ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Throughout this section, the Big 5 Sporting Goods Corporation (“we,” “our,” “us”) fiscal years ended December 29, 2024 and December 31, 2023 are referred to as fiscal 2024 and 2023, respectively. The following discussion and analysis of our financial condition and results of operations for the years presented includes information with respect to our plans and strategies for our business and should be read in conjunction with the consolidated financial statements and related notes, the risk factors and the cautionary statement regarding forward-looking information included elsewhere in this Annual Report on Form 10-K.
Our fiscal year ends on the Sunday nearest December 31. Fiscal 2024 and fiscal 2023 each included 52 weeks.
Overview
We are a leading sporting goods retailer in the western United States, operating 422 stores and an e-commerce platform under the name “Big 5 Sporting Goods” as of December 29, 2024. We provide a full-line product offering in a traditional sporting goods store format that averages approximately 12,000 square feet. Through our e-commerce platform, we also offer selected products online. E-commerce sales for fiscal 2024 and 2023 were not material. Our product mix includes athletic shoes, apparel and accessories, as well as a broad selection of outdoor and athletic equipment for team sports, fitness, camping, hunting, fishing, home recreation, tennis, golf, and winter and summer recreation.
We believe that over our 70-year history we have developed a reputation with the competitive and recreational sporting goods customer as a convenient neighborhood sporting goods retailer that consistently delivers value on quality merchandise. Our stores carry a wide range of products at competitive prices from well-known brand name manufacturers, including adidas, Coleman, Columbia, Everlast, New Balance, Rawlings, Skechers, Spalding, Under Armour and Wilson. We also offer brand name merchandise produced exclusively for us, private label merchandise and specials on quality items we purchase through opportunistic buys of vendor over-stock and close-out merchandise. We reinforce our value reputation through digital marketing and periodic print advertising in major and local newspapers and direct mailers, in an effort to generate customer traffic, drive sales and build brand awareness. Over the last several years we have been reducing our overall advertising spend and also shifting our advertising spend away from print media towards digital advertising, which we believe allows us to more effectively manage our advertising expense. We also maintain social media sites to enhance distribution capabilities for our promotional offers and to enable communication with our customers.
Throughout our history, we have emphasized controlled growth. Our store openings during recent years reflect our cautious approach toward store expansion in the current retail environment, which includes increasing e-commerce competition. The following table summarizes our store count for the periods presented:
Fiscal Year
Beginning of period
New stores (1)
Stores relocated
Stores closed (2)
End of period
Stores opened (closed) per year, net
Stores that are relocated are classified as new stores. Sales from the prior location are treated as sales from a closed store and thus are excluded from same store sales calculations.
In the first two months of fiscal 2025 we closed eight stores, lowering our store count to 414 at the end of fiscal February 2025.
For fiscal 2025, we do not anticipate opening any new stores and we anticipate closing approximately 15 stores (including eight stores that we closed in the first two months of fiscal 2025).
Executive Summary
Our increased net loss for fiscal 2024 compared to fiscal 2023 was mainly attributable to reduced net sales, partially offset by lower selling and administrative expense year over year. We believe the decrease in net sales in fiscal 2024 reflected a variety of factors, including significant inflationary pressures which dampened consumer sentiment and reduced demand for discretionary products.
Net sales for fiscal 2024 decreased 10.1% to $795.5 million compared to $884.7 million for fiscal 2023. The decrease in net sales reflects a decline of 9.4% in same store sales when compared with fiscal 2023. We believe our lower same store sales in fiscal 2024 in part reflected significant inflationary pressures that negatively impacted consumer demand as well as reduced store count, which contributed to reduced net sales across each of our major merchandise categories of hardgoods, apparel and footwear.
Gross profit for fiscal 2024 represented 29.5% of net sales, compared with 32.3% in the prior year. Merchandise margins decreased an unfavorable 34 basis points compared with the prior year, and store occupancy expense and distribution expense, including costs capitalized into inventory, as a percentage of net sales were higher compared with fiscal 2023. While merchandise margins decreased year over year, they remained healthy and continued to compare favorably to pre-pandemic levels.
Selling and administrative expense for fiscal 2024 decreased 2.2% to $290.1 million, or 36.5% of net sales, compared to $296.6 million, or 33.5% of net sales, for fiscal 2023. The reduction in selling and administrative expense primarily reflects decreases in employee labor, legal expense, company performance-based incentive accruals and operational expenses resulting from a lower store count, partially offset by certain higher operational expense impacted by inflation.
