UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

 

WASHINGTON, D. C.  20549

 

 

FORM 10-Q

 

(Mark One)
ý		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended January 31, 2005
OR
o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from            to            

 

Commission file number 1-4822

 

EARL SCHEIB, INC.
(Exact name of registrant as specified in its charter)

 

Delaware		95-1759002
(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		Identification No.)
15206 Ventura Boulevard, Suite 200
Sherman Oaks, California		91403
(Address of principal executive offices)		(Zip Code)

 

Registrant’s telephone number, including area code:   (818) 981-9992

 

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, 2005, the registrant had 4,803,311 shares of its Capital Stock, $1.00 par value issued and 4,388,118 shares outstanding.

 

This report contains a total of 14 pages.

 

 

PART I-FINANCIAL INFORMATION

 

EARL SCHEIB, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except share data)

 

		Unaudited
		January 31, 2005			April 30, 2004
ASSETS
Current Assets:
Cash and cash equivalents		$	2,107		$	2,188
Accounts receivable, less allowances of $112 at  January 31, 2005 and $143 at April 30, 2004		584			485
Inventories		2,006			1,829
Prepaid expenses, including advertising costs of $402 at January 31, 2005 and $393 at April 30, 2004		1,419			1,649
Deferred income taxes		1,707			1,707
Other current assets		284			435
Total Current Assets		8,107			8,293
Property, plant and equipment, net		8,227			8,668
Deferred income taxes		234			234
Other, including cash surrender value of life insurance of $2,649 at January 31, 2005 and $2,598 at April 30, 2004		2,896			2,949
Total Assets		$	19,464		$	20,144
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current Liabilities:
Accounts payable		$	783		$	598
Accrued expenses:
Payroll and related taxes		1,186			1,192
Insurance		2,680			2,564
Interest		96			117
Advertising		350			359
Legal and professional		332			443
Other		1,119			1,208
Income taxes payable		3			30
Total Current Liabilities		6,549			6,511
Deferred management compensation		2,874			2,931
Long-term debt and obligations to life insurance companies		1,683			1,683
Commitments and contingencies		—			—
Shareholders’ Equity:
Capital stock $1 par - 12,000,000 shares authorized; 4,803,000 issued; 4,388,000 and 4,380,000 outstanding at  January 31, 2005 and April 30, 2004, respectively		4,803			4,803
Additional paid-in capital		6,756			6,756
Retained earnings (accumulated deficit)		(298		)	422
Treasury stock (415,000 and 423,000 shares at  January 31, 2005 and April 30, 2004, respectively)		(2,903		)	(2,962		)
Total Shareholders’ Equity		8,358			9,019
Total Liabilities and Shareholders’ Equity		$	19,464		$	20,144

 

 

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 January31,
		2005			2004			2005			2004
Net sales		$	9,732		$	9,001		$	34,871		$	35,115
Cost of sales		8,455			8,341			26,639			28,320
Gross profit		1,277			660			8,232			6,795
Selling, general & administrative expense		2,369			2,371			8,321			8,514
Operating loss		(1,092		)	(1,711		)	(89		)	(1,719		)
Gain on sales of property  and equipment		—			—			15			—
Interest expense		(194		)	(208		)	(555		)	(499		)
Interest income		3			3			11			13
Loss before income taxes		(1,283		)	(1,916		)	(618		)	(2,205		)
Provision for income taxes		20			35			70			52
Net loss		$	(1,303	)	$	(1,951	)	$	(688	)	$	(2,257	)
Basic loss per share		$	(0.30	)	$	(0.45	)	$	(0.16	)	$	(0.52	)
Diluted loss per share		$	(0.30	)	$	(0.45	)	$	(0.16	)	$	(0.52	)

 

 

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

 

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EARL SCHEIB, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)

(Unaudited)

 

		Nine Months Ended January 31,
		2005			2004
NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES		$	499		$	(677	)
CASH FLOWS USED IN INVESTING ACTIVITIES:
Net maturities of certificates of deposit		—			1,378
Capital expenditures		(506		)	(88		)
Proceeds from disposals of property and equipment		46			—
Net cash provided by (used in) investing activities		(460		)	1,290
CASH FLOWS USED IN FINANCING ACTIVITIES:
Credit facility financing costs		(120		)	(713		)
Net decrease in cash and cash equivalents		(81		)	(100		)
Cash and cash equivalents, at beginning of the period		2,188			3,447
Cash and cash equivalents, at end of the period		$	2,107		$	3,347
NON CASH FINANCING ACTIVITY:
Issuance of Restricted Stock		$	27		$	—

 

 

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 U.S. generally accepted accounting principles. 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 U.S. generally accepted accounting principles 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, 2004.

