UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

(Mark One)

x		QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended July 2, 2006

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: 000-49850

Registrant’s telephone number, including area code: (310) 536-0611

     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  x     No  o

     Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act (check one):

Large accelerated filer  o		Accelerated filer  x		Non-accelerated filer  o

     Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes  o     No  x

     There were 22,709,627 shares of common stock, with a par value of $0.01 per share outstanding at August 4, 2006.

 

 

BIG 5 SPORTING GOODS CORPORATION

INDEX

						Page
PART I – FINANCIAL INFORMATION
Item 1				Financial Statements
				Unaudited Condensed Consolidated Balance Sheets at July 2, 2006 and January 1, 2006			3
				Unaudited Condensed Consolidated Statements of Operations for the Thirteen and Twenty Six Weeks Ended July 2, 2006 and July 3, 2005			4
				Unaudited Condensed Consolidated Statements of Cash Flows for the Twenty Six Weeks Ended July 2, 2006 and July 3, 2005			5
				Notes to Unaudited Condensed Consolidated Financial Statements			6
Item 2				Management’s Discussion and Analysis of Financial Condition and Results of Operations			14
Item 3				Quantitative and Qualitative Disclosures About Market Risk			24
Item 4				Controls and Procedures			25
PART II – OTHER INFORMATION
Item 1				Legal Proceedings			27
Item 1A				Risk Factors			27
Item 2				Unregistered Sales of Equity Securities and Use of Proceeds			28
Item 3				Defaults Upon Senior Securities			28
Item 4				Submission of Matters to a Vote of Security Holders			28
Item 5				Other Information			29
Item 6				Exhibits			29
SIGNATURES							30
EXHIBIT 10.1
EXHIBIT 31.1
EXHIBIT 31.2
EXHIBIT 32.1
EXHIBIT 32.2

PART I. FINANCIAL INFORMATION

See accompanying notes to unaudited condensed consolidated financial statements.

See accompanying notes to unaudited condensed consolidated financial statements.

BIG 5 SPORTING GOODS CORPORATION

2006. The fiscal interim periods ended July 2, 2006, April 2, 2006, July 3, 2005 and April 3, 2005 were comprised of 13 weeks.

Use of Estimates

     Management of the Company has made a number of estimates and assumptions relating to the reporting of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and reported amounts of revenues and expenses during the reporting period to prepare these financial statements in conformity with GAAP. Significant items subject to such estimates and assumptions include the value of stock options; the carrying amount of property and equipment, intangibles and goodwill; valuation allowances for receivables, sales returns, inventories and deferred income tax assets; and obligations related to litigation, workers’ compensation and employee benefits. Actual results could differ significantly from these estimates under different assumptions and conditions.

Segment Reporting

     Given the economic characteristics of the Company’s store formats, the similar nature of the products sold, the type of customer and the method of distribution, its operations are aggregated in one reportable segment as defined by Statement of Financial Accounting Standards (“SFAS”) No. 131, Disclosure About Segments of an Enterprise and Related Information.

Reclassifications

     Certain prior period amounts have been reclassified to conform to the current year presentation.

Stock-Based Compensation

     In June 2002, the Company adopted the 2002 Stock Incentive Plan (“2002 Plan”). The 2002 Plan provides for the grant of incentive stock options and non-qualified stock options to the Company’s employees, directors, and specified consultants. Under the 2002 Plan, the Company may grant options to purchase up to 3,645,000 shares of common stock. At July 2, 2006, 2,411,850 shares remained available for future grant under the 2002 Plan. Options granted under the 2002 Plan generally vest and become exercisable at the rate of 25% per year with a maximum life of ten years. Upon exercise of granted options, shares are expected to be issued from new shares previously registered for the 2002 Plan.

     In the first quarter of fiscal 2006, the Company adopted SFAS No. 123(R), Share-Based Payment , in accordance with the modified-prospective-transition method and began recognizing compensation expense for stock options which vested during the quarter. The adoption of this method increased compensation expense by $0.7 million and $1.1 million for the 13 weeks and 26 weeks ended July 2, 2006, respectively, and reduced operating income and income before income taxes by the same amount. The recognized tax benefit related to the compensation expense for the 13 weeks and 26 weeks ended July 2, 2006 was $0.3 million and $0.4 million, respectively. Net income for the 13 weeks and 26 weeks ended

July 2, 2006 was reduced by $0.4 million, or $0.02 per basic and diluted share, and $0.7 million, or $0.03 per basic and diluted share, respectively.

     A summary of the status of the Company’s stock options is presented below:

     The aggregate intrinsic value in the preceding table represents the total pretax intrinsic value, based upon the Company’s closing stock price of $19.50 as of July 2, 2006, which would have been received by the option holders had all option holders exercised their options as of that date. The total intrinsic value of stock options exercised for the 26 weeks ended July 2, 2006 and July 3, 2005 was approximately $0.2 million and $1,600, respectively.