Net loss for fiscal 2024 was $69.1 million, or $3.15 per basic share, compared to net loss of $7.1 million, or $0.33 per basic share, for fiscal 2023. The increased loss primarily reflected lower net sales and a non-cash charge for the establishment of a valuation allowance related to deferred tax assets, partially offset by the favorable impact of lower selling and administrative expense year over year.
Our principal liquidity requirements are for working capital and capital expenditures. We fund our liquidity requirements primarily through cash on hand, cash flows from operations and borrowings from our revolving credit facility.
Operating cash flow for fiscal 2024 was a negative $11.4 million compared to a positive $18.5 million in the prior year. The decreased operating cash flow was primarily due to decreased net income.
Capital expenditures for fiscal 2024 decreased slightly to $10.9 million from $11.0 million in fiscal 2023. We do not anticipate opening any new stores in fiscal 2025, after opening three new stores in fiscal 2024.
We had cash of $5.4 million and $9.2 million as of December 29, 2024 and December 31, 2023, respectively. In the fourth quarter of fiscal 2024, we resumed borrowings under our credit facility since the full pay-down of outstanding balances under the credit facility in the third quarter of fiscal 2020 with a balance outstanding of $13.8 million as of December 29, 2024.
We paid cash dividends in fiscal 2024 of $2.8 million, or $0.10 per share, compared with $19.8 million, or $0.875 per share, in fiscal 2023. The decrease in dividend payments reflected the suspension of our quarterly cash dividend in the second half of fiscal 2024.
Results of Operations
The following table sets forth selected items from our consolidated statements of operations by dollar and as a percentage of our net sales, and other financial data, for the periods indicated:
Fiscal Year (1)
(Dollars in thousands)
Statement of Operations Data:
Net sales
Cost of sales (2)
Gross profit
Selling and administrative expense (3)
Operating loss
Interest expense (income)
Loss before income taxes
Income tax expense (benefit)
Net loss
Other Financial Data:
Net sales change
Same store sales change (4)
Fiscal 2024 and 2023 each included 52 weeks.
Cost of sales includes the cost of merchandise, net of discounts or allowances earned, freight, inventory reserves, buying, distribution center expense, including depreciation, and store occupancy expense. Store occupancy expense includes rent, amortization of leasehold improvements, common area maintenance, property taxes and insurance.
Selling and administrative expense includes store-related expense, other than store occupancy expense, as well as advertising, depreciation and amortization, expense associated with operating our corporate headquarters, and impairment charges, if any.
Same store sales for a period reflect net sales from stores that operated throughout the period as well as the full corresponding prior-year period and sales from e-commerce.
Fiscal 2024 Compared to Fiscal 2023
Net Sales. Net sales decreased by $89.2 million, or 10.1%, to $795.5 million for fiscal 2024 from $884.7 million for fiscal 2023. The change in net sales was primarily attributable to the following:
Same store sales decreased by $81.0 million, or 9.4%, for fiscal 2024 versus the comparable prior-year period. We believe the decrease in same store sales reflected the following:
Our markets were influenced by a continuation of significant and persistent inflationary pressures that dampened consumer sentiment and weakened demand for discretionary products, which negatively affected sales.
Our markets also reflected a reduction in store count from 430 stores in fiscal 2023 to 422 stores in fiscal 2024.
In the fourth quarter of fiscal 2024 and 2023, we experienced unfavorable winter weather conditions across a large part of our market, with unseasonably warm weather adversely impacting sales of our winter-related products.
Our lower same store sales in fiscal 2024 reflected a decrease in each of our major merchandise categories of hardgoods, apparel and footwear.
Same store sales are made on a comparable-week basis. Same store sales comparisons exclude sales from stores permanently closed, or stores in the process of permanently closing, during the comparable periods. Sales from e-commerce in fiscal 2024 and 2023 were not material.
We experienced decreased customer transactions of 7.8% and a lower average sale per transaction of 1.6% in fiscal 2024 compared to the prior year.
Gross Profit . Gross profit decreased by $51.3 million to $234.5 million, or 29.5% of net sales, in fiscal 2024 from $285.8 million, or 32.3% of net sales, in fiscal 2023. The change in gross profit was primarily attributable to the following:
Net sales decreased by $89.2 million, or 10.1%, in fiscal 2024 compared to the prior year.
Merchandise margins, which exclude buying, occupancy and distribution expense, decreased by an unfavorable 34 basis points compared with fiscal 2023, when merchandise margins were unchanged over the prior year. While merchandise margins decreased year over year they remained healthy and continued to compare favorably to pre-pandemic levels.
Store occupancy expense increased by $2.6 million, or an unfavorable 160 basis points as a percentage of net sales, compared with last year.
Distribution expense, including costs capitalized into inventory, increased by $1.2 million, or an unfavorable 83 basis points as a percentage of net sales, compared to the prior year. The increase in expense primarily reflected decreased costs capitalized into inventory and higher trucking expense, partially offset by lower employee labor and benefit-related expense and lower fuel expense.
Selling and Administrative Expense . Selling and administrative expense decreased by $6.5 million, or 2.2%, to $290.1 million, or 36.5% of net sales, in fiscal 2024 from $296.6 million, or 33.5% of net sales, in fiscal 2023. The change in selling and administrative expense was primarily attributable to the following:
Administrative expense decreased by $3.8 million, primarily attributable to reduced legal expense, company performance-based incentive accruals and employee labor and associated staffing expense in the current fiscal year, partially offset by an increase in employee benefit-related expense primarily related to health and welfare benefits.
Store-related expense, excluding occupancy, decreased by $2.8 million, due largely to reductions in employee labor expense and credit card fees attributable to lower sales, partially offset by increases in employee benefit-related expense and higher utility expense. While employee labor expense decreased by $4.1 million, mainly as a result of managing employee labor hours in light of reduced sales, this reduction was partially offset by continuing wage rate pressures that include the incremental impact of legislated minimum wage rate increases primarily in California, where over half of our stores are located, as well as higher demand for labor in certain other markets in which we operate resulting in higher wage rates. Our lower year-over-year store-related expense also reflected reduced stores in operation, which declined to 422 stores at the end of fiscal 2024 from 430 stores at the end of fiscal 2023.
Advertising expense increased by $0.1 million and remains less than half of our pre-pandemic expense level.
Interest Expense (Income) . Interest expense increased by $1.2 million in fiscal 2024 compared to fiscal 2023 due primarily to higher year-over-year lease interest expense as a result of additional leases and rising overall interest rates, combined with decreased interest income.
Income Tax Expense (Benefit) . Income tax expense of $12.5 million for fiscal 2024 compared to a benefit of $3.5 million for fiscal 2023, primarily reflecting the establishment of a valuation allowance related to deferred tax assets in fiscal 2024.
Liquidity and Capital Resources
Our principal liquidity requirements are for working capital and capital expenditures. We fund our liquidity requirements primarily through cash on hand, cash flows from operations and borrowings from our revolving credit facility. We believe our cash on hand, future cash flows from operations and borrowings from our revolving credit facility will be sufficient to fund our cash requirements for at least the next 12 months.
We ended fiscal 2024 and 2023 with $5.4 million and $9.2 million of cash, respectively, and $13.8 million in revolving credit borrowings as of the end of fiscal 2024. The following table summarizes our cash flows from operating, investing and financing activities:
Fiscal Year
(In thousands)
Total cash (used in) provided by:
Operating activities
Investing activities
Financing activities
Net decrease in cash and cash equivalents
For fiscal 2024, we believe our lower net same store sales in part reflected a continuation of significant and persistent inflationary pressures that dampened consumer sentiment and weakened demand for discretionary products, which negatively affected sales. In response to weak sales, during fiscal 2024 we further reduced our merchandise inventory levels. Despite our reduction in year-over-year working capital, our operating cash flow for fiscal 2024 declined from fiscal 2023 due primarily to our lower net same store sales and resulting increased loss for the period.
For fiscal 2023, we believe our lower net same store sales in part reflected a continuation of significant and persistent inflationary pressures and heightened recessionary concerns that dampened consumer sentiment and weakened demand for discretionary products, which negatively affected sales. Consequently, after replenishing depleted merchandise inventory levels in fiscal 2022, in response to lower sales for fiscal 2023 we reduced our merchandise inventory balances. The increase in our operating cash flow for fiscal 2023 compared to the prior year primarily reflected our reduced funding of merchandise inventory partially offset by lower net income.
