UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

 

WASHINGTON, D. C.  20549

 

 

FORM 10-Q

 

(Mark One)

 

EARL SCHEIB, INC.

(Exact name of registrant as specified in its charter)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

 

Yes ý

No o

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

 

Yes o

No ý

 

As of March 8, 2004, the registrant had 4,803,311 shares of its Capital Stock, $1.00 par value issued and 4,379,682 shares outstanding.

 

This report contains a total of 15 pages.

 

 

PART I-FINANCIAL INFORMATION

 

EARL SCHEIB, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Dollars in thousands, except share data)

 

		Unaudited
		January 31, 2004			April 30, 2003
ASSETS
Current Assets:
Cash and cash equivalents		$	3,347		$	3,447
Certificates of deposit (restricted)		—			1,378
Accounts receivable, less allowances of $113 at January 31, 2004 and $108 at April 30, 2003		486			541
Inventories		2,235			1,666
Prepaid expenses, including advertising costs of $382 at January 31, 2004 and $444 at April 30, 2003		1,367			1,696
Deferred income taxes		1,173			1,173
Other current assets		373			21
Total Current Assets		8,981			9,922
Property, plant and equipment, net		9,117			10,281
Deferred income taxes		768			768
Other, including cash surrender value of life insurance of $2,571 at January 31, 2004 and $2,433 at April 30, 2003		3,010			2,701
Total Assets		$	21,876		$	23,672
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current Liabilities:
Accounts payable		$	1,043		$	596
Accrued expenses:
Payroll and related taxes		945			1,262
Insurance		2,593			2,349
Interest		1,461			1,337
Advertising		197			193
Legal and professional		297			328
Other		1,149			1,144
Income taxes payable		1,398			1,405
Total Current Liabilities		9,083			8,614
Deferred management compensation		3,012			3,020
Long-term debt and obligations		1,683			1,683
Commitments and contingencies		—			—
Shareholders’ Equity:
Capital stock $1 par - 12,000,000 shares authorized; 4,803,000 issued and 4,380,000 outstanding		4,803			4,803
Additional paid-in capital		6,756			6,756
Retained earnings (Accumulated deficit)		(499		)	1,758
Treasury stock (423,000 shares)		(2,962		)	(2,962		)
Total Shareholders’ Equity		8,098			10,355
Total Liabilities and Shareholders’ Equity		$	21,876		$	23,672

 

The accompanying notes are an integral part of these condensed consolidated balance sheets.

 

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EARL SCHEIB, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Dollars in thousands, except per share data)

(Unaudited)

 

 

		Three Months Ended January 31,						Nine Months Ended January 31,
		2004			2003			2004			2003
Net sales		$	9,001		$	9,290		$	35,115		$	35,115
Cost of sales		8,341			8,652			28,320			28,676
Gross profit		660			638			6,795			6,439
Selling, general & administrative expense		2,371			2,830			8,514			9,263
Operating loss		(1,711		)	(2,192		)	(1,719		)	(2,824		)
Gain (loss) on sales and disposals of property and equipment		—			(22		)	—			1,479
Interest expense		(208		)	(136		)	(499		)	(376		)
Interest income		3			593			13			600
Loss before income taxes		(1,916		)	(1,757		)	(2,205		)	(1,121		)
Provision (benefit) for income taxes		35			(179		)	52			62
Net loss		$	(1,951	)	$	(1,578	)	$	(2,257	)	$	(1,183	)
Basic earnings (loss) per share		$	(0.45	)	$	(0.36	)	$	(0.52	)	$	(0.27	)
Diluted earnings (loss) per share		$	(0.45	)	$	(0.36	)	$	(0.52	)	$	(0.27	)

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

3

 

EARL SCHEIB, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in thousands)

(Unaudited)

 

		Nine Months Ended January 31,
		2004			2003
NET CASH USED IN OPERATING ACTIVITIES		$	(677	)	$	(2,340	)
CASH FLOWS FROM INVESTING ACTIVITIES:
Net maturities (purchases) of certificates of deposit		1,378			(415		)
Capital expenditures		(88		)	(185		)
Proceeds from disposals of property and equipment		—			1,936
Net cash provided by investing activities		1,290			1,336
CASH FLOWS USED IN FINANCING ACTIVITIES:
Credit facility financing costs		(713		)	—
Net increase (decrease) in cash and cash equivalents		(100		)	(1,004		)
Cash and cash equivalents, at beginning of the period		3,447			$	2,524
Cash and cash equivalents, at end of the period		$	3,347		$	1,520
SUPPLEMENTAL CASH FLOW DISCLOSURES:
Income taxes paid		$	59		$	281
Interest paid		211			157
NONCASH FINANCING ACTIVITY:
Issuance of restricted stock		$	—		$	35

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

4

 

EARL SCHEIB, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Dollars in thousands, except per share data)

 

NOTE 1.  BASIS OF PRESENTATION

 

The condensed consolidated financial statements have been prepared by Earl Scheib, Inc. and subsidiaries (the “Company”) without audit, in accordance with accounting principles generally accepted in the United States. Pursuant to the rules and regulations of the Securities and Exchange Commission, certain information and footnote disclosures normally included in consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States have been omitted or condensed. It is management’s belief that the disclosures made are adequate to make the information presented not misleading and reflect all significant adjustments (consisting primarily of normal recurring adjustments) necessary for a fair presentation of financial position and results of operations for the periods presented. The results of operations for the periods presented should not be considered as necessarily indicative of operations for the full year due to the seasonality of the Company’s business. It is recommended that these condensed consolidated financial statements be read in conjunction with the consolidated financial statements and the notes thereto included in the Company’s Annual Report on Form 10-K for the year ended April 30, 2003.

 

Certain reclassifications have been made to prior period financial statements to conform to the current period presentation.

 

NOTE 2. INVENTORIES

 

Inventories consist of the following:

 

		Unaudited January 31, 2004			April 30, 2003
Paint and related supplies		$	2,037		$	1,797
Raw materials		777			448
LIFO reserve		(579		)	(579		)
Total inventories		$	2,235		$	1,666

 

NOTE 3. STOCK-BASED COMPENSATION

 

The Company accounts for its employee stock plan under the intrinsic value method prescribed by Accounting Principles Board Opinion (“APB”) No. 25, “Accounting for Stock Issued to Employees,” and related interpretations, and has adopted the disclosure-only provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123, “Accounting for Stock-Based Compensation” and as amended by SFAS No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure, an amendment of SFAS No. 123.”

 

SFAS No. 123, and as amended by SFAS No. 148, permits companies to recognize, as expense over the vesting period, the fair value of all stock-based awards on the date of grant.  The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options, which have no vesting restrictions and are fully transferable.  Because the Company’s stock-based compensation plans have characteristics significantly different from those of traded options and because changes in the subjective input assumptions can materially affect the fair value estimate, management believes that the existing option valuation models do not necessarily provide a reliable single measure of the fair value of awards from the plan.  Therefore, as permitted, the Company applies the existing accounting rules under APB No. 25 and provides pro forma net income (loss) and pro forma net income (loss) per share disclosures for stock-based awards made during the indicated periods as if the fair value method defined in SFAS No. 123, as amended, had been applied. Net income (loss) and net income (loss) per share for each of the three and nine months ended January 31, 2004 and 2003 would have been changed to the following pro forma amounts.

 

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		(Unaudited)
		Three Months Ended January 31						Nine Months Ended January 31
		2004			2003			2004			2003
Net income (loss) as reported		$	(1,951	)	$	(1,578	)	$	(2,257	)	$	(1,183	)
Stock based employee compensation expense determined under SFAS No. 123		(31		)	(40		)	(94		)	(120		)
Pro forma net income (loss)		$	(1,982	)	$	(1,618	)	$	(2,351	)	$	(1,303	)
Net income (loss) per common share:
As reported:
Basic		$	(0.45	)	$	(0.36	)	$	(0.52	)	$	(0.27	)
Diluted		(0.45		)	(0.36		)	(0.52		)	(0.27		)
Pro forma:
Basic		$	(0.45	)	$	(0.37	)	$	(0.54	)	$	(0.30	)
Diluted		(0.45		)	(0.37		)	(0.54		)	(0.30		)

 

Because options vest over several years and additional options are granted each year, the effects on pro forma net income (loss) and related per share amounts presented above are not representative of the effect for future periods.

 

NOTE 4. SECURED CREDIT FACILITY

 

In August 2003, the Company entered into a loan and security agreement with a financial institution for a two-year $10,000 revolving line and letter of credit facility.  The credit facility, as amended, is secured by substantially all of the assets of the Company, including its owned real estate properties, and requires the maintenance of certain financial covenants.  The Company could be exposed to interest rate risk since any cash borrowings under this credit facility will bear interest at the financial institution’s prime rate, plus four percent.  The Company has an available borrowing base, as defined, of approximately $5,500; which, at the Company’s discretion, can be increased up to $10,000 upon the completion of satisfactory appraisals, surveys, title and certain environmental reports on its real properties located outside of the state of California.

