary above (I really recommend you look at that document briefly) just how difficult, rigorous and grinding the process was and, in my experience, usually is for a troubled company.
Your goal? To be realistic and see far enough ahead so you never find yourself trying to make a deal when you have no choice but to make one. Let’s hope the tender offer works out, the deal closes, and Sport Chalet prospers.
Excellent message.
Thanks Lloyd,
J.
Jeff
Once again, your evaluation and synopsis informs me while I get to carry on with my day. Thanks, can’t help but somehow feeling I owe you something for your efforts. Adulation and applause will have to do for now.
Regards,
Mark
Thanks Mark,
Just ask occasional, cogent questions we can all learn stuff from. Or, send me a check.
J.