Operating Activities . Operating cash flows for fiscal 2024 and 2023 were a negative $11.4 million and a positive $18.5 million, respectively. The decreased cash flow from operating activities in fiscal 2024 compared to fiscal 2023 primarily reflects decreased net income, partially offset by a larger decrease in prepaid expense primarily related to insurance and income taxes and a smaller decrease in accrued expense related primarily to employee performance-based incentives and sales taxes accruals.
Investing Activities . Net cash used in investing activities for fiscal 2024 and 2023 was $10.9 million and $11.0 million, respectively. Capital expenditures, excluding non-cash acquisitions, represented substantially all of the cash used in investing activities for each period. Our capital expenditures primarily reflect store-related remodeling, new store openings, distribution center investments and computer hardware and software purchases. Capital expenditures by category are as follows:
Fiscal Year
(In thousands)
Store-related remodels
New stores
Computer hardware, software and other
Distribution center
Total
Capital expenditures in the fiscal years presented included investment in existing store remodeling to support our merchandising initiatives and enhancement of information security measures to support our infrastructure. Our capital expenditures included two new stores, including relocations, in fiscal 2024 and three new stores, including relocations, in fiscal 2023.
Financing Activities . Financing cash flows for fiscal 2024 and 2023 were a positive $18.4 million and a negative $23.9 million, respectively. For fiscal 2024, net cash was provided primarily from borrowings under our credit facility and reduced funding of outstanding checks, partially offset by cash used to make principal payments on finance lease liabilities and fund dividend payments. For fiscal 2023, net cash was used primarily to fund dividend payments and make principal payments on finance lease liabilities.
As of December 29, 2024, we had revolving credit borrowings of $13.8 million and letter of credit commitments of $6.1 million outstanding. These balances compare to no revolving credit borrowings and letter of credit commitments of $2.0 million outstanding as of December 31, 2023.
In fiscal 2024 and 2023 we paid cash dividends of $0.10 and $0.875 per share of outstanding common stock, respectively. The decrease in dividend payments in the current fiscal year reflected the suspension of our quarterly cash dividend in the second half of fiscal 2024. As of December 29, 2024, our Loan Agreement with Bank of America restricted future cash dividend payments until certain fixed charge coverage ratio requirements are met.
Periodically, we have repurchased our common stock in the open market pursuant to programs approved by our Board of Directors. We may repurchase our common stock for a variety of reasons, including, among other things, our alternative cash requirements, existing business conditions and the current market price of our stock. In the first quarter of fiscal 2022, our Board of Directors authorized a new share repurchase program of up to $25.0 million of our common stock, which replaced the previous share repurchase program. As of December 29, 2024, a total of $20.9 million remained available for share repurchases under our new share repurchase program. Under this program, we may purchase shares from time to time in the open market or in privately negotiated transactions in compliance with the applicable rules and regulations of the Securities and Exchange Commission. However, the timing and amount of such purchases, if any, would be at the discretion of our management and Board of Directors, and would depend on market conditions and other considerations. We did not repurchase any shares of common stock in fiscal 2024 or 2023. Since the inception of our initial share repurchase program in May 2006 through December 29, 2024, we have repurchased a total of 4,186,014 shares for $53.6 million. As of December 29, 2024, our Loan Agreement with Bank of America restricted future repurchases of our common stock until certain fixed charge coverage ratio requirements are met.
Loan Agreement . On December 18, 2024, we entered into an agreement to amend and extend our credit facility with Bank of America, N.A. (“BofA”), as administrative agent and lender (the “Loan Agreement”). The Loan Agreement has a maturity date of December 18, 2029 and amends and restates our prior financing agreement with BofA. Similar to the prior financing agreement, the Loan Agreement provides for a revolving credit facility with an aggregate committed availability of up to $150.0 million. We may also request additional increases in aggregate availability, up to a maximum of $200.0 million, in which case the existing lenders under the Loan Agreement will have the option to increase the commitment to accommodate the requested increase. If such existing lenders do not exercise that option, we may (with the consent of BofA in its role as the administrative agent, not to be unreasonably withheld) seek other lenders willing to provide such commitments. The credit facility includes a $50.0 million sublimit for issuances of letters of credit.
We may borrow under the Loan Agreement from time to time, provided the amounts outstanding will not exceed the lesser of the then aggregate committed availability (as discussed above) and the Borrowing Base (such lesser amount being referred to as the “Line Cap”). As defined in the Loan Agreement, the “Borrowing Base” generally is comprised of the sum, at the time of calculation, of (a) 90.00% of eligible credit card receivables; plus (b) the lesser of (i) the value of eligible inventory (other than eligible in-transit inventory), net of inventory reserves, multiplied by 75.00%, or (ii) the value of eligible inventory (other than eligible in-transit inventory), net of inventory reserves, multiplied by 85.00% of the appraised net orderly liquidation value of eligible inventory (expressed as a percentage of the cost of eligible inventory); plus (c) the lesser of (i) the value of eligible in-transit inventory, net of inventory reserves, multiplied by 75.00% , or (ii) the value of eligible in-transit inventory, net of inventory reserves, multiplied by 85.00% of the appraised net orderly liquidation value of eligible in-transit inventory (expressed as a percentage of the cost of eligible in-transit inventory); minus (d) certain agreed upon reserves as well as other reserves established by BofA in its role as the administrative agent in its reasonable discretion.
Generally, we may designate specific borrowings under the Loan Agreement as either base rate loans or term SOFR rate loans. The applicable interest rate on our borrowings is a function of the daily average, over the preceding fiscal quarter, of the excess of the Line Cap over amounts borrowed (such amount being referred to as the “Average Daily Availability”). Those loans designated as term SOFR rate loans bear interest at a rate equal to the then applicable adjusted SOFR rate plus an applicable margin as shown in the tables below. Those loans designated as base rate loans bear interest at a rate equal to the applicable margin for base rate loans (as shown below) plus the highest of (a) the rate of interest in effect for such day as announced from time to time within BofA as its “prime rate”, (b) the Federal funds rate, as in effect from time to time, plus one-half of one percent (0.50%), or (c) the term SOFR rate, plus one percentage point (1.00%). As set forth below, the applicable margin for all loans is a function of (i) the Average Daily Availability for the preceding fiscal quarter, and (ii) whether the “Financial Covenant Conversion Date” has occurred by achieving a fixed charge coverage ratio of at least 1.00 to 1.00 for a period of six (6) consecutive months, as measured on a trailing 12-month basis.
Level
Average Daily Availability
Base Rate
Applicable Margin
SOFR Rate
Applicable Margin
Greater than or equal to $112,500,000
Greater than or equal to $70,000,000 but less than $112,500,000
III
Greater than or equal to $45,000,000 but less than $70,000,000
Less than $45,000,000
For the period commencing on the Financial Covenant Conversion Date and continuing thereafter, the applicable margin for all loans is a function of Average Daily Availability for the preceding fiscal quarter as set forth below.
Level
Average Daily Availability
Base Rate
Applicable Margin
SOFR Rate
Applicable Margin
Greater than or equal to $70,000,000
Less than $70,000,000
As set forth below, the Loan Agreement requires us to pay a commitment fee assessed on the unused portion of the credit facility at the unused line fee rate specified below, which is a function of credit facility utilization, calculated as the daily average revolver usage for the month as a percentage of the applicable commitments during the preceding calendar month.
Through Financial Covenant Conversion Date
Utilization
Unused Line Fee Rate
Greater than or equal to 50%
Less than 50%
After Financial Covenant Conversion Date
Utilization
Unused Line Fee Rate
Greater than or equal to 50%
Less than 50%
Obligations under the Loan Agreement are secured by a general lien on and security interest in substantially all of our assets. The Loan Agreement contains covenants that require us to maintain a fixed charge coverage ratio of not less than 1.0:1.0 in certain circumstances after the Financial Covenant Conversion Date, and limits the ability to, among other things, incur liens, incur additional indebtedness, transfer or dispose of assets, change the nature of the business, guarantee obligations, pay dividends or make other distributions or repurchase stock, and make advances, loans or investments. We may generally declare or pay cash dividends or repurchase stock only if, among other things, the Financial Covenant Conversion Date has occurred, no default or event of default then exists or would arise from such dividend or repurchase of stock and, after giving effect to such dividend or repurchase, certain availability and/or fixed charge coverage ratio requirements are satisfied. The Loan Agreement contains customary events of default, including, without limitation, failure to pay when due principal amounts with respect to the credit facility, to pay any interest or other amounts under the credit facility, to comply with certain agreements or covenants contained in the Loan Agreement, to certain judgments us, to pay when due (or any other which permits the acceleration of) certain other material indebtedness in principal amount in excess of $5.0 million, and certain and events. The Loan Agreement also requires us to use BofA and its affiliates as our primary depository institution for all cash management and treasury needs.
The following table provides information about our revolving credit borrowings as of and for the periods indicated:
Fiscal Year
(Dollars in thousands)
Fiscal year-end balance
Average interest rate
Maximum outstanding during the year
Average outstanding during the year
Future Capital Requirements . We had cash of $5.4 million as of December 29, 2024. We expect capital expenditures for fiscal 2025, excluding non-cash acquisitions, to range from approximately $4.0 million to $8.0 million, primarily to fund store-related remodeling, distribution center investments and computer hardware and software purchases. For fiscal 2025, we do not anticipate opening any new stores and we anticipate closing approximately 15 stores.
We believe we will be able to fund our cash requirements from cash on hand, operating cash flows and borrowings from our credit facility, for at least the next 12 months.
Contractual Obligations . Our material contractual obligations include operating lease commitments associated with our leased properties and other occupancy expense, finance lease obligations, borrowings under our credit facility, if any, and other liabilities. Operating lease commitments consist principally of leases for our retail store facilities, distribution center and corporate offices. These leases frequently include options which permit us to extend the terms beyond the initial fixed lease term, and we intend to renegotiate most of these leases as they expire. Operating lease commitments also generally consist of information technology (“IT”) systems hardware, distribution center delivery tractors and vehicle leases. Additional information regarding our operating leases is available in Item 2, Properties and Note 7, Lease Commitments , of the Notes to Consolidated Financial Statements included in Item 8, Financial Statements and Supplementary Data , of this Annual Report on Form 10-K.
As of the end of fiscal 2024, we had $13.8 million of borrowings under our revolving credit facility and letter of credit commitments of $6.1 million outstanding, and as of the end of fiscal 2023, we had no borrowings under our revolving credit facility and letter of credit commitments of $2.0 million outstanding.
In the ordinary course of business, we enter into arrangements with vendors to purchase merchandise in advance of expected delivery. Because most of these purchase orders do not contain any termination payments or other penalties if cancelled, they are not considered as outstanding contractual obligations.
Critical Accounting Estimates
Our critical accounting estimates detailed below are included in our significant accounting policies as described in Note 2 of the Consolidated Financial Statements included in Item 8, Financial Statements and Supplementary Data , of this Annual Report on Form 10-K. Those consolidated financial statements were prepared in accordance with GAAP. Critical accounting estimates are those that we believe are most important to the portrayal of our financial condition and results of operations. The preparation of our consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expense. Our estimates are evaluated on an ongoing basis and drawn from historical experience, current trends and other factors that management believes to be relevant at the time our consolidated financial statements are prepared. Actual results may differ from our estimates. Management believes that the following accounting estimates are critical and reflect the more significant judgments and estimates we use in preparing our consolidated financial statements.
Valuation of Merchandise Inventories, Net
Our merchandise inventories are valued at the lower of cost or net realizable value using the weighted-average cost method that approximates the first-in, first-out (“FIFO”) method. Average cost consists of the direct purchase price of merchandise inventory, net of vendor allowances and cash discounts, in-bound freight-related costs and allocated overhead costs associated with our distribution center.
We record valuation reserves on a quarterly basis for merchandise items with slow-moving or obsolescence exposure and merchandise that has a carrying value that exceeds net realizable value. These reserves are estimates of a reduction in value to reflect inventory valuation at the lower of cost or net realizable value. Factors included in determining slow-moving or obsolescence reserve estimates include recent customer demand, merchandise aging, seasonal trends and decisions to discontinue certain products. Because of our merchandise mix, we have not historically experienced significant occurrences of obsolescence. Our inventory valuation reserves for damaged and defective merchandise, slow-moving or obsolete merchandise and for lower of cost or net realizable value provisions totaled $2.7 million and $2.2 million as of December 29, 2024 and December 31, 2023, respectively, representing approximately 1% of our merchandise inventory for both periods.
A 10% change in our inventory valuation reserves estimate in total as of December 29, 2024, would result in a change in reserves of $0.3 million and a change in pre-tax earnings by the same amount. Our reserves are estimates, which could vary significantly, either favorably or unfavorably, from actual results if future economic conditions, consumer demand and competitive environments differ from our expectations. At this time, we do not believe that there is a reasonable likelihood that there will be a material change in the future estimates or assumptions that we use to calculate our inventory reserves.
Valuation of Long-Lived Assets
In accordance with Accounting Standards Codification 360, Property, Plant and Equipmen t, we review our long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable.
Long-lived assets are reviewed for recoverability at the lowest level in which there are identifiable cash flows (“asset group”), usually at the store level. The carrying amount of a store asset group includes stores’ operating lease right-of-use (“ROU”) assets and property and equipment, which consists primarily of leasehold improvements. Factors that could trigger an impairment review include a current-period operating or cash flow loss combined with a history of operating or cash flow losses, and a projection that demonstrates continuing losses or insufficient income over the remaining reasonably certain lease term associated with the use of a store asset group. Other factors may include an adverse change in the business climate or an adverse action or assessment by a regulator in the market of a store asset group.
We evaluate the store asset groups with indicators of impairment by estimating future undiscounted cash flows of a store asset group over its remaining reasonably certain lease term to determine whether the long-lived assets are recoverable. In situations where the carrying amount of the store asset group exceeds the undiscounted cash flows, a fair value of the store asset group is determined using discounted cash flow valuation techniques and impairment is recognized when the carrying amount exceeds the fair value.
We determine the sum of the undiscounted cash flows expected to result from the asset group by projecting future revenue, gross margin and operating expense for each store under evaluation for impairment. The estimates of future cash flows involve management judgment and are based upon assumptions about expected future operating performance. Assumptions used in these forecasts are consistent with internal planning, and include assumptions about sales growth rates, gross margins, operating expense in relation to the current economic environment and our future expectations, competitive factors in our various markets, inflation, sales trends and other relevant environmental factors that may impact the store under evaluation. The actual cash flows could differ from management’s estimates due to changes in business conditions, operating performance and economic conditions.
The resulting impairment charge, if any, is allocated to the property and equipment, primarily leasehold improvements, and operating lease ROU assets on a pro rata basis using the relative carrying amounts of those assets. The allocated impairment charge to a long-lived asset is limited to the extent that the impairment charge does not reduce the carrying amount of an individual long-lived asset below its individual fair value. The estimation of the fair value of an ROU asset involves the evaluation of current market value rental amounts for leases associated with ROU assets. The estimates of current market value rental amounts are primarily based on recent observable market rental data of other comparable retail store locations. The fair value of an ROU asset is measured using a discounted cash flow valuation technique by discounting the estimated current and future market rental values using a property-specific discount rate.
Our evaluation resulted in impairment charges recognized in fiscal 2024 and 2023 of $0.8 million and $0.6 million, respectively.
Seasonality and Impact of Inflation
We experience seasonal fluctuations in our net sales and operating results, which can suffer when weather does not conform to seasonal norms. Seasonality in our net sales influences our buying patterns which directly impacts our merchandise and accounts payable levels and cash flows. We purchase merchandise for seasonal activities in advance of a season and supplement our merchandise assortment as necessary and when possible during the season. Our efforts to replenish products during a season are not always successful. In the fourth fiscal quarter, which includes the holiday selling season and the start of the winter selling season, we normally experience higher inventory purchase volumes and increased expense for staffing and advertising. If we miscalculate the consumer demand for our products generally or for our product mix in advance of a season, particularly the fourth quarter, our net sales can decline, which can harm our financial performance. A significant shortfall from expected net sales, particularly during the fourth quarter, can negatively impact our annual operating results.
In fiscal 2023 and 2024, we experienced significant inflation in the cost of products that we purchase for resale. While our merchandise inventory costs have been impacted by inflationary pressures, we have generally been able to adjust our selling prices in response to these higher product purchase costs. However, if we are unable to adjust our selling prices for product purchase cost increases that might occur in the future, then our merchandise margins could decline, which would adversely impact our operating results. In fiscal 2023 and 2024, we experienced broad-based inflationary pressures which adversely impacted many categories of costs and expenses, including increased wage-rate pressures, and which are expected to continue during fiscal 2025.
Recently Issued Accounting Updates
See Note 2 to the Consolidated Financial Statements included in Item 8, Financial Statements and Supplementary Data , of this Annual Report on Form 10-K.
ITEM 7A. QUANTITATIVE AND QUALITAT IVE DISCLOSURES ABOUT MARKET RISK
Because we are a smaller reporting company as defined by Rule 12b-2 of the Exchange Act, we are not required to provide the information under this item.
ITEM 8. FINANCIAL STATEMEN TS AND SUPPLEMENTARY DATA
The financial statements and the supplementary financial information required by this Item and included in this Annual Report on Form 10-K are listed in the “Index to Consolidated Financial Statements” beginning on page F-1.