 

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:

 

 

 

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 loss and pro forma net 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 loss and net loss per share for each of the three and nine month periods ended January 31, 2005 and 2004 would have been changed to the following pro forma amounts (in thousands, except per share data):

 

5

 

		(Unaudited)
		Three Months Ended January 31						Nine Months Ended January 31
		2005			2004			2005			2004
Net loss as reported:		$	(1,303	)	$	(1,951	)	$	(688	)	$	(2,257	)
Add: stock based employee compensation  expense, as reported		0			0			0			0
Less: stock based employee compensation  expense determined under SFAS No. 123		(13		)	(30		)	(43		)	(93		)
Pro forma net loss		$	(1,316	)	$	(1,981	)	$	(731	)	$	(2,350	)
Net loss per common share:
As reported:
Basic		$	(0.30	)	$	(0.45	)	$	(0.16	)	$	(0.52	)
Diluted		(0.30		)	(0.45		)	(0.16		)	(0.52		)
Pro forma:
Basic		$	(0.30	)	$	(0.45	)	$	(0.17	)	$	(0.54	)
Diluted		(0.30		)	(0.45		)	(0.17		)	(0.54		)

 

 

Because options vest over several years and additional options are granted each year, the effects on pro forma net income 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.  At January 31, 2005, the Company had not made any cash borrowings.  The Company has an available borrowing base, as defined, of approximately $7,182 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.  Subsequent to January 31, 2005, this credit facility was amended (see Note 11).

 

Under the secured credit facility, the financial institution issued $2,705 (which will increase by $700 in February 2005) and $2,392 in standby letters of credit at January 31, 2005, and April 30, 2004, respectively.  The letters of credit are in favor of the Company’s insurance carriers and currently secure the unfunded portion of the Company’s estimated workers compensation insurance liabilities which were incurred over many policy years.

 

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 and will continue to provide full 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 insurance 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 numbers of claims made, or any of them, are indemnifiable under the applicable policy and reserved jurisdiction to resolve that dispute at a later date. The policy has an aggregate limit of liability of $3,000, which is available for the cost of defense of this claim less reimbursements made to the Company to date for this claim and payments of $345 made for other claims covered by the policy, by the insurance carrier. In February 2002, the Court sustained the demurrer of the Individual Defendants to all causes of action pleaded

 

6

 

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 resolved.

 

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. As of January 31, 2005, a hearing date had not been scheduled by the California Supreme Court.

 

The Company is involved in certain other legal proceedings and claims which arise in the ordinary course of its business. Management currently believes that the financial disposition of such matters should not have a material adverse affect on 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 4,388 and 4,380 for the quarters ended January 31, 2005 and 2004, respectively; and 4,382 and 4,380 for the nine months ended January 31, 2005 and 2004, respectively.

 

The weighted-average number of shares used to calculate diluted loss per share was 4,388 and 4,380 for the nine months ended January 31, 2005 and 2004, respectively; and 4,382 and 4,380 for the nine months ended January 31, 2005 and 2004, respectively.  Options to purchase 438 and 587 shares were not included in the calculation of diluted loss per share in the quarter and nine-month periods ended January 31, 2005 and 2004, respectively, because the effect would be antidilutive.

 

NOTE 7. DEFERRED MANAGEMENT COMPENSATION PLAN

 

In 1987, the Company adopted a nonqualified supplemental compensation plan (the “Plan”), which provides benefits to certain employees who were officers or key employees of the Company prior to fiscal 1995 (admission to the Plan was discontinued at the beginning of 1995).

 

The current portion of the Plan ($253 at January 31, 2005 and April 30, 2004) is included in “Accrued expenses - Other” in the condensed consolidated balance sheets.

 

The Plan is an unfunded non-qualified plan. The components included in the net periodic cost for the three and nine months ended January 31, 2005 and 2004 are as follows:

 

		(Unaudited)
		Three Months Ended January 31,						Nine Months Ended January 31,
		2005			2004			2005			2004
Service cost		$	7		$	13		$	21		$	39
Interest cost		39			43			117			129
Amortization of prior service cost		(15		)	(15		)	(45		)	(45		)
Amortization of net gain		(1		)	—			(3		)	—
Total net periodic Plan cost		$	30		$	41		$	90		$	123

 

 

NOTE 8. 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 6.2% at January 31, 2005 and April 30, 2004) 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

 

7

 

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 9. RECENT ACCOUNTING PRONOUNCEMENTS

 

In November 2004, the Financial Accounting Standards Board issued SFAS No. 151, “Inventory Costs.” This statement requires that certain costs such as idle facility expense, freight, handling costs and wasted material (spoilage) be recognized as current-period charges and that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. The provisions of this Statement will be effective for inventory costs incurred during the Company’s fiscal year ending April 30, 2007.

 

In December 2004, the Financial Accounting Standards Board revised SFAS No. 123R, “Share-Based Payment.” The revision of the statement requires issuance of stock options to employees to be recognized in the financial statements as compensation expense, valued at the grant-date fair value. The annual disclosure requirements will be effective for the Company’s fiscal year ending April 30, 2007 and the interim period disclosure requirements will be effective beginning with the Company’s second quarter of the fiscal year ending April 30, 2006.

 

NOTE 10. ISSUANCE OF RESTRICTED STOCK TO DIRECTORS

 

During the quarter ended January 31, 2005, the Company issued 8,436 shares of its capital stock to three of the outside members of the Board of Directors as a portion of their compensation for their service on the Board. The shares were issued from treasury stock held by the Company and are “restricted securities” as defined by the rules of the Securities and Exchange Commission. The aggregate fair market value of these shares at the date of issuance of $27 (or $3.20 per share) has been recorded as compensation expense and the excess of the Company’s acquired cost over this fair market value, or $32, was charged directly to retained earnings.

 

NOTE 11. SUBSEQUENT EVENTS

 

In February 2005, the Company amended its secured loan and security agreement with a financial institution (see Note 4) to, among other things, increase the maximum borrowing base to $11,500, establish a subline of $1,300 to assist in funding the costs of implementing an integrated business system and extend the term of the facility to August 2008.  Borrowings under the subline will bear interest at the financial institution’s prime rate, plus 1.5%, and would mature in August 2008.

 

As a result of the Board of Directors believing that such action will save significant administrative costs, permit management to focus more completely on operational matters and enable the redeployment of those resources to create value for the shareholders; the Company, in February 2005, submitted its intent to withdraw from listing its common stock with the American Stock Exchange and filed an application for voluntary delisting with the Securities and Exchange Commission. The Company intends to file Form 15 with the Securities and Exchange Commission to terminate its reporting obligations under the rules and regulations of the Securities and Exchange Commission.

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
(Dollars in thousands)

 

QUARTER ENDED JANUARY 31, 2005 (“THIRD QUARTER OF FISCAL 2005”) COMPARED TO THE QUARTER ENDED JANUARY  31, 2004 (“THIRD QUARTER OF FISCAL 2004”)

 

Net sales for the Third Quarter of Fiscal 2005 increased by $731, or 8.1%, compared to the Third Quarter of Fiscal 2004 despite the loss of sales of $260 resulting from a weighted-average seven fewer retail shops since the Third Quarter of Fiscal 2004.  This was because same-shop (shops open one year or more) sales increased by $792, or 9.7%, with one more sales day in the Third Quarter of Fiscal 2005 versus the Third Quarter of Fiscal 2004; and the combined sales from the Company’s fleet and truck center and commercial coatings operations increased by $199.

 

8

 

The gross profit margin percentage increased to 13.1% in the Third Quarter of Fiscal 2005 from 7.3% in the Third Quarter of Fiscal 2004. 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 increase in net sales.

 

Selling general and administrative expenses decreased as a percentage of sales to 24.3% in the Third Quarter of Fiscal 2005 from 26.3% in the Third Quarter of Fiscal 2004 reflecting that the slight absolute dollar reduction of $2 was proportionally greater when compared to the increase in sales.

 

Interest expense was $194 in the Third Quarter of Fiscal 2005, as compared to $208 in the Third Quarter of Fiscal 2004, and relates primarily to life insurance loans, financing for letters of credit requirements and the amortization of deferred financing costs related to the Company’s secured credit facility (see Note 4 to the Condensed Consolidated Financial Statements).

 

The Company provides for federal income taxes based on an estimated effective annual rate.  The Company provides for state income taxes for state jurisdictions where the Company expects to pay taxes.

 

NINE MONTHS ENDED JANUARY 31, 2005 (“FIRST NINE MONTHS OF FISCAL 2005”) COMPARED TO THE NINE MONTHS ENDED JANUARY 31, 2004 (“FIRST NINE MONTHS OF FISCAL 2004”)

 

Net sales for the First Nine Months of Fiscal 2005 decreased by $244, or 0.7%, compared to the First Nine Months of Fiscal 2004 due primarily to the loss of sales of $1,316 resulting from a weighted-average eight fewer retail shops since the First Nine Months of Fiscal 2004.  However, same-shop (shops open one year or more) sales increased by $673, or 2.1%, with one less sales day in the First Nine Months of Fiscal 2005 versus the First Nine Months of Fiscal 2004; and the combined sales from the Company’s fleet and truck center and commercial coatings operations increased by $399.

 

The gross profit margin percentage increased to 23.6% in the First Nine Months of Fiscal 2005 from 19.4% in the First Nine Months of Fiscal 2004.  The increase in gross margin percentage was primarily due to the overall reduction in the components of cost of sales (particularly insurance expense), which were proportionally greater than the decrease in net sales.  During the First Nine Months of Fiscal 2005 insurance expense decreased from the First Nine Months of Fiscal 2004 primarily as a result of favorable claims experience in both group medical insurance and workers compensation.  Insurance expense in cost of sales totaled $2,785 and $3,891 during the First Nine Months of Fiscal 2005 and Fiscal 2004, respectively.

 

Selling, general and administrative expenses decreased by $193 in absolute dollars and as a percentage of sales in the First Nine Months of Fiscal 2005 from the First Nine Months of Fiscal 2004 reflecting reductions that were proportionally greater than the decrease in net sales.

 

Interest expense was $555 in the First Nine Months of Fiscal 2005 as compared to $499 in the First Nine Months of Fiscal 2004, and relates primarily to financing for letters of credit requirements, life insurance loans and, commencing in the Second 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 $345 in the First Nine Months of Fiscal 2005 and $173 in the First Nine Months of Fiscal 2004.

 

The Company provides for federal income taxes based on an estimated effective annual rate. The Company provides for state income taxes for state jurisdictions where the company expects to pay taxes.

 

LIQUIDITY AND CAPITAL RESOURCES

 

The Company’s cash requirements are based upon its seasonal working capital needs and capital requirements for new shops, 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, 2005, the Company had current assets of $8,107 and current liabilities of $6,549 for a net working capital of $1,558. During the First Nine Months of Fiscal 2005, net cash provided by operating activities was $499, compared with $677 net cash used in the First Nine Months of Fiscal 2004, and capitalized expenditures were $506 in the First Nine Months of Fiscal 2005. The Company expects that future cash flow from operations will be enhanced by these capital additions. During the year ending

 

9

 

April 30, 2005, the Company plans to perform various capital improvements and commence the implementation of an integrated business information system for an estimated cost of approximately $1,000 (see Note 11 to the Condensed Consolidated Financial Statements).

 

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, financing and investing activities. Accumulated cash values under the insurance contracts and the related loan and accrued interest balances at April 30, 2004 totaled $2,598, $1,683 and $110, 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, financing and investing activities, should be adequate to meet its obligations under the Plan. At April 30, 2004, the face value of the life insurance policies totaled $5,096.

 

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, 2004, the proceeds from the death benefits that would be available to satisfy the undiscounted Plan obligations of $3,574 (generally payable over 15 years) totaled $3,303.

 

The Company arranges for the issuance of standby letters of credit to the benefit of its insurance carriers primarily for the unfunded portion of estimated workers compensation liabilities over different policy years. At January 31, 2005, this arrangement was made with a financial institution pursuant to its secured line and letters of credit facility with the Company (see Note 10 to the Condensed Consolidated Financial Statements).

 

As of January 31, 2005, the Company owned 43 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); and, in management’s opinion, based on the most recent appraisals on certain real properties and other valuation estimates, have an aggregate market value of over $20,000. The company has received limited environmental assessments on some of the real properties which, as of the date of each respective report, indicated no significant environmental issues; however, there is no assurance that the real properties are free of environmental concerns which could impact the valuation estimate. 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 as its exclusive financial advisor with respect to the evaluation, report and recommendation to the Board of Directors of strategic options designed to maximize shareholder value. In May 2004, the Company announced it had executed a Letter of Intent (“LOI”) for the sale of all of the Company’s issued and outstanding shares to Elden Holding Group, LLC (“Elden”), for $15,000 plus assumption of certain transaction and related costs and expenses.  In August 2004, the Company announced that it had elected to terminate the LOI with Elden.  In January 2005, the Company terminated the retention of the investment banking firm as its exclusive financial advisor, and is no longer soliciting any opportunities to sell or to enter into a business combination with another company.

 

As of January 31, 2005, the Company had recorded net deferred income tax assets totaling $1,941, which realization would require a significant increase from Fiscal 2004 taxable income to approximately $5,708. The Company believes, however, that because of the relatively long 20-year 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, it is more likely than not that the net 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.

 

10

 

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 U.S. generally accepted accounting principles. 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 more fully 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, 2004. 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.

 

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 consultants. 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 generally 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, 2005, the Company had no significant exposure to the market risks related to changes in currency exchange rates, commodity prices and equity values. The Company could be exposed to interest rate risk under its credit facility with a financial institution since any cash borrowings will bear interest at the financial institution’s prime rate, plus 1.5% to 4% (see Note 4 to the Condensed Consolidated Financial Statements).

 

Item 4.  Controls and Procedures

 

The Company’s Chief Executive Officer, Christian K. Bement, and Chief Financial Officer, Charles E. Barrantes, 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 upon 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 all material information relating to the Company (including its consolidated subsidiaries) required to be included in this report.

 

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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 or mistakes or intentional circumvention of the established process.

 

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

 

Written and oral statements made by the Company that are not historic in nature are “forward looking statements” as defined under the Private Securities Litigation Reform Act of 1995, including statements made in this report and other 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. All statements which address operating performance, events, developments or strategies that the Company expects or anticipates in the future are forward-looking statements.

 

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 risks and uncertainties that may impact the forward-looking statements: the recent trend in quarterly increases in the Company’s same-shop sales may not continue or be sustainable, 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, new product rollout and Quality Fleet & Truck Centers, commercial coatings business, the potential adverse effects of certain litigation, financing, insurance or lending constraints, the impact of various tax positions taken by the Company0, the outcome of the Company’s application for delisting from the American Exchange and deregistration under the Exchange Act, uncertainty whether trading in the Company’s capital stock will continue on the Pink Sheets or any other forum after delisting and deregistration, whether the Company will realize significant savings from the termination of public reporting or successfully re-allocate management resources, and the other factors discussed in the Company’s reports filed with the Securities and Exchange Commission.

 

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PART II - OTHER INFORMATION

 

Item  6.   Exhibits

 

3(a)(1)     Certificate of Incorporation of Earl Scheib, Inc., dated December 22, 1961, as amended, filed as Exhibit 3(a) to Registrant’s Registration Statement No. 2-21540, effective as of August 7, 1963, and hereby incorporated herein by reference.

 

3(a)(2)     Amendment to Certificate of Incorporation dated October 28, 1969, filed as Exhibit 1 to Registrant’s Form 8-K Current Report for the month of October, 1969 and hereby incorporated herein by reference.

 

3(a)(3)     Amendment to Certificate of Incorporation dated August 16, 1971, filed as Exhibit 1 to Registrant’s Form 8-K Current Report for the month of August, 1971 and hereby incorporated herein by reference.

 

3(a)(4)     Amendment to Certificate of Incorporation dated November 4, 1983, filed as Exhibit 3(a)(1) to Registrant’s Form 8-K Current Report for the month of August, 1983 and hereby incorporated herein by reference.

 

3(a)(5)     Amendment to Certificate of Incorporation dated October 2, 1986, as set forth in the Proxy Statement dated July 22, 1986 and Registrant’s 10-Q Quarterly Report for the quarter ended July 31, 1986 and hereby incorporated herein by reference.

 

3(b)         Amended and Restated Bylaws of Earl Scheib, Inc., incorporated by reference to Exhibit 3(b) to the Registrant’s Annual Report on Form 10-K for the year ended April 30, 2003.

 

10(a)       Amendment, dated December 10, 2004, to the Earl Scheib, Inc. Modified Executive Retention and Incentive Plan, filed as Exhibit 10(a) in the Registrant’s 10-Q Quarterly Report for the quarterly period ended October 31, 2004, and hereby incorporated herein by reference.

 

10(b)       Amendment No. 5, dated February 2, 2005, to the Wells Fargo Foothill/Earl Scheib Loan and Security Agreement..

 

31.1         Chief Executive Officer Certification pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act, as amended, adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

31.2         Chief Financial Officer Certification pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act, as amended, adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

32            Certification pursuant to 18 U.S.C. Section 1350, adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

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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, 2005		/s/   Christian K. Bement
Dated		Christian K. Bement, President and
		Chief Executive Officer
March 15, 2005		/s/   Charles E. Barrantes
Dated		Charles E. Barrantes, Vice President and
		Chief Financial Officer

 

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