 

Under the secured credit facility, the financial institution issued $2,392 in standby letters of credit at January 31, 2004.  The letters of credit are in favor of certain of the Company’s insurance carriers and currently secure the unfunded portion of the Company’s estimated workers compensation insurance liabilities.  At April 30, 2003, the Company satisfied its letter of credit requirements totaling $2,340 through a facility with one of its banks.  That facility, which was replaced with the current secured credit facility, required that at least 50% of the issued standby letters of credit be secured by certificates of deposit at the bank ($1,378 at April 30, 2003) and by the personal assets of the Company.

 

NOTE 5. COMMITMENTS AND CONTINGENCIES

 

The Company is a defendant in a lawsuit filed in Superior Court in Los Angeles, California in March 2000. The lawsuit essentially alleges that the Company, in California, failed to pay overtime benefits to shop managers and assistant managers and made unlawful deductions from the compensation of certain managers and assistant managers.  The plaintiff subsequently added certain directors and officers as defendants (the ‘‘Individual Defendants’’) for whom the Company has provided indemnity.  The applicable law provides for up to a four-year statute of limitations for unpaid overtime and the plaintiff is seeking class certification in this case.  The Company intends to vigorously defend against this action, but at this point the ultimate outcome of this matter cannot be determined with certainty. Unfavorable rulings and/or the cost of resolution of any unfavorable rulings cannot be determined at this time.  The Company tendered this claim to its insurance carrier seeking coverage, which was denied.  The Company then submitted the matter to binding arbitration, which was held in September 2001.  In October 2001, the arbitrator ruled that the insurance carrier has a duty to advance the Company’s defense costs in this case and ordered the carrier to reimburse the Company for its defense costs, less the applicable deductible.  The arbitrator was not asked to, nor did, rule on whether the claims made, or any of them, are indemnifiable under the applicable policy.  The policy has an aggregate limit of liability of $3,000, all of which is available for the cost of defense of this claim less reimbursements made to the Company to date, by the insurance carrier.  In February 2002, the Court sustained the demurrer of the Individual Defendants to all causes of action pleaded against them. A final judgment dismissing all claims against the Individual Defendants was entered on March 27, 2002.  On May 23, 2002, the plaintiff filed and served a Notice of Appeal against the Individual Defendants. On June 5, 2002, the trial judge in the underlying action against the Company issued an Order which stays further action in the case until the appeal is completed.

 

6

 

On April 2, 2003, the Court of Appeals unanimously affirmed the dismissal on the demurrer of the Individual Defendants.  On May 16, 2003, the plaintiff filed and served a Petition for Review with the California Supreme Court.  On July 23, 2003, the California Supreme Court granted the Petition for Review and will review the Court of Appeals decision.

 

The Company is involved in certain other legal proceedings and claims arising in the ordinary course of its business. Management currently believes that the amount of ultimate liability with respect to these matters should not materially affect the Company’s operations and/or financial position.

 

NOTE 6. EARNINGS PER SHARE

 

Basic earnings per share excludes dilution and is computed by dividing income available to common shareholders by the weighted-average number of common shares outstanding for the period.  Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity.  The only potential dilutive securities the Company has outstanding are stock options issued to the Company’s Board of Directors, management and employees.

 

The weighted-average number of shares used to calculate basic loss per share was 4,380 for the quarters ended January 31, 2004 and 2003; and 4,380 and 4,374 for the nine months ended January 31, 2004 and 2003, respectively.

 

The weighted-average number of shares used to calculate diluted loss per share was 4,380 for the quarters ended January 31, 2004 and 2003; and 4,380 and 4,374 for the nine months ended January 31, 2004 and 2003, respectively.  Options to purchase 587 and 730 shares were not included in the calculation of diluted loss per share in the quarter and nine month periods ended January 31, 2004 and 2003, respectively, because the effect would be antidilutive.

 

NOTE 7. RESTRUCTURING OF RETAIL PAINT AND BODY BUSINESS

 

In February 2001, the Board of Directors approved a plan to restructure and reorganize the Company’s retail paint and body business.  The plan is being implemented over primarily the three-year period ending April 30, 2004, generally as lease obligations expire, and will result in the closing of approximately 40 retail shops located in primarily single-shop areas and in markets where seasonal weather adversely impacts operating results.  The restructuring should result in a leaner infrastructure and allow the Company to concentrate its efforts in those geographic areas where it historically has been profitable.

 

During the year ended April 30, 2001, the Company recorded restructuring charges totaling $645 for the planned closure of 25 retail shops during the year ended April 30, 2002, including estimated exit costs (shop closure costs and early termination of leases) totaling $288.  During the year ended April 30, 2002, $131 of these exit costs were utilized and $134 were reversed to the benefit of operating results, leaving $23 remaining at April 30, 2002.  During the year ended April 30, 2003, $3 of the exit costs were reversed to the benefit of operating results, leaving $20 remaining at April 30, 2003 for two retail shops.  During the quarter ended October 31, 2003, these remaining exit costs of $20 were utilized.

 

During the year ended April 30, 2002, the Company recorded restructuring charges totaling $143 for the planned closure of eight leased retail shops through April 30, 2003, including estimated exit costs of $70.  During the fiscal year ended April 30, 2003, $53 of these exit costs were utilized and $12 were reversed to the benefit of operating results, leaving $5 remaining.  During the quarter ended July 31, 2003, these remaining exit costs of $5 were reversed to the benefit of operating results.

 

Because of the reliance on estimates and potential changing conditions for the planned shop closures in the year ending April 30, 2004 and subsequently, the Company believes that future charges to its results of operations are possible during the years in which the shops actually close.

 

NOTE 8. DEFERRED MANAGEMENT COMPENSATION PLAN

 

The current portion of the deferred management compensation plan ($265 at January 31, 2004 and $253 at April 30, 2003) is included in “Accrued expenses - Other” in the condensed consolidated balance sheets.

 

7

 

NOTE 9. LONG-TERM DEBT AND OBLIGATIONS

 

Long-term debt and obligations consist of loans against life insurance policy cash surrender values, which bear interest at a variable rate (4.5% to 6.9% at October 31, 2003 and 5.0% to 7.65% at April 30, 2003) with interest payable annually.  The principal is not due until such time as the policies may be surrendered by the Company.  The Company entered into these life insurance policies to partially fund its obligations under the deferred management compensation plan.  The loans and related accrued interest (each of which is against a specific life insurance contract) would become immediately payable upon the death of a covered plan participant.  All of the participants were officers or key employees prior to fiscal 1995.

 

NOTE 10. INCOME TAXES

 

In February 1999, the Company received a Notice of Disallowance from the Internal Revenue Service (“IRS”) disallowing a refund of $1,845 from a net operating loss carryback received by the Company during its year ended April 30, 1997.  The IRS is also seeking interest (but not penalties) on the amount of the refund.  The Company protested the IRS’s position and in a notice dated February 24, 2003, the IRS allowed a portion of the refund and stated that the amount of the disallowance and interest thereon would total $2,629 as of that date.  As a result, the Company recorded a benefit of $425 during the third quarter ended January 31, 2003 for the excess of previously accrued interest expense over that required by the IRS at February 24, 2003.  Though the amount of the disallowance and interest thereon is accrued in the consolidated financial statements at January 31, 2004, such a large single payment would significantly deplete the Company’s available cash and would require the Company to evaluate other financial resources that may be available to it in order to satisfy the payment to the IRS.  As a result, the Company has filed an Offer In Compromise with the IRS for the total amount due.

 

The Company did not recognize any federal or state income tax benefit for its operating loss during the quarter ended January 31, 2004.  Due to income allocation and state income tax laws, only a portion of the Company’s state income taxes in the quarter ended January 31, 2004 was offset by the operating loss; therefore, the Company provided $35 for state income taxes during this period.  The Company recorded a benefit for federal and state income taxes at an effective rate of 10.2% during the quarter ended January 31, 2003, which essentially consisted of the reversal of the federal income tax provision for the first six months ended October 31, 2002.

 

The Company did not recognize any federal or state income tax benefit for its operating loss during the nine-month periods ended January 31, 2004 and 2003.  Due to income allocation and state income tax laws, only a portion of the Company’s state income taxes in the nine-month periods ended January 31, 2004 and 2003 was offset by the operating loss; therefore, the Company provided $52 and $62, respectively, for state income taxes during these periods.

 

NOTE 11. RECENT ACCOUNTING PRONOUNCEMENTS

 

In December 2003, the Financial Accounting Standards Board revised Statement of Financial Accounting Standards (“SFAS”) No. 132, “Employers’ Disclosures about Pensions and Other Postretirement Benefits.”  The revision of the statement requires additional disclosures about pension plans and other postretirement benefit plans; however, it does not change the measurement or recognition provisions of SFAS No. 87 and SFAS No. 106.  The annual disclosure requirements will be effective for the Company’s fiscal year ending April 30, 2004 and the interim period disclosure requirements will be effective beginning in the Company’s first quarter of the fiscal year ending April 30, 2005.

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

AND RESULTS OF OPERATIONS

(Dollars in thousands)

 

QUARTER ENDED JANUARY 31, 2004 (“THIRD QUARTER OF FISCAL 2004”) COMPARED TO THE QUARTER ENDED JANUARY 31, 2003 (“THIRD QUARTER OF FISCAL 2003”)

 

Net sales for the Third Quarter of Fiscal 2004 decreased by $289, or 3.1%, compared to the Third Quarter of Fiscal 2003 due primarily to the loss of sales of $573 resulting from a weighted-average 11 fewer retail shops since the Third Quarter of Fiscal 2003 (pursuant to the planned restructuring of the retail paint and body business announced in the fourth quarter of fiscal year 2001).  The decrease in net sales was substantially offset by a 2.7% same-shop (shops open one year or more) sales increase of $224, despite one less sales day in the Second Quarter of Fiscal 2004 versus the Second Quarter of Fiscal 2003, and an increase of $60 in combined sales from the Company’s fleet and truck center and commercial coatings operations.

 

8

 

The gross profit margin percentage increased to 7.3% in the Third Quarter of Fiscal 2004 from 6.9% in the Third Quarter of Fiscal 2003.  The increase in gross margin percentage was primarily due to the overall reduction in the components of cost of sales, which were proportionally greater than the decrease in net sales.

 

Selling, general and administrative expenses decreased by $459 in absolute dollars and as a percentage of sales in the Third Quarter of Fiscal 2004 from the Third Quarter of Fiscal 2003 due primarily to overall reductions in administrative expenses, partially offset by increased shop exit and fixed asset disposal costs of $154.

 

Interest expense was $208 in the Third Quarter of Fiscal 2004 as compared to $136 in the Third Quarter of Fiscal 2003, and relates primarily to the accrual of estimated interest on the disallowance of a net operating loss carryback by the Internal Revenue Service (“IRS”) (see Note 10 to the Condensed Consolidated Financial Statements), life insurance loans and, for the Third Quarter of Fiscal 2004, the amortization of deferred financing costs related to the Company’s secured credit facility (see Note 4 to the Condensed Consolidated Financial Statements).  This amortization totaled $89 in the Third Quarter of Fiscal 2004.

 

During the Third Quarter of Fiscal 2003, the Company recorded interest income of $164 on refunds of federal income taxes paid for fiscal years 1999 and 1998.  In addition, the Company recorded a benefit of $425 for the excess of previously accrued interest expense over that required at February 24, 2003 by the IRS regarding the disallowance of a net operating loss carryback refund received during fiscal 1997 (see above).

 

During the Third Quarter of Fiscal 2003, the Company sold one parcel of real estate and disposed of other fixed assets for a pretax loss of $22.

 

The Company did not recognize any federal or state income tax benefit for its operating loss during the Third Quarter of Fiscal 2004.  Due to income allocation and state income tax laws, only a portion of the Company’s state income taxes in the Third Quarter of Fiscal 2004 was offset by the operating loss; therefore, the Company provided $35 for state income taxes during this period.  The Company recorded a benefit for federal and state income taxes at an effective rate of 10.2% during the Third Quarter of Fiscal 2003, which essentially consisted of the reversal of the federal income tax provision for the first six months of Fiscal 2003.

 

NINE MONTHS ENDED JANUARY 31, 2004 (“FIRST NINE MONTHS OF FISCAL 2004) COMPARED TO THE NINE MONTHS ENDED JANUARY 31, 2003 (“FIRST NINE MONTHS OF FISCAL 2003”)

 

Net sales for the First Nine Months of Fiscal 2004 were the same as the First Nine Months of Fiscal 2003 despite the loss of sales of $1,759 resulting from a weighted-average nine fewer retail shops since the First Nine Months of Fiscal 2003 (pursuant to the planned restructuring of the retail paint and body business announced in the fourth quarter of fiscal year 2001).  However, this loss of sales was offset by a 5.0% same-shop (shops open one year or more) sales increase of $1,590 and from an increase of $169 in combined sales from the Company’s fleet and truck center and commercial coatings operations.

 

The gross profit margin percentage increased to 19.4% in the First Nine Months of Fiscal 2004 from 18.3% in the First Nine Months of Fiscal 2003.  The increase in gross margin percentage was primarily due to the overall reductions in the components of cost of sales, which were proportionally greater than the decrease in net sales.

 

Selling, general and administrative expenses decreased by $749 in absolute dollars and as a percentage of sales in the First Nine Months of Fiscal 2004 from the First Nine Months of Fiscal 2003 due primarily to overall reductions in administrative expenses, partially offset by increased shop exit and fixed asset costs totaling $298 (related to the closing of nine shops in the First Nine Months of Fiscal 2004).

 

Interest expense was $499 in the First Nine Months of Fiscal 2004 as compared to $376 in the First Nine Months of Fiscal 2003, and relates primarily to the accrual of estimated interest on the IRS’s disallowance of a net operating loss carryback (see Note 10 to the Condensed Consolidated Financial Statements), life insurance loans and, for the First Nine Months of Fiscal 2004, the amortization of deferred financing costs related to the Company’s secured credit facility (see Note 4 to the Condensed Consolidated Financial Statements).  This amortization totaled $173 in the First Nine Months of Fiscal 2004.

 

During the First Nine Months of Fiscal 2003, the Company recorded interest income of $164 on refunds of federal income taxes paid for fiscal years 1999 and 1998.  In addition, the Company recorded a benefit of $425 for the excess of previously accrued interest

 

9

 

expense over that required at February 24, 2003 by the IRS regarding the disallowance of a net operating loss carryback refund received during fiscal 1997 (see above).

 

During the First Nine Months of Fiscal 2003, the Company sold four parcels of real estate and disposed of other fixed assets for a pretax gain of $1,479.

 

The Company did not recognize any federal or state income tax benefit for its operating loss in the First Nine Months of Fiscal 2004 and 2003.  Due to income allocation and state income tax laws, only a portion of the Company’s state income taxes in the First Nine Months of Fiscal 2004 and 2003 was offset by the operating loss; therefore, the Company provided $52 and $62, respectively, for state income taxes during these periods.

 

LIQUIDITY AND CAPITAL RESOURCES

 

The Company’s cash requirements are based upon its seasonal working capital needs and capital requirements for new shops and fleet and truck centers, if any, and for additions and improvements.  Historically, the first and second quarters and, occasionally, the fourth quarter of a fiscal year usually have positive cash flow from operations, while the third and, occasionally, the fourth quarters are net users of cash.

 

As of January 31, 2004, the Company had current assets of $8,981 and current liabilities of $9,083 for a net working capital deficit of $102.  During the First Nine Months of Fiscal 2004, net cash used in operating activities was $677, compared with $2,340 net cash used in the First Nine Months of Fiscal 2003, and capitalized expenditures were $88.  The Company expects that future cash flow from operations should be enhanced by these capital additions.  During the last quarter of Fiscal 2004, the Company plans to perform various capital improvements for an estimated cost of under $150.

 

The Company’s long-term financial obligations consist of its deferred management compensation plan and loans against various life insurance policies.  The Company has no specific assets dedicated to its deferred compensation plan (the “Plan), but has entered into life insurance contracts on behalf of certain participants to partially fund its obligations under the Plan.  Obligations under the Plan are generally payable over a 15-year period after the participant attains age 65 and has been employed by the Company for at least 10 years.  The Company expects to satisfy these obligations by utilizing the accumulated cash values in the insurance contracts (net of the related loans), by cash to be received through the death benefits in these insurance contracts and from cash to be provided in its operating, investing and financing activities.  Accumulated cash values under the insurance contracts and the related loan and accrued interest balances at April 30, 2003 totaled $2,433, $1,683 and $124, respectively.

 

The Company believes that the death benefits under the life insurance contracts, along with the accumulated net cash values and cash to be provided from its operating, investing and financing activities, should be adequate to meet its obligations under the Plan.  At April 30, 2003, the face value of the life insurance policies totaled $4,954.

 

The loans and related accrued interest (each of which is against a specific life insurance contract) would become immediately payable upon the death of the covered Plan participant.  In that event, the Company intends to satisfy this liability from the proceeds received from the life insurance contract death benefit.  The proceeds not utilized to repay the loan and accrued interest would be available to satisfy the benefit obligations under the Plan.  Assuming that all covered participants had died and the Company then repaid the related loans and accrued interest at April 30, 2003, the proceeds from the death benefits that would be available to satisfy the undiscounted Plan obligations of $4,031 (generally payable over 15 years) totaled $3,148.

 

The Company arranges for the issuance of standby letters of credit to the benefit of certain of its insurance carriers for the unfunded portion of estimated workers compensation liabilities over different policy years.  At January 31, 2004, this arrangement was made with a financial institution pursuant to its secured line and letter of credit facility with the Company.  During the year ended April 30, 2003, this arrangement was made with one of the Company’s banks and required the Company to purchase certificates of deposit totaling $1,378 at April 30, 2003 to secure 59% of the standby letters of credit issued.  See Note 4 to the Condensed Consolidated Financial Statements.

 

In February 1999, the Company received a Notice of Disallowance from the IRS disallowing a refund of $1,845 from a net operating loss carryback received by the Company during its year ended April 30, 1997.  The IRS is also seeking interest (but not penalties) on the amount of the refund.  The Company protested the IRS’s position and in a notice dated February 24, 2003, the IRS allowed a portion of the refund and stated that the amount of the disallowance and interest thereon would total $2,629 as of that date.  As a result, the Company recorded a benefit of $425 during the third quarter ended January 31, 2003 for the excess of previously

 

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accrued interest expense over that required by the IRS at February 24, 2003.  Though the amount of the disallowance and interest thereon is accrued in the consolidated financial statements at January 31, 2004, such a large single payment would significantly deplete the Company’s available cash and would require the Company to evaluate other financial resources that may be available to it in order to satisfy the payment to the IRS.  As a result, the Company has filed an Offer In Compromise with the IRS for the total amount due.

 

As of January 31, 2004, the Company owned 44 parcels of real estate, including the Company’s paint factory and warehouse, which secure the Company’s revolving line and letter of credit facility.  See Note 4 to the Condensed Consolidated Financial Statements.  The Company believes that it has, or has the ability to have, the liquidity and capital resources necessary to meet its cash needs for the foreseeable future.

 

During the fourth quarter of Fiscal 2003, the Company engaged an investment banking firm, Ryan Beck & Co., as its exclusive financial advisor with respect to the evaluation, report and recommendation to the Board of Directors of options designed to maximize shareholder value.

 

As of January 31, 2004, the Company had deferred income tax assets totaling $1,941, which realization would require taxable income of approximately $5,708.  The Company believes, however, that because of the relatively long expiration period of its federal net operating loss carryforward, combined with its ability to devise tax-planning strategies involving the sales of owned real estate, or the likelihood of the consummation of a transaction through the services of the investment banking firm recently engaged, or both; it is more likely than not that the deferred income tax assets will be realized.

 

INFLATION

 

Inflation has not had a significant impact on the Company’s results of operations for the periods presented.

 

RECENT ACCOUNTING PRONOUNCEMENTS

 

In December 2003, the Financial Accounting Standards Board revised Statement of Financial Accounting Standards (“SFAS”) No. 132, “Employers’ Disclosures about Pensions and Other Postretirement Benefits.”  The revision of the statement requires additional disclosures about pension plans and other postretirement benefit plans; however, it does not change the measurement or recognition provisions of SFAS No. 87 and SFAS No. 106.  The annual disclosure requirements will be effective for the Company’s fiscal year ending April 30, 2004 and the interim period disclosure requirements will be effective beginning in the Company’s first quarter of the fiscal year ending April 30, 2005.

 

CRITICAL ACCOUNTING POLICIES

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations discusses the Company’s consolidated financial statements which have been prepared in accordance with accounting principles generally accepted in the United States of America.  The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities and contingencies as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods.  Management evaluates its estimates and judgments, including those related to its most critical accounting policies, on an ongoing basis. Management bases its estimates and judgments on historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities. Actual results may differ from these estimates under different assumptions or conditions.  Management believes the following critical accounting policies affect its more significant judgments and estimates used in the preparation of its consolidated financial statements.

 

The Company’s significant accounting policies are disclosed in Note 1 to the Consolidated Financial Statements in the Company’s Annual Report on Form 10-K for the year ended April 30, 2003.  The Company believes its critical accounting policies to be in the area of risk management, specifically workers compensation, which records the uninsured or deductible portion of the liability based on estimates of the development of incurred claims; and in the provision for impairment to long-lived assets, which is based on the estimate of future cash flows for the operating unit.  Changing conditions and the use of different assumptions in deriving these estimates could have a material effect on reported financial results.

 

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The estimate of the Company’s workers compensation deductible liability is performed by its risk management department, based on claims incurred as of the date of the balance sheet and is reviewed by senior management.  The estimate for this liability is established upon analysis of historical data, discussions with third-party insurance carriers and brokers, and estimates provided by the Company’s workers compensation third party administrators and professional consultant.  The estimates are subject to a high degree of variability.  On at least an annual basis, the claims are actuarially reviewed. Sources for the variability are numerous and include, but are not limited to, severity and frequency of claims, future economic conditions, court decisions and legislative actions.  The Company’s workers compensation liability estimates anticipate no change in the benefit structure, but statutory changes could have an impact on the estimated liability.

 

Because of the seasonality of its business, the Company reviews its long-lived assets for impairment annually as part of the fiscal year end procedures, unless there are events or changes in circumstances that indicate there is a significant question as to whether the respective carrying amounts are recoverable.  The most significant long-lived asset is the economic unit of the individual retail paint and body shop.  An evaluation is performed annually on all shops operating for at least a year and an impairment write-down is recognized if a shop’s estimated undiscounted future cash flows are less than its carrying amount.  The Company primarily uses historical performance in determining its estimate of the undiscounted future cash flows; but future cash flows are influenced by, among other factors, changes in competition, marketing strategy, human resources and general market conditions. These factors could affect the amount, if any, of the impairment provision recognized.

 

Changing conditions and the use of different assumptions in deriving the estimates described above could have a material effect on the reported financial results.

 

Item 3.  Quantitative and Qualitative Disclosures About Market Risk

 

As of January 31, 2004, the Company had no significant exposure to the market risks related to changes in interest rates, currency exchange rates, commodity prices and equity values.  See Note 4 to the Condensed Consolidated Financial Statements.

 

Item 4.  Controls and Procedures

 

The Chief Executive Officer and the Chief Financial Officer of the Company, with the participation of the Company’s management, carried out an evaluation of the effectiveness of the Company’s disclosure controls and procedures pursuant to Exchange Act Rule 13a-15(e). Based on that evaluation, the Chief Executive Officer and the Chief Financial Officer believe that, as of the end of the period covered by this report, the Company’s disclosure controls and procedures are effective in making known to them material information relating to the Company (including its consolidated subsidiaries) required to be included in this report.

 

Disclosure controls and procedures, no matter how well designed and implemented, can provide only reasonable assurance of achieving an entity’s disclosure objectives. The likelihood of achieving such objectives is affected by limitations inherent in disclosure controls and procedures. These include the fact that human judgment in decision-making can be faulty and that breakdowns in internal control can occur because of human failures such as simple errors, mistakes or intentional circumvention of the established processes.

 

There were no significant changes in the Company’s internal controls or in other factors that could significantly affect internal controls, known to the Chief Executive Officer or the Chief Financial Officer, that occurred during the period covered by this report that have materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

“SAFE HARBOR” STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995

 

Certain written and oral statements made by the Company may be “forward looking statements” as defined under the Private Securities Litigation Reform Act of 1995, including statements made in this report and in filings with the Securities and Exchange Commission.  Generally, the words “believe,” “expect,” “hope,” “intend,” “estimate,” “anticipate,” “plan,” “will,” “project,” and similar expressions identify forward-looking statements which generally are not historical in nature.  All statements which address operating performance, events, developments or strategies that the Company expects or anticipates in the future are forward-looking statements.

 

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Forward-looking statements involve risks and uncertainties that could cause actual results or events to differ materially from the Company’s past experience or current expectations.  The following are some of the risk and uncertainties that may impact the forward-looking statements: the impact of the Company’s retail paint and body shop closures and operational restructuring, the effect of weather, the effect of economic conditions, the impact of competitive products, services, pricing, capacity and supply constraints or difficulties, changes in laws and regulations applicable to the Company, the impact of advertising and promotional activities, the impact of the Company’s expansion of its fleet services division, new product rollout and Quality Fleet and Truck Centers, commercial coatings business, the potential adverse effects of certain litigation, financing, insuring or lending constraints, the impact of various tax positions taken by the Company and the risk that the identification or consummation of any particular transaction or strategic outcome as a result of the Company’s retention of an investment banking firm is not assured.

 

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PART II - OTHER INFORMATION

 

Item 6.    Exhibits and Reports on Form 8-K

 

(a)     Exhibits:

 

31.1  Chief Executive Officer Certification Pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act., as amended.

 

31.2  Chief Financial Officer Certification Pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act., as amended.

 

32.1  Certification by the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

32.2  Certification by the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

(a)     Reports on Form 8-K:

 

(i)  On December 11, 2003, the Registrant filed a Current Report on Form 8-K under Items 7 and 9, filing as Exhibit 99.1 the press release of Registrant, dated December 11, 2003, announcing financial results for the second quarter ended October 31, 2003.

 

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SIGNATURES

 

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

		EARL SCHEIB, INC.
		Registrant
March 15, 2004		/s/   Christian K. Bement
Dated		Christian K. Bement, President and Chief Executive Officer
March 15, 2004		/s/   Charles E. Barrantes
Dated		Charles E. Barrantes, Vice President and Chief Financial Officer

 

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