     The fair value of each option was estimated on the date of grant using the Black-Scholes method based on the following weighted-average assumptions:

     The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of grant for periods corresponding with the expected term of the option; the expected term represents the weighted-average period of time that options granted are expected to be outstanding giving consideration to vesting schedules and using the simplified method pursuant to Staff Accounting Bulletin (“SAB”) No. 107, Share-based Payment ; the expected volatility is based upon historical volatilities of the Company’s common stock and an index of a peer group because the Company’s historical period to measure volatility was not long

enough to cover the expected terms of the options; and the expected dividend yield is based upon the Company’s current dividend rate and future expectations.

     Pursuant to SFAS No. 123(R), the weighted-average fair value of stock options granted during the 13 weeks and 26 weeks ended July 2, 2006 was $9.79 per share and $8.96 per share, respectively. The Company did not grant any stock options during the 26 weeks ended July 3, 2005. The total cash received from employees as a result of employee stock option exercises during the 13 weeks and 26 weeks ended July 2, 2006 was approximately $49,000 and $0.2 million, respectively. The total cash received from employees as a result of employee stock option exercises during the 26 weeks ended July 3, 2005, was $4,100. There were no options exercised during the 13 weeks ended July 3, 2005.

     As of July 2, 2006, there was $6.3 million of total unrecognized compensation cost related to nonvested stock options granted. That cost is expected to be recognized over a weighted-average period of 3.1 years. The total fair value of shares vested during the 26 weeks ended July 2, 2006 and the 26 weeks ended July 3, 2005 was $0.7 million and $1.7 million, respectively.

     Awards which vested in fiscal 2005 and earlier were accounted for under the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25 (“APB 25”). No compensation expense related to options was recognized because the exercise price of our employee stock options equaled the market price of the underlying stock on the grant date. If we had elected to recognize compensation cost based on the fair value of the awards at the grant date under SFAS No. 123, net earnings would have been the pro forma amounts shown below:

     The effects of applying SFAS No. 123 in the above pro forma disclosures are not necessarily indicative of future amounts. The fair value of each option was estimated on the date of grant using the Black-Scholes method based on the following weighted-average assumptions:

Valuation of Merchandise Inventories

     The Company’s merchandise inventories are made up of finished goods and are valued at the lower of cost or market using the weighted-average cost method that approximates the first-in, first-out (“FIFO”) method. Average cost includes the direct purchase price of merchandise inventory and allocated overhead costs associated with the Company’s distribution center. Management has evaluated the current level of inventories in comparison to planned sales volume and other factors and, based on this evaluation, has recorded adjustments to inventory and cost of goods sold for estimated decreases in inventory value.

     Inventory shrinkage is accrued as a percentage of merchandise sales based on historical inventory shrinkage trends. The Company performs physical inventories of stores and its distribution center throughout the year. The reserve for inventory shrinkage represents an estimate for inventory shrinkage for each location since the last physical inventory date through the reporting date.

Recently Issued Accounting Pronouncements

     In July 2006, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 48 (“FIN 48”), Accounting for Uncertainty in Income Taxes – an Interpretation of FASB Statement No. 109 . FIN 48 clarifies the accounting for income taxes by prescribing the minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. FIN 48 also provides guidance on derecognition, measurement, classification, interest and penalties, accounting in interim periods, disclosure and transition. In addition, FIN 48 excludes income taxes from SFAS No. 5, Accounting for Contingencies . FIN 48 is effective for fiscal years beginning after December 15, 2006 and provides transitional guidance for treating differences between the amounts recognized in the statements of financial position prior to the adoption of FIN 48 and the amounts reported after adoption. The Company does not expect that FIN 48, when adopted, will have a material impact on the Company’s consolidated financial statements.

     In July 2006, the Emerging Issues Task Force (“EITF”) promulgated Issue No. 06-3, How Taxes Collected from Customers and Remitted to Governmental Authorities Should be Presented in the Income Statement (i.e., Gross Versus Net Presentation) . The task force concluded that entities should present these taxes in the income statement on either a gross or a net basis based upon their accounting policy. However, Issue No. 06-3 states that if such taxes are significant, and are presented on a gross basis, the amounts of those taxes should be disclosed. The Company currently records taxes on a net basis (i.e., sales tax is not included in sales, but is instead recorded as a liability under accrued expenses), so Issue No. 06-3 is not expected to have an impact on the Company’s consolidated financial statements.

     There are no other accounting standards issued as of August 11, 2006 that are expected to have a material impact on the Company’s consolidated financial statements.

(2) Quarterly Dividend

     Quarterly dividend payments of $0.07 per share were paid during fiscal 2005. For fiscal 2006, a quarterly dividend of $0.07 per share was paid in the first quarter. In the second quarter of fiscal 2006, the Company’s Board of Directors authorized an increase of the dividend to an annual rate of $0.36 per share of outstanding common stock, and declared a quarterly cash dividend of $0.09 per share which was paid on June 15, 2006 to stockholders of record as of June 1, 2006. In the third quarter of fiscal 2006, the Company’s Board of Directors declared a quarterly cash dividend of $0.09 per share of outstanding common stock, which will be paid on September 15, 2006 to stockholders of record as of September 1, 2006.

(3) Earnings Per Share

     The Company calculates earnings per share in accordance with SFAS No. 128, Earnings Per Share , which requires a dual presentation of basic and diluted earnings per share. Basic earnings per share is calculated by dividing net income available to common stockholders by the weighted-average shares of common stock outstanding during the period. Diluted earnings per share is calculated by using the weighted-average shares of common stock outstanding adjusted to include the potentially dilutive effect of outstanding stock options.

     The following table sets forth the computation of basic and diluted net income per common share:

     The computation of diluted earnings per share for the 13 weeks ended July 2, 2006, the 26 weeks ended July 2, 2006, the 13 weeks ended July 3, 2005, and the 26 weeks ended July 3, 2005 does not include 877,090, 697,042, 2,500 and 2,500 options, respectively, that were outstanding and had an antidilutive effect on those dates.

(4) Long-Term Debt

     On December 15, 2004, we entered into a $160.0 million financing agreement with The CIT Group/Business Credit, Inc. and a syndicate of other lenders. On May 24, 2006, we amended the financing agreement to, among other things, increase the line of credit to $175.0 million, consisting of a non-amortizing $161.7 million revolving credit facility and an amortizing term loan balance of $13.3 million. The initial termination date of the revolving credit facility is March 20, 2011 (subject to annual extensions thereafter). The financing agreement is secured by a first priority security interest in substantially all of our assets.

     The revolving credit facility may be terminated by the lenders by giving at least 90 days prior written notice before any anniversary date, commencing with its anniversary date on March 20, 2011. We may terminate the revolving credit facility by giving at least 30 days prior written notice, provided that if we terminate prior to March 20, 2011, we must pay an early termination fee. Unless it is terminated, the revolving credit facility will continue on an annual basis from anniversary date to anniversary date beginning on March 21, 2011.

     The revolving credit facility bears interest at various rates based on our overall borrowings, with a floor of LIBOR plus 1.00% or the JP Morgan Chase Bank prime lending rate and a ceiling of LIBOR plus 1.75% or the JP Morgan Chase Bank prime lending rate plus 0.25%.

     A principal payment on the term loan of $6.7 million is due December 15, 2007, with the remaining balance due December 15, 2008. On June 30, 2006 we prepaid $5.0 million of the term loan to bring the outstanding balance at July 2, 2006 to $8.3 million. We may prepay without penalty the principal amount of the term loan, subject to certain financial restrictions. The term loan bears interest at LIBOR plus 3.00% or the JP Morgan Chase Bank prime lending rate plus 1.00%.

(5) Contingencies

     On August 12, 2005, the Company was served with a complaint filed in the California Superior Court in the County of Los Angeles, entitled William Childers v. Sandra N. Bane, et al., Case No. BC337945 (“Childers”), alleging breach of fiduciary duty, violation of the Company’s bylaws and unjust enrichment by certain executive officers. On November 17, 2005, the plaintiff filed an amended complaint in this action. The amended complaint was brought as a purported derivative action on behalf of the Company against all of the members of the Company’s Board of Directors and certain executive officers. The amended complaint alleges that the Company’s directors breached their fiduciary duties and violated the Company’s bylaws by, among other things, failing to hold an annual stockholders’ meeting on a timely basis and allegedly ignoring certain unspecified internal control problems, and that certain executive officers were unjustly enriched by their receipt of certain compensation items. The amended complaint seeks an order requiring that an annual meeting of the Company’s stockholders be held, an award of unspecified damages in favor of the Company and against the individual defendants and an award of attorneys’ fees. On January 20, 2006, the Company filed a demurrer to the amended complaint (as did the individual director and officer defendants). At a hearing on April 3, 2006, the court sustained the demurrers and granted the plaintiff leave to further amend the complaint and to seek limited discovery.

     Prior to the filing of any further amendment to the complaint, and following arms-length negotiations, the parties came to an agreement in principle to settle the matter. Terms of the proposed settlement include no admission of liability with regard to the litigation by the Company or any individual defendant, an acknowledgment by the Company that the litigation preceded the adoption or implementation of certain measures, internal controls and procedures that relate to certain of the allegations raised in the litigation and thus confer a benefit to the Company, and the payment by the Company’s insurance carrier of $150,000 in plaintiffs’ attorneys’ fees on behalf of the Company and the individual director and officer defendants. The settlement remains subject to, among other things, the parties’ approval and execution of definitive settlement agreements with respect to the matters described above and judicial approval of the settlements by the court.

     In addition, the Company is involved in various claims and legal actions arising in the ordinary course of business. In the opinion of management, the ultimate disposition of these matters will not have a material adverse effect on the Company’s financial position, results of operations or liquidity.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

CRITICAL ACCOUNTING POLICIES

     We believe that the following discussion addresses our critical accounting policies, which are those that are most important to the portrayal of our financial condition.

Use of Estimates

     We have made a number of estimates and assumptions relating to the reporting of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and reported amounts of revenues and expenses during the reporting period to prepare these financial statements in conformity with accounting principles generally accepted in the United States (“GAAP”). Significant items subject to such estimates and assumptions include the value of stock options; the carrying amount of property and equipment, intangibles and goodwill; valuation allowances for receivables, sales returns, inventories and deferred income tax assets; and obligations related to litigation, workers’ compensation and employee benefits. Actual results could differ significantly from these estimates under different assumptions and conditions.

Revenue Recognition

     We earn revenue by selling merchandise primarily through our retail stores. Also included in revenue are sales of returned merchandise to vendors specializing in the resale of defective or used products, which historically has accounted for less than 1% of net sales. Revenue is recognized when merchandise is purchased by and delivered to the customer and is shown net of estimated returns during the relevant period. The allowance for sales returns is estimated based upon historical experience. Cash received from the sale of gift cards is recorded as a liability, and revenue is recognized upon the redemption of the gift card or when it is determined that the likelihood of redemption is remote and no liability to relevant jurisdictions exists. Installment payments on layaway sales are recorded as a liability, and revenue is recognized upon receipt of final payment from and delivery of product to the customer.

Valuation of Merchandise Inventories

     Our merchandise inventories are made up of finished goods and are valued at the lower of cost or market using the weighted-average cost method that approximates the first-in, first-out (“FIFO”) method. Average cost includes the direct purchase price of merchandise inventory and allocated overhead costs associated with our distribution center. Management has evaluated the current level of inventories in comparison to planned sales volume and other factors and, based on this evaluation, has recorded adjustments to inventory and cost of goods sold for estimated decreases in inventory value. These adjustments 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. We are not aware of any events or changes in demand or price that would indicate to us that our inventory valuation may be materially inaccurate at this time.

     Inventory shrinkage is accrued as a percentage of merchandise sales based on historical inventory shrinkage trends. We perform physical inventories of our stores and distribution center throughout the year. The reserve for inventory shrinkage represents an estimate for inventory shrinkage for each location since the last physical inventory date through the reporting date.

Valuation of Long-Lived Assets

     Long-lived assets and certain identifiable intangibles are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of the assets to future net cash flows estimated by us to be generated by these assets. If such assets are considered to be impaired, the impairment to be recognized is the amount by which the carrying amount of the assets exceeds the fair value of the assets. We are not aware of any events or changes in circumstances that would indicate to us that our long-lived assets are impaired. We did not recognize any significant impairment charges in the 13 or 26 weeks ended July 2, 2006 or the 13 or 26 weeks ended July 3, 2005.

Leases

     We lease the majority of our store locations. We account for our leases under the provisions of SFAS No. 13, Accounting for Leases , and subsequent amendments, which require that our leases be evaluated and classified as operating or capital leases for financial reporting purposes.

     Certain leases have scheduled rent increases. In addition, certain leases include an initial period of free or reduced rent as an inducement to enter into the lease agreement (“rent holidays”). We recognize rental expense for rent escalations and rent holidays on a straight-line basis over the terms of the underlying leases, without regard to when rent payments are made. The calculation of straight-line rent is based on the reasonably assured lease term as defined in SFAS No. 98, Accounting for Leases , which may exceed the initial non-cancelable lease term.

     Certain leases also may provide for payments based on future sales volumes at the leased location, which are not measurable at the inception of the lease. In accordance with SFAS No. 29, Determining Contingent Rentals, an amendment of FASB Statement No. 13 , these contingent rents are expensed as they accrue.

      Net Sales . Net sales increased by $13.7 million, or 6.9%, to $211.8 million in the 13 weeks ended July 2, 2006 from $198.1 million in the same period last year. The growth in net sales is mainly attributable to an increase of $5.8 million in same store sales and an increase of $7.4 million in new store sales, net of sales for closed stores, which reflected the opening of 21 new stores, net of relocations, since April 3, 2005. Same store sales increased 2.9% in the 13 weeks ended July 2, 2006 versus the 13 weeks ended July 3, 2005. The increase in net sales for the 13 weeks ended July 2, 2006 was attributable to higher sales in each of our three major merchandise categories of footwear, hard goods and apparel. Store count at July 2, 2006 was 329 versus 311 at July 3, 2005. We opened three new stores in the 13 weeks ended July 2, 2006, and opened three stores, one of which was a relocation of an existing store, in the 13 weeks ended July 3, 2005. We expect to open approximately 20 new stores during fiscal 2006.

      Gross Profit . Gross profit increased by $4.3 million, or 5.9%, to $76.7 million in the 13 weeks ended July 2, 2006 from $72.4 million in the 13 weeks ended July 3, 2005. Our gross profit margin was 36.2% in the 13 weeks ended July 2, 2006 compared to 36.6% in the same period last year. Product selling margins, which exclude buying, occupancy and distribution costs, increased 20 basis points versus the same period in the prior year. Distribution center costs during the second quarter increased $2.2 million, or 70 basis points, due primarily to the commencement of operations at our new distribution center, higher labor-related costs and increased trucking expense related in part to higher gasoline prices. Store occupancy costs also increased by $1.1 million, or 10 basis points, year-over-year due mainly to new store openings. Distribution center costs capitalized into inventory for the

second quarter increased by $0.4 million, or 10 basis points, compared to the same period in the prior year, primarily due to higher costs related to our new distribution center and increased merchandise inventory. Inventory reserve provisions decreased by $0.2 million, or 20 basis points, from the prior year due primarily to a lower provision for shrink offset partially by an increased provision for the realizability of the value of returned goods. Also, in the 13 weeks ended July 3, 2005 we received $0.4 million, or 20 basis points, in insurance reimbursement related to flood damage to one of our stores which occurred in the first quarter of fiscal 2005.

      Selling and Administrative . Selling and administrative expenses increased by $1.1 million to $58.6 million, or 27.7% of net sales, in the 13 weeks ended July 2, 2006 from $57.5 million, or 29.0% of net sales, in the same period last year. Store-related expenses, excluding occupancy, increased by $1.5 million due primarily to an increase in store count. Store-related expenses for the second quarter of this year were favorably impacted by a reduction of $0.4 million in workers’ compensation reserves and the Company’s receipt of $0.7 million of proceeds as a participant in the settlement of a class-action lawsuit relating to credit card fees, which favorable impacts were partially offset by an increased provision of $0.6 million for public liability claims. Store-related expenses, excluding occupancy, declined 40 basis points as a percentage of sales, due in part to the favorable items noted above and because our sales level for the current period allowed leveraging of these expenses. Advertising expense decreased by $0.2 million, or 50 basis points, from the prior year due primarily to the benefit of recording co-op advertising cost reimbursements from vendors for fiscal 2006 earlier in the year. Stock-based compensation expense increased $0.6 million, or 30 basis points, due to the Company’s implementation of SFAS No. 123(R) on January 2, 2006. Legal and audit fees decreased $1.4 million, or 70 basis points, from the prior year due to additional expense in the prior year related to the restatement of our prior period financial statements.

      Depreciation and Amortization . Depreciation and amortization expense increased $0.5 million, or 14.9%, to $4.0 million for the 13 weeks ended July 2, 2006 from $3.5 million for the same period last year. The higher expense was primarily due to the commencement of operations at our new distribution center as well as the increase in store count to 329 stores at the end of the second quarter of fiscal 2006 from 311 stores at the end of the second quarter of fiscal 2005.

      Interest Expense . Interest expense increased by $0.6 million, or 45.7%, to $1.9 million in the 13 weeks ended July 2, 2006 from $1.3 million in the same period last year. The increase in interest expense primarily reflects the impact of rising interest rates on our variable rate debt and higher average debt levels.

      Income Taxes . The provision for income taxes was $4.8 million for the 13 weeks ended July 2, 2006 and $4.0 million for the 13 weeks ended July 3, 2005. Our effective tax rate was 39.4% for both the second quarter of fiscal 2006 and the second quarter of fiscal 2005.

26 Weeks Ended July 2, 2006 Compared to 26 Weeks Ended July 3, 2005

     The following table sets forth selected items from our operating results as a percentage of our net sales for the periods indicated:

      Net Sales . Net sales increased by $30.8 million, or 7.9%, to $419.0 million in the 26 weeks ended July 2, 2006 from $388.2 million in the same period last year. The growth in net sales is mainly attributable to an increase of $15.6 million in same store sales and an increase of $14.4 million in new store sales, net of sales for closed stores, which reflected the opening of 22 new stores, net of relocations, since January 2, 2005. Same store sales increased 4.1% in the 26 weeks ended July 2, 2006 versus the 26 weeks ended July 3, 2005. The net sales increase was due to higher sales in each of our three major merchandise categories of footwear, hard goods and apparel. Store count at July 2, 2006 was 329 versus 311 at July 3, 2005. We opened five new stores in the 26 weeks ended July 2, 2006, and we opened four new stores, two of which were relocations, in the 26 weeks ended July 3, 2005. We expect to open approximately 20 new stores during fiscal 2006.

      Gross Profit . Gross profit increased by $9.8 million, or 7.0%, to $150.1 million in the 26 weeks ended July 2, 2006 from $140.3 million in the same period last year. The gross profit margin was 35.8% in the 26 weeks ended July 2, 2006 compared to 36.1% in the prior year period. Product selling margins, which exclude buying, occupancy and distribution costs, were up slightly from the same period last year. Distribution center costs during the period increased by $6.8 million, or 130 basis points, due primarily to the commencement of operations at our new distribution center, higher labor-related costs and increased trucking expense related in part to higher gasoline prices. Store occupancy costs increased by $2.3 million, or 10 basis points, over the same period last year, due mainly to new store openings. Distribution center costs capitalized into inventory increased by $2.2 million, or 50 basis points, compared to the prior year period due primarily to higher costs for our new distribution center. Inventory reserve provisions decreased by $1.5 million, or 40 basis points, from the prior year due primarily to lower provisions for shrink and for the realizability of the value of returned goods inventories.

      Selling and Administrative . Selling and administrative expenses increased by $5.8 million to $116.0 million, or 27.7% of net sales, in the 26 weeks ended July 2, 2006 from $110.2 million, or 28.4% of net sales, in the same period last year. Store-related expenses, excluding occupancy, increased by $3.5 million due primarily to an increase in store count. Store-related expenses for the first half of this year were favorably impacted by a reduction of $0.4 million in workers’ compensation reserves and the Company’s receipt of $0.7 million of proceeds as a participant in the settlement of a class-action lawsuit relating to credit card fees, which favorable impacts were partially offset by an increased provision of $0.6 million for public liability claims. Store-related expenses, excluding occupancy, declined 40 basis points as a percentage of sales, due in part to the favorable items noted above and because our sales level for the current period allowed leveraging of these expenses. Advertising expense increased by $0.1 million compared to last year, but declined 50 basis points as a percentage of sales, due primarily to the benefit of recording co-op advertising cost reimbursements from vendors for fiscal 2006 earlier in the year. Selling and administrative expenses for fiscal 2006 reflect stock-based compensation expense of $1.0 million due to the Company’s implementation of SFAS No. 123(R) on January 2, 2006.

      Depreciation and Amortization . Depreciation and amortization expense increased $1.5 million, or 21.2%, to $8.4 million for the 26 weeks ended July 2, 2006 from $6.9 million for the same period last year. The higher expense this year is primarily due to the commencement of operations at our new distribution center and the increase in store count to 329 stores at July 2, 2006 from 311 stores at July 3, 2005.

      Interest Expense . Interest expense increased by $1.3 million, or 52.6%, to $3.7 million in the 26 weeks ended July 2, 2006 from $2.4 million in the same period last year. The increase in interest expense primarily reflects the impact of rising interest rates on our variable rate debt and higher average debt levels.

      Income Taxes . The provision for income taxes was $8.7 million for the 26 weeks ended July 2, 2006 and $8.2 million for the 26 weeks ended July 3, 2005. Our effective tax rate was 39.4% for both periods.

LIQUIDITY AND CAPITAL RESOURCES

     Our principal liquidity requirements are for working capital and capital expenditures. We fund our liquidity requirements with cash on hand, cash flow from operations and borrowings from the revolving credit facility under our financing agreement.

      Operating Activities . Net cash used in operating activities was $1.0 million for the first 26 weeks of fiscal 2006 and $0.3 million for the first 26 weeks of fiscal 2005. The decrease for fiscal 2006 primarily reflects increased funding for working capital partially offset by higher net income versus the same period last year. Comparing the first half of fiscal 2006 to the corresponding period in the prior year, the increased use of cash to purchase merchandise inventories and to fund a reduction in accrued expenses, for employee benefits and other expenses, was partially offset by the positive cash flow effect of higher accounts payable.

      Investing Activities . Net cash used in investing activities for the first 26 weeks of fiscal 2006 and fiscal 2005 was $5.0 million and $17.1 million, respectively. Capital expenditures, excluding non-cash acquisitions, for the first 26 weeks of fiscal 2006 were $5.2 million compared to $17.2 million for the same period last year. The higher capital expenditures last year reflect expenditures for our new distribution center.

      Financing Activities . Net cash provided by financing activities for the first 26 weeks of fiscal 2006 and fiscal 2005 was $8.2 million and $18.4 million, respectively. Cash requirements were provided by our revolving credit facility to finance working capital, capital expenditures and dividend payments.

     As of July 2, 2006, we had revolving credit borrowings of $101.3 million, a term loan balance of $8.3 million and letter of credit commitments of $0.6 million outstanding under our financing agreement. These balances compare to revolving credit borrowings of $87.1 million, a term loan balance of $20.0 million and letter of credit commitments of $0.5 million outstanding under our financing agreement as of July 3, 2005.

      Future Capital Requirements . We had cash and cash equivalents on hand of $8.2 million at July 2, 2006. We expect capital expenditures for the second half of fiscal 2006, excluding non-cash acquisitions, to range from $9.0 million to $10.0 million, primarily to fund the opening of approximately 15 new stores, store-related remodeling, distribution center and corporate office improvements and computer hardware and software purchases.

     We believe we will be able to fund our future cash requirements for operations from cash on hand, operating cash flows and borrowings from the revolving credit facility under our financing agreement. We believe these sources of funds will be sufficient to continue our operations and planned capital expenditures, satisfy our scheduled payments under debt obligations, repurchase common stock and pay quarterly dividends for at least the next twelve months. However, our ability to satisfy such obligations depends upon our future performance, which in turn is subject to general economic conditions and regional risks, and to financial, business and other factors affecting our operations, including factors beyond our control. See Item 1A, “Risk Factors” included in this report and in our Annual Report on Form 10-K for the fiscal year ended January 1, 2006.

     If we are unable to generate sufficient cash flow from operations to meet our obligations and commitments, we will be required to refinance or restructure our indebtedness or raise additional debt or equity capital. Additionally, we may be required to sell material assets or operations, suspend dividend payments or delay or forego expansion opportunities. We might not be able to effect these alternative strategies on satisfactory terms, if at all.

      Contractual Obligations and Other Commitments . Our material off-balance sheet contractual commitments are operating lease obligations and letters of credit. We excluded these items from the balance sheet in accordance with GAAP.

     Operating lease commitments consist principally of leases for our retail store facilities, distribution center and corporate office. These leases frequently include options

which permit us to extend the terms beyond the initial fixed lease term. With respect to most of those leases, we intend to renegotiate those leases as they expire. Capital lease commitments consist principally of leases for our distribution center trailers and management information systems hardware. Payments for these lease commitments are provided for by cash flows generated from operations or through borrowings from the revolving credit facility under our financing agreement.

     Issued and outstanding letters of credit were $0.6 million at July 2, 2006, and were related primarily to importing of merchandise and funding insurance program liabilities.

     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 included as outstanding contractual obligations.

      Financing Agreement . On December 15, 2004, we entered into a $160.0 million financing agreement with The CIT Group/Business Credit, Inc. and a syndicate of other lenders. On May 24, 2006, we amended the financing agreement to, among other things, increase the line of credit to $175.0 million, consisting of a non-amortizing $161.7 million revolving credit facility and an amortizing term loan balance of $13.3 million. The initial termination date of the revolving credit facility is March 20, 2011 (subject to annual extensions thereafter). The financing agreement is secured by a first priority security interest in substantially all of our assets.

     The revolving credit facility may be terminated by the lenders by giving at least 90 days prior written notice before any anniversary date, commencing with its anniversary date on March 20, 2011. We may terminate the revolving credit facility by giving at least 30 days prior written notice, provided that if we terminate prior to March 20, 2011, we must pay an early termination fee. Unless it is terminated, the revolving credit facility will continue on an annual basis from anniversary date to anniversary date beginning on March 21, 2011.

     The revolving credit facility bears interest at various rates based on our overall borrowings, with a floor of LIBOR plus 1.00% or the JP Morgan Chase Bank prime lending rate and a ceiling of LIBOR plus 1.75% or the JP Morgan Chase Bank prime lending rate plus 0.25%.

     A principal payment on the term loan of $6.7 million is due December 15, 2007, with the remaining balance due December 15, 2008. On June 30, 2006 we prepaid $5.0 million of the term loan to bring the outstanding balance at July 2, 2006 to $8.3 million. We may prepay without penalty the principal amount of the term loan, subject to certain financial restrictions. The term loan bears interest at LIBOR plus 3.00% or the JP Morgan Chase Bank prime lending rate plus 1.00%.

     Our financing agreement contains various financial and other covenants, including covenants that require us to maintain various financial ratios, restrict our ability to incur indebtedness or to create various liens and restrict the amount of capital expenditures that we may incur. Our financing agreement also restricts our ability to engage in mergers or

acquisitions, sell assets or pay dividends. We may declare a dividend only if no default or event of default exists on the dividend declaration date and is not expected to result from the payment of the dividend and certain other criteria are met, which may include the maintenance of certain financial ratios. We are currently in compliance with all covenants under our financing agreement. If we fail to make any required payment under our financing agreement or if we otherwise default under this instrument, our debt may be accelerated under this agreement. This acceleration could also result in the acceleration of other indebtedness that we may have outstanding at that time.

SEASONALITY

     We experience seasonal fluctuations in our net sales and operating results. In fiscal 2005, we generated 26.9% of our net sales and 29.5% of our operating income in the fourth fiscal quarter, which includes the holiday selling season as well as the peak winter sports selling season. As a result, we incur significant additional expenses in the fourth fiscal quarter due to higher purchase volumes and increased staffing. If we miscalculate the demand for our products generally or for our product mix during the fourth fiscal quarter, our net sales could decline, resulting in excess inventory, which could harm our financial performance. Because a substantial portion of our operating income is derived from our fourth fiscal quarter net sales, a shortfall in expected fourth fiscal quarter net sales could cause our annual operating results to suffer significantly.

RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

     In July 2006, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 48 (“FIN 48”), Accounting for Uncertainty in Income Taxes – an Interpretation of FASB Statement No. 109 . FIN 48 clarifies the accounting for income taxes by prescribing the minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. FIN 48 also provides guidance on derecognition, measurement, classification, interest and penalties, accounting in interim periods, disclosure and transition. In addition, FIN 48 excludes income taxes from SFAS No. 5, Accounting for Contingencies . FIN 48 is effective for fiscal years beginning after December 15, 2006 and provides transitional guidance for treating differences between the amounts recognized in the statements of financial position prior to the adoption of FIN 48 and the amounts reported after adoption. The Company does not expect that FIN 48, when adopted, will have a material impact on the Company’s consolidated financial statements.

     In July 2006, the Emerging Issues Task Force (“EITF”) promulgated Issue No. 06-3, How Taxes Collected from Customers and Remitted to Governmental Authorities Should be Presented in the Income Statement (i.e., Gross Versus Net Presentation) . The task force concluded that entities should present these taxes in the income statement on either a gross or a net basis based upon their accounting policy. However, Issue No. 06-3 states that if such taxes are significant, and are presented on a gross basis, the amounts of those taxes should be disclosed. The Company currently records taxes on a net basis (i.e., sales tax is not included in sales, but is instead recorded as a liability under accrued expenses), so Issue No. 06-3 is not expected to have an impact on the Company’s consolidated financial statements.

     There are no other accounting standards issued as of August 11, 2006 that are expected to have a material impact on the Company’s consolidated financial statements.

FORWARD-LOOKING STATEMENTS

     This document includes certain “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements relate to, among other things, our financial condition, our results of operations, our growth strategy and the business of our company generally. In some cases, you can identify such statements by terminology such as “may”, “will”, “could”, “project”, “estimate”, “potential”, “continue”, “should”, “feels”, “expects”, “plans”, “anticipates”, “believes”, “intends” or other such terminology. These forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause our actual results in future periods to differ materially from forecasted results. These risks and uncertainties include, among other things, the competitive environment in the sporting goods industry in general and in our specific market areas, inflation, product availability and growth opportunities, seasonal fluctuations, weather conditions, changes in costs of goods, operating expense fluctuations, disruption in product flow or increased costs related to distribution center operations, changes in interest rates and economic conditions in general. Those and other risks and uncertainties are more fully described in Item 1A, “Risk Factors” in this report and in our Annual Report on Form 10-K and other risks and uncertainties more fully described in our other filings with the SEC. We caution that the risk factors set forth in this report are not exclusive. In addition, we conduct our business in a highly competitive and rapidly changing environment. Accordingly, new risk factors may arise. It is not possible for management to predict all such risk factors, nor to assess the impact of all such risk factors on our business or the extent to which any individual risk factor, or combination of factors, may cause results to differ materially from those contained in any forward-looking statement. We disclaim any obligation to revise or update any forward-looking statement that may be made from time to time by us or on our behalf.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

     We are subject to risks resulting from interest rate fluctuations since interest on our borrowings under our financing agreement are based on variable rates. If the LIBOR rate were to increase 1.0% as compared to the rate at July 2, 2006, our interest expense would increase $1.1 million on an annual basis based on the outstanding balance of our borrowings under our financing agreement at July 2, 2006. We do not hold any derivative instruments and do not engage in hedging activities.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

     As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), of the effectiveness of the design and operation of our disclosure controls and procedures (as such terms are defined in Rules 13a-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)). Based upon that evaluation, as discussed below under “Changes in Internal Control Over Financial Reporting”, our CEO and CFO concluded that our disclosure controls and procedures were effective as of July 2, 2006.

Changes in Internal Control Over Financial Reporting

     As described in our Annual Report on Form 10-K for the fiscal year ended January 1, 2006, management conducted an assessment of the effectiveness of our internal control over financial reporting as of January 1, 2006, based upon the Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). Based on this assessment, management concluded that, as of January 1, 2006, we did not maintain effective internal control over financial reporting. We identified the following material weaknesses in our internal control over financial reporting as of January 1, 2006:

	1.		We lacked the necessary depth of personnel with adequate technical accounting expertise to ensure the preparation of interim and annual financial statements in accordance with GAAP. As a result, there was more than a remote likelihood that a material misstatement of our annual or interim financial statements would not have been prevented or detected.
	2.		We did not maintain effective controls in relation to segregation of duties and user access to business process applications on the primary information system that services our corporate office and distribution center, nor were there effective controls in place to monitor user access to that system. Specifically, there were instances in which information technology or finance personnel maintained access to specific applications within the system environment beyond that needed to perform their individual job responsibilities. As a result, there was more than a remote likelihood that a material misstatement of our annual or interim financial statements would not have been prevented or detected.

     As a result of the identification of these material weaknesses, during the fiscal year ended January 1, 2006, we implemented significant changes in our internal control over financial reporting, including the following:

•

We hired Barry Emerson, an individual with experience as a certified public accountant who we believe has a strong background in GAAP and public reporting to be our principal financial officer, as our Senior Vice President,

CFO and Treasurer. Mr. Emerson began employment with the Company on September 12, 2005. Mr. Emerson is responsible for our accounting function (including the closing of our books and records), is in charge of our public reporting and preparation of our financial statements, and has responsibility for improving internal controls. Mr. Emerson reports directly to the CEO. Mr. Emerson is in charge of our accounting department, and as such, senior accounting department personnel report to him. We also retained outside accounting consultants with significant public reporting and internal audit experience to assist us. We also implemented a policy requiring increased training and continuing education for certain members of our accounting department management, including persons with the responsibilities of CFO, controller and treasurer (including assistants).

     In the second fiscal quarter ended July 2, 2006, we completed the remediation of the material weaknesses described above. The following changes in our internal control over financial reporting occurred subsequent to January 1, 2006 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting:

	1.		We have hired a Vice President - Corporate Controller and a Director of Internal Audit with significant GAAP, public reporting and internal control experience, as well as a Manager of Financial Reporting, to provide technical support to our accounting and reporting functions. Each of these three individuals is a certified public accountant. We believe that the accounting personnel we have hired and consultants we have retained provide us with the necessary depth of personnel with adequate technical accounting expertise to ensure the preparation of our interim and annual financial statements in accordance with GAAP.
	2.		We assessed user access capability and identified personnel with inappropriate responsibilities and user access to the business process applications on the primary information system that services our corporate office and distribution center. We defined user access profiles by job function and addressed inappropriate access to business process applications within the system environment beyond those needed to perform individual job responsibilities. We have established policies and procedures to appropriately control and monitor access rights with respect to our primary information system environment including business process applications.

     These additional procedures have not been audited at this time by our independent registered public accounting firm.

     Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projection of any evaluation of effectiveness to future periods is subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

PART II. OTHER INFORMATION

Item 5. Other Information

     Subsequent to the end of the second quarter of fiscal 2006, the Company negotiated a one-year extension to its existing contract, as previously amended, with The Steel, Paper House, Chemical Drivers & