Big 5 Sporting Goods Corp (BGFV) 2005 Q2 法說會逐字稿

Welcome to the Big 5 Sporting Goods second quarter earnings conference call. Today's call is being recorded. (OPERATOR INSTRUCTIONS). I would like to remind everyone that this conference is being recorded, and would now like to turn the conference over to Mr. Steve Miller, Chief Executive Officer. Please go ahead, Mr. Miller.

Thank you. Good afternoon everyone and welcome to our fiscal 2005 first and second quarter conference call. Today we will talk about our recently completed restatement process, review our financial results for the first and second quarters of 2005, and provide an update on our store openings, our new distribution center, and our third quarter sales, and of course, open it up for questions. With us on the call today are members of our executive team who may be called upon to respond to questions as appropriate.

Before we proceed with our prepared remarks, I would like to introduce everyone to Barry Emerson, our new Chief Financial Officer. As we have previously announced, Barry joined us a few weeks go as a Senior Vice President, and as a result of the completion and filing of our first and second quarter 10-Q reports on Friday, Barry also became our CFO. Barry brings with him over 20 years of accounting and financial management experience, including Chief Financial Officer positions with the Elite Information Group, a premier software developer that traded on NASDAQ before being acquired, and U.S. Auto Parts Network, a leading Internet direct marketer of automotive replacement parts and accessories. Barry also served as Vice President and Corporate Controller for Wyle Electronics, an electronics distribution company with 1.7 billion in revenue which traded on the New York Stock Exchange before being acquired.

We are truly excited to have an individual of Barry's caliber and experience leading the efforts to strengthen our finance and accounting department. Although he has only been here a few weeks, Barry has hit the ground running and is well on his way to learning the Big 5 story. I will now turn the call over to Barry to read our Safe Harbor statement.

First I want to say how excited I am to be a part of the Big 5 team. I am also very encouraged by the commitment I have seen on the part of management and the audit committee to devote the necessary resources to strengthen the Company's finance and accounting department and to establish the internal controls that are needed to support Big 5's long-term growth and success. I have a good feel for what we need to do to accomplish this, and it will be my top priority to see this effort through.

Now on to the Safe Harbor statement. Except for statements of historical fact any remarks that we may make about our future expectations, plans and prospects constitute forward-looking statements made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements involve known and unknown risks and uncertainties that may cause our actual results in future periods to differ materially from forecasted results. These risks and uncertainties include those more fully described in our Form 10-K for fiscal 2004, our recently filed Form 10-Q for our second quarter of fiscal 2005, and other filings with the Securities and Exchange Commission. We disclaim any obligation to update these factors or to publicly announce results of any revisions to any of the forward-looking statements made during this call that reflect future events or developments.

Because our fiscal year period shifted from a 53 week fiscal year in 2004 to a 52 week fiscal year in 2005, each of our quarterly periods in 2005 began a week later than the same quarterly period in 2004. As a result, comparability between the fiscal 2005 quarters and the fiscal 2004 quarters is challenging. For this reason we will provide our same-store sales and certain other financial information on a comparative, calendar day to calendar day 13 week basis.

Thank you, Barry. It has been almost five months since our last call. Consequently, we have a number of matters to update you on. Because of the issues involved in our restatement process, not to mention the cost of the restatement, as well as the ongoing transition to our new distribution center, and our calendar shift from a 53 week year to a 52 week year, we can appreciate that the initial picture presented by our reported results is somewhat complex.

The good news is that our fundamental business remains very healthy. Yesterday we completed our fiscal 2005 third quarter, and can now report that we have enjoyed 39 consecutive quarters of positive same-store sales growth. Additionally, it is nice to note that our comp store sales trends have improved over each quarter this year. We have now completed the filing of our Form 10-Q reports for the first and second quarters of 2005. And we met the September 30 NASDAQ deadline for our SEC filings.

Now I would like to sort through some of the issues relating to our restatement, and provide some information and color relating to our first and second quarter results. As a brief review, most of you are aware that our restatement process began when the Company discovered that an error has been made within Accounts Payable relating to letters of credit that resulted in an overstatement of prior periods' reported income. The fact that this error occurred and went undetected for a number of years lead to a comprehensive review by the Company, our audit committee and our auditors to determine that no other errors had gone undetected. As part of this effort, additional items were identified for correction in our restatement. These additional corrections, which are more fully described in our fiscal 2004 Form 10-K, relate in part to refinement of our accounting methodologies, such as truing up certain allowances on a quarterly basis rather than on an annual basis, and to the establishment of additional allowances.

The impact on net income of these additional corrections was relatively small. However, the work associated with quantifying these corrections and establishing that no other material corrections were necessary by leaving no stone unturned was exhaustive and much more time-consuming than we could have ever reasonably anticipated. The refinement of our accounting methodologies as part of the restatement process resulted in a number of changes that affected comparisons of our fiscal 2005 results to prior periods. Certain prior periods benefited from the application of many of these changed accounting methodologies, while 2005 periods generally do not.

Another impact of the restatement process was, of course, the costs associated with it. Through the second quarter we incurred approximately $1.8 million in legal and audit fees relating to the restatement. We also incurred substantial legal and audit fees relating to the restatement in the third quarter, although we do not have that final tally yet. While these costs will generally subside in the fourth quarter, we do expect to incur additional costs relating to Sarbanes-Oxley 404 compliance work in the fourth quarter.

In our remarks today we will attempt to explain the impact of the cost of the restatement and the application of refined accounting methodologies on our first and second quarter results. I will now provide a brief overview of our first and second quarters.

In the first quarter net sales were 190.1 million, up 4.5% from restated sales of 181.9 million in the first quarter of 2004. Our same-store sales increased 1.8% for the first quarter on a calendar day to calendar day basis versus the comparable 13 week period last year. On a fiscal quarter basis same-store sales increased 1.6% in the 13 weeks ended April 3, 2005 versus the 13 weeks ended March 28, 2004.

Gross profit margin was 35.7% of sales during the first quarter versus 37.5% for the same quarter of last year. Our point-of-sale margins were down 10 basis points for the quarter versus the first quarter of 2004. So our occupancy costs, distribution center labor and tracking expenses as a percent of sales increased 50 basis points. Our revenue growth for the first quarter limited our ability to fully leverage these expenses.

Gross profit was also impacted by unusual items, including a 1.5 million, or 80 basis point variance in inventory allowances that resulted largely from our restatement. Additionally, a 0.5 million flood loss at one of our stores was fully recognized in the first quarter. And this was partially offset by insurance proceeds received and recognized during the second quarter.

Gross profit comparisons were also hampered by the application of revised inventory cost capitalization methodologies adopted as part of the restatement. This added 0.4 million pretax dollars, or $0.01 per diluted share, to fiscal 2005 first quarter results, and added 0.8 million pretax, or $0.02 per diluted share, to fiscal 2004 first quarter results. Our SG&A expenses increased 4.6 during the quarter as the percent of sales remained unchanged at 27.7%.

SG&A in the first quarter was impacted by legal and audit costs associated with the restatement, which were roughly $0.3 million pretax or $0.01 per diluted share. Net income for the first quarter was $6.4 million, or $0.28 per diluted share versus restated net income of 7.9 million or $0.34 per diluted share.

To recap briefly as we see it, first quarter 2005 results were hurt by the cost of the restatement, the flood loss, and the impact of the application of new accounting methodologies as part of the restatement whereas first quarter 2000 results largely benefited from the application of those new methodologies.

Now living onto the second quarter. In the 2005 second quarter we rang the register to the tune of $198.1 million, up 7.3% from 184.7 million of sales as restated for the second quarter of 2004. Our same-store sales increased 2.6% for the quarter on a calendar day to calendar day basis versus the comparable 13 week period last year. This represented our 38th consecutive quarter, or 9.5 years, of positive comp store quarterly comparisons. On a fiscal quarter basis, same-store sales increased 3.8% in the 13 weeks ended July 3, 2005 versus the 13 weeks ended June 27, 2004.

Our sales gains for the quarter were driven by increased customer traffic and a slight increase in our average transaction size. We comped positively in each of our three major merchandise categories. Apparel was our strongest performing category followed by footwear and then hard goods.

Gross profit margin for the second quarter was 36.6% of sales compared to 36.9% for the second quarter of 2004. Our point-of-sale margins improved 10 basis points during the quarter versus the same period last year. Gross margins during the quarter benefited from an increase of 0.4 million in cost capitalized into inventory versus the same period of 2004, and also from an insurance reimbursement of 0.4 million related to the first quarter flood loss at one of our stores.

Our gross margins were impacted during the second quarter by an increase of 1.7 million, or 90 basis points, in our distribution center costs. This increase was due largely to our having to recognize rent at our new DC earlier than we had previously expected, as well as higher payroll related expenses and increased trucking expenses resulting from higher gasoline prices.

Our SG&A expenses increased to 29 percent of sales for the second quarter versus 27.1% of sales in the second quarter of 2004. This increase was driven by a $1.9 million increase in legal and audit fees due primarily to costs related to the restatement. Store related expenses increased $3 million during the second quarter, attributable primarily to an increase in store count and higher labor and benefit costs.

SG&A expenses also increased as a result of accrual adjustments relating to workers’ compensation costs and employee bonuses. Advertising expense also increased 1.1 million for the quarter, due mainly to store growth, and a shift in the timing of our July 4th holiday advertising into this year's second quarter.

Net income during the second quarter was $6.1 million, or $0.27 per diluted share, versus restated net income in the second quarter of 2004 of 7.7 million, or $0.34 per diluted share, which included an one time note redemption charge of $0.02 per diluted share.

To briefly recap the second quarter, clearly legal and audit costs, which amounted to roughly $0.05 per diluted share, and costs associated with earlier than expected recognition of rent and other costs related to the transition to our new distribution center, which amounted to roughly $0.02 per diluted share, was the driving factors affecting our earnings for the second quarter.

At this time I will turn the call over to Barry who'll speak to our balance sheet, our capital expenditures and our cash flows.

As Steve mentioned, I will review some highlights of our balance sheet. We believe our inventories at the end of the second quarter were in good shape. Total chain inventories amounted to 220.3 million at the end of the second quarter, up 12.8 million frown 207.5 million at the end of the second quarter of 2004. We feel our inventory levels are appropriate given that we were operating 16 new stores at the end of the second quarter of 2005 compared to the prior year period. On a more comparable per store basis inventories this year were up less than 1% over the second quarter of 2004.

Turning to our capital spending, CapEx totaled 11.3 million for the second quarter and 18.7 million for the first two quarters of this year. This reflects capital expenditures for our new distribution center in Riverside, California of 14.1 million year-to-date. The balance of the expenditures was primarily for store related remodeling and new store openings.

We continue to expect to spend 12 to 14 million on normal store maintenance and new store openings in 2005, driven by the opening of 15 to 17 net new stores. We also anticipate additional capital expenditures related to our new distribution center of approximately 1 million this year, which would bring the total for this new facility to 23.3 million. We reported positive operating cash flow of 1.2 million for the first two quarters of 2005.

The Company's business model has historically allowed it to generate healthy free cash flow, and we expect that to continue. We plan to use the cash to reduce debt and to pay our quarterly cash dividend to further enhance shareholder value. Our total debt of 107.1 million at the end of the first two quarters of 2005 was down 2.4 million from 109.5 as of the same time last year. This debt reduction was accomplished despite the funding of 21.2 million for our new distribution center and 4.8 million in shareholder dividends.

Now I will turn it back over to Steve to speak about our distribution center construction, new store openings and guidance.

We opened one new store, which was the relocation during the fiscal 2005 first quarter. We opened three new stores, one of which was a relocation during the second quarter. During the third quarter we opened four new stores and closed one store, bringing our current total store count to 314.

In terms of overall store growth for 2005, initially we guided to 16 to 20 net new stores. The restatement process, including the delay in getting our 10-K on file, caused a couple of stores to fall out of our store openings scheduled for this year and created delays for a few other stores. That being said, we still believe we will be able to open a total of between 15 and 17 net new stores during fiscal 2005. Those stores will be spread within our 10 state geographic footprint. We believe our store growth in 2006 will be closer to 20 net new store openings.

Additionally, we are excited to report that we have actively begun the transition to our new distribution center in Riverside, California, and to date all systems are go. Construction on the building is substantially complete, and the building is fully functional with only the addition of our fuel and truck maintenance station and minor cosmetic work remaining to be down. We began receiving product at the new facility several weeks ago. We are pleased to report that as of today we began shipping product from our new distribution center. We have also begun to systematically transfer product from our existing DC to our new facility. We are obviously doing this in a very controlled manner in order to minimize any interruption in our supply chain. We anticipate that this transition will be completed and we will be 100% operational in our new DC during the first quarter of 2006.

Now I will spend a few moments on our third quarter sales and guidance going forward. We completed our third quarter of fiscal 2005 yesterday. While we're still finalizing sales results, we expect to realize same-store sales growth in the low to mid single digit range for the third quarter versus the same thirteen week period last year. I should point out that this is on a calendar day to calendar day basis. When we report our fiscal third quarter same-store sales results due to the 53 week to 52 week calendar shift, they will be lower than the calendar day to calendar day figure by approximately 2.5 percentage points. This large swing is due to the July 4th holiday business falling in the second fiscal quarter this year, whereas it fell in the third fiscal quarter in 2004. However, anyway you look at it, our streak is alive and well. This was our 39th consecutive quarter of positive same-store sales growth.

We expect that costs associated with our restatement and resulting changes in the application of our accounting methodologies, including those we have discussed today, may continue to have an impact on our previously issued earnings guidance. For that reason we have announced that previously issued full year guidance should not be relied upon. Our accounting personnel, including Barry, will be analyzing the anticipated impact of these costs and accounting changes on future earnings. Once they have sufficient opportunity to do so, we intend to provide redevised guidance for the fiscal 2005 full year.

In summary, this clearly has been a challenging time for us. We are pleased that we were able to meet these challenges, get our filings completed, and remain focused on our core business. With that I would like to turn the call back to the operator and open it up for questions and answers.

(OPERATOR INSTRUCTIONS). Sean McGowan with Harris Nesbitt.

I think you answered one of them, so the question was the difference between fiscal and calendar being so big in the second quarter is the July 4th weekend?

Exactly.

Two other -- actually one other thing. Can you just talk about what are the expenses that we are either seeing so far this year or will see for the balance of the year, our cash versus what is non-cash? And maybe in a similar vein what would you characterize as recurring versus non-recurring?

I understand we would probably have a permanently higher level of accounting expenses given the update in systems, but if you could just give us -- get our arms around what are the expenses that we will see this year which would not be expected to be recurring?

Certainly the cost of the restatement will not be recurring. The costs associated with the transition to the distribution center will not be recurring. Barry and Chuck are here to --.

I think beyond that basically they will all be pretty (inaudible).

When you are calling out these expenses you are essentially calling out non-recurring expenses?

There are expenses and then there is of course -- this is Barry Emerson. There is the changes in the accounting methodologies related to some of the inventory allowances, and they are not expenses but they are certainly provisions to cost of revenue, and they will continue. And what we're trying real hard to get our arms around is the effect of those in the future and how that will impact our future financial results.

And would those provisions be non-cash?

They are non-cash.

I am trying to get the distinction between just recognizing some expenses sooner versus a permanently higher level of cost of doing business.

Right.

What I guess you're saying is you left it at later in the year on where expenses are going to wind up.

That's right. We have indicated that we are -- basically we have looking backwards now for quite a few months, and we're going to start looking forward in a meaningful way here, and really trying to get our arms around completely the inventory methodology calculation changes here for the various allowances and so on. And they are really affected by movement of returned goods through our distribution center. And we've got to make sure that we've got a good grip on the consistent processing of those returned goods, etc.

Mitch Kaiser with Piper Jaffray.

I understand giving guidance. Do you have a sense for when we might get an update on that?

I think as soon as we get comfortable and have a chance, and Barry has a chance to analyze all the so-called moving parts. We would certainly hope we are in a position to do that and expect to be by the time we issue our third quarter results.

I guess at this point can you just point us directionally where you think maybe gross margins and SG&A might shake out, or aren't you at a point to really do that right now either? I know for example in the second quarter SG&A I look at it and an apples-to-apples basis it was up about 100 basis points, if you strip out the legal fees due to higher store expenses. Should we see that trend continuing in the third quarter? Or just any color on those two items would be helpful.

I don't know that we are prepared to give guidance. I think absent all the unusual items, I think our business would be more normalized going forward.

And then just lastly on the inventory allowances should we -- can we get any color on where that might shake out for the last couple of quarters?

That is a challenge for us. If we look back historically these numbers -- the revised calculations are really kind of tied to the processing of returned goods. And for various reasons the processing hasn't necessarily been consistent on a month by month basis, so that impacts the calculations looking back. And so trying to take history and look forward, clearly what we're going to try and do is establish good, consistent procedures for processing these items through the warehouse, etc., so that we can try and get some consistent results out of the inventory allowance calculations going forward. At this point we wouldn't want to say anything. We really want to put some time into analyzing the effects going forward.

I might add, just backing up on the second quarter SG&A, there were some items that I don't -- clearly will not go forward. And those have to do with timing issues in terms of bonus accrual, bonus and workers’ compensation how that -- comparisons of timing were from the prior year where we have smoothed out how we are providing for bonus accruals this year over the course of the year. Last year -- the last several years it was more back end loaded. And we have established a methodology now where our provisions for bonuses will be more consistent with how income rolls out over the year. That will return some of the benefits so to speak, all things being equal, in the fourth quarter.

So on a comparison basis last year you do it more in the fourth quarter, but now you're doing it -- smoothing it out across the year. So on an apples-to-apples basis it was -- that was probably up a little bit this year just because of the smoothing out, I guess, right?

Exactly.

Rick Nelson with Stephens Inc.

This is Paul Swinand for Rick. Rick is traveling right now. Firstly, I would just like to say congratulations. I realize this must be a difficult time, and you kept your streak alive. So I guess you can point to that and congratulations. I just wanted to ask on the inventory cost changed capitalization methodology, what exactly is that? Is it something you couldn't explain fairly easily?

Sure. I can take a crack at it. This is Barry Emerson. The inventory cost cap, and of course it is straight out of GAAP, and the way it is really calculated is we take the cost in our inventory, the days of inventory on hand. And for us that tends to run just over kind of half a year or so. And then we look at -- that is the number of days of costs in inventory, and then we look at a cost pool which really is costs that are for our distribution center. And we basically have to load up -- if we've got 160 days worth of inventory on hand, we've got to load up 160 days worth of costs from that cost pool into inventory. And then basically you just adjust that every quarter and it could go up and down. So it can have some variability in it depending on what is in that cost pool.

You weren't doing that before?

We were doing it before, but we were doing it at the end of year, and now we're doing it on a quarterly basis. We have also adjusted some expenses out of the cost pool and refined the cost pool.

This goes back to Sean's question, but is this something that we're going to see coming back that the -- since we're pushing -- we are getting a short-term benefit now, would we be getting a little bit of extra costs later next year, or is it apples-to-apples?

I'm not sure where we're getting a short-term benefit from this?

I thought the inventory -- wasn't that one of the things you got $0.02 benefit in the last quarter --?

It hurt us in the first quarter. It helped us in the second quarter. It is relatively level against '04, because we went back as part of a restatement and applied this methodology backwards in '04.

Over the course of one fiscal year it would net out? Does that make sense?

If you mean going forward -- if the cost pool is growing, you're going to tend to continue to add more and more inventory cost into your inventory, which would tend to increase that benefit. But if you end up with fluctuations in your cost pool for whatever reason, it can go up and down.

Right. And then my second question is thinking about the previous guidance, what was in that guidance already? I realize that the legal and the audit was not in it. But were some of these accounting changes -- I know some of them you were already working on, right? So were some of those already in there or not?

Primarily not. The only one that was in there was the impact from our initial issue being -- that being the letters of credit. Other changes were not factored into our guidance.

Jason West with Deutsche Bank.

One thing I guess back to the inventory question -- the 1.5 million that you pointed out that hurt you this year and then helped you last year, I guess -- is there any way you could tell us how to think about that going forward at all? I don't know -- that is sort of the big question I guess you guys are grappling with as well. If maybe you could talk about why it helped you last year and then hurt you this year, maybe that would help us understand it a little bit better.

Jason, this is Barry Emerson. The way these calculations work, and there are several of them, not just one to point out. But it really has to do with the net realizability of our returned products and then shrink of our returned products. And then -- those are kind of generally the categories. And there are several different calculations that go into that. We really kind of have to determine what is -- what percentage of our current chain inventory are likely going to get returned back to us in the future. And then a different calculation figures out what percent of that returned products is actually going to be realizable. It gets a little tricky.

And so what we're really doing is a couple of things. One, evaluating very, very carefully the methodologies here and fine-tuning them with our auditors, and also establishing procedures that will allow us to consistently perform the processing that we need to so that these reserve calculations make sense going forward. But if you go back and look historically these procedures were not necessarily being followed, because there wasn't any kind of an inventory allowance methodology that was being driven by those procedures.

And so if you go back and look historically, we're establishing, or we are developing the new distribution center, and we've got people with lots of different priorities. And although returned goods were processed, they may not have been processed on a standard routine monthly basis. It is very difficult to look back and compare it to the current year and make sense of the flip-flops in the numbers.

Okay. So looking at the restated numbers though '04 for the full year and by quarter, we shouldn't think about that as a stable earning pace. And this is a Company that can grow 10, 15% based on your store growth and comps and so forth. We shouldn't think about this '04 number as your starting point because you're going to have some more fluctuations going forward?

I would hate to go back -- these restatements back in '04 they have caused some gyrations, and so to try and build a steady-state off of these inventory provisions in the 2004 quarters is going to be a little challenging.

A separate question. You guys had originally talked about $0.09 from the new DC. It is sort of the non-recurring impact on your expense line. Is that sort of the kind of number you're still looking at?

Yes, we've probably got to make it closer -- probably $0.10, because we recognized one quarter, an additional quarter of rent as part of the whole new lease accounting provision, where we paid rent beginning the second quarter -- recognized rent in the second quarter, in that that became our official possession date, even though the cash payment of rent didn't start until the third quarter. So that added a penny. It take us to $0.10. Perhaps to be conservative, as we look at our models, we may incur an additional penny of expense in terms of labor associated with the move in the fourth quarter. I am not sure, but perhaps to be conservative I would allow for that.

You are saying an additional penny, meaning taking to 11 or --?

Yes. The rent which was in the second quarter was totally unanticipated. That takes us clearly to 10. And we think that maybe another penny at the end of the day from labor associated with getting all the product in the right place.

That is all this year, or is some of it that going to fall into next year?

There will be -- I think we always provide for another penny or two I would suspect in Q1 of '06.

And then last thing. On the bonus accrual issue, you guys never quantified that -- any of these numbers, I don't think. Can you give us any quantification on what the impact of that was from the bonus accruals and the worker comp?

Collectively -- the workers’ comp was more a comparison issue where last year we received some refunds from the insurance provider due to some adjustments and over payments, I guess, for over simplification. The bonus accrual would be roughly probably a penny. It would equate to about a penny a share.

The worker's comp compare impact was that another penny or so or --?

Right there. Yes, another penny there.

Okay, got you. Thanks a lot.

In that case this year's figure is probably a better figure to model off of.

Right, right. Okay. Thanks a lot.

Ian Corydon with B. Riley & Company.

This question might be redundant at this point. But just looking at the net impact of all the accounting changes, not the expenses associated with the changes, but just the impact of the actual changes and the result it had on the first half of the year, it looks like it was pretty minor. Is there any reason to believe that would be a materially greater impact in the second half of the year?

I would say currently no. Do you agree, Barry?

Yes, I don't see -- at this point in terms of the reserves, or the allowances on the inventory side, again I think we need to get into the dynamics of this carefully before we go ahead and make too many predictions here out for the back half of the year. But I hate to have -- clearly the impact was significant in the first quarter of these accounting methodology changes. It was not as significant in the second quarter of this year; not by a wide margin. But at this point I don't want to predict what it is going to look like for the second half.

You mentioned some additional Sarbanes-Oxley expense coming in the fourth quarter. Was that in your previous guidance?

We had -- yes, we did have some Sarbanes Oxley expenses I think. Probably similar to where we will end up. I think we are going to be covered there from our previous guidance.

I think what we're kind of doing is we have had all points focused on the Qs, and so we have kind of pushed back the Sarbanes-Oxley work a little bit. So we're going to jump on that strongly and get the resources in place to get all our documentation and testing done for the year end.

Steve, maybe it would be helpful if you could just provide a time line on how the distribution center is going to progress until you get to full operation?

Sure. We are -- as we mentioned, we just today began shipping product. We have been receiving product into the new DC. We're continuing to -- we are actually continuing to receive product in our old DC as well. We're going to be running them sort of simultaneously, and start a sort of slow controlled move of product by class -- classification of product from the existing DC to the new DC. And complete this transition in the first quarter of next year.

We're going to initially be picking orders in the new DC, shuffling them to our current DC, marrying them up, and sending it to our stores. There will be a point of time we think somewhere probably right after the Christmas holiday that that process will reverse itself, where we will have more product in our new DC. And then we will reverse the process until all product is in Riverside, our new DC.

Ralph Sean with Wachovia.

I think I will change the subject to how your fundamental business is going. I'm just wondering if you are seeing any kind of change in the promotional environment, particularly from Sportsmart or Sports Authority?

Not significantly that we can speak to. Our fundamental business is going well. I'm not sure I can speak to any dramatic changes that we have seen in the competitive environment.

The categories are doing well -- apparel, footwear and hard goods were all up, as you said. Are the trends continuing that you have seen throughout the first half -- kind of last year and this year where performance apparel is strong, performance footwear strong, etc.?

I think -- in the third quarter I think performance apparel remained strong. In the third quarter I think I can tell you on a very top-level basis that apparel and hard goods were stronger performing categories than footwear. I think we have seen a comparatively -- a little softness in footwear relative to how it had been performing earlier in the year.

Chris Sazia (ph) with Susquehanna Financial Group.

Just a quick question, just telling on top of what we just commented on. Steve, do you get any sense that looking at your business, obviously comps continue to improve as you go through this year. As you look to the fourth quarter is there anything in the fourth quarter that would give you any concern whether on the part of your consumer, a lot of distortions in the marketplace about fuel costs and things of that nature, that would give you any concern, or just in the competitive environment about whether or not you guys can continue to maintain the momentum that you are currently seeing in your business?

We don't see anything irrational going on in the competitive environment. In terms of the consumer, look, I think anybody in retail who didn't say they had some concern, given the impact fuel prices have on our consumer would be, I would think, kidding themselves. That being said, our business trends remained very strong in the third quarter. We feel the fact that we are very promotional -- we create a strong value proposition for our customers. We believe this will continue to serve us well going into the holiday season.

I think you had mentioned the merchandise margins, I think, were up in the quarter incrementally. Is that pretty much broad-based? In the second quarter it was pretty much among all the categories -- footwear, hard lines and apparel as well?

In the -- what quarter are you talking about now?

In the second quarter. Because I know you obviously will not -- I assume you will not comment obviously on the third quarter.

I don't even have all the figures given that we just finished our third quarter yesterday. In the second quarter again we don't comment by -- to margins by category. Second quarter is so far back I am not sure it is on the top of my mind. But our margins, we were up 10 basis points in product margin. As I said, at a glance here, reasonably consistent amongst our categories.

I guess the last question I have is just on the new DC center, when do you guys anticipate starting to leverage the DC center and starting to actually see some of that benefit flow through the cost of goods sold through the bottom line? Is that something you can anticipate maybe in the second half of next year?

To us it is a little early to promise that or guide towards that. We have been very focused on looking backward at our business really over the last five or six months to say the least. But our guess would be that we are going to transition and be fully operational in the first quarter. We know there is a learning curve associated with utilizing the space as efficiently as is possible and how that translates into precisely leveraging the new DC, I think, would be early to come out and hazard a guess.

Steve, just one last thing, if I could. You had mentioned in a previous answer to a question that there is a potential that the costs associated with the new DC center could potentially -- I think you said you -- is it $0.11 potentially could be the cost with the new distribution center?

For '05. Yes.

For '05. And is there a possibility for a penny in the first quarter of next year?

I would say there will be a penny or two pennies.

Yes, because we will continue to pay rent on our current facility in Q1, so basically that will be the penny or two pennies.

Anthony Lebiedzinski with Sidoti & Co.

A couple of questions. I was wondering if looking back at the third quarter and fourth quarter of last year, if perhaps you could maybe discuss how much of the change in the accounting methodologies either benefit or hurt your results for the third quarter and fourth quarter of last year?

Boy, Anthony, you have got me. I don't have the effect on the third and fourth quarter. We were so looking at first and second, we don't have third and fourth.

I guess you will have that when you report your third quarter results?

Absolutely.

This is Chuck. There would have been an impact in Q4 from the inventory path from spreading that back from what we initially reported.

Now as far as the bonus accrual, was that -- last year was it done everything in the fourth quarter?

There will be -- all things being equal, there will be a benefit to the fourth quarter in terms of bonus accrual.

As far as -- do you have any idea when you will report the third quarter results?

We expect that to be the second week in November at this point in time.

And as far as the distribution center, how many stores do you think that facility will have, the capacity?

Comfortably 5 to 600 and perhaps more.

In terms of the additional -- the Sarbox 404 costs, can you quantify how much of that is going to impact in the fourth quarter of this year?

I don't think we're prepared to do that now.

David Magee with SunTrust Robinson Humphrey.

I will apologize before I ask this question. As you think about next year, and I guess the upcoming change in option accounting, have you thought theoretically how you might approach compensation, or is that going to be a big impact in your mind?

This is Barry Emerson. And as you look at our financial results, in the notes of course, it tends to run about a penny a share per quarter, and so roughly $0.03 to $0.04 a year. And at this point I think we haven't gone a lot farther other than anticipating other compensation strategies, although it is something that we have talked about. But at this stage we're still in the evaluation period.

Thank you, and congratulations on the good comps.

Bill Gazalum (ph) with Titan Capital.

We have a group of questions. First of all, to make sure that we understood clearly the early recognition, or earlier recognition, of rent with the distribution center, that is entirely an accounting issue, and it is not because you are ahead of plan on the construction? Is that correct?

That is correct.

The second question is relative to the third quarter same-store sales you had mentioned that the comps on a per day basis were going to be better than the second quarter comps. But would you walk us through the strength that you saw throughout the course of how the Q3 -- basically how it trended through the quarter?

It was remarkably consistent for the -- throughout the whole entire quarter. We were a solid -- July, August and September were all very solid and reasonably consistent periods.

And then the final question is to what degree do you feel -- and this question may be early -- but that you may have a benefit from -- with the higher gas prices, the fact that your locations are oftentimes more neighborhood locations rather than a destination location to some of the larger box competitors of yours?

We think that is definitely a plus in our quarter. The fact that certainly in metropolitan areas we can -- and clearly out store the competition, we think that is a plus. It has to be.

Do you see any tangible evidence that you may be gaining market share from your larger box competitors due to your promotional environment with gas prices being higher and budgets being squeezed, and therefore the family is more interested in getting a good deal?

That is a good theory. I don't know that we can speak to -- since the competitors don't share their comps sales with us, I'm not sure that I can speak to that more directly. We are pleased with our comp store performance.

(OPERATOR INSTRUCTIONS). Sean McGowan with Harris Nesbitt.

I had a couple of follow-ups, but they have been answered already. Thank you.

That does conclude our question-and-answer session today, ladies and gentlemen. We appreciate your participation. Now I'll turn the conference back to our speakers for closing remarks.

Thank you. We appreciate everybody being on the call today. And we certainly look forward to speaking with you again next month now when we report our third quarter results. Thank you and take care.

And that does conclude our conference call, ladies and gentlemen. We do appreciate your participation. You may disconnect at this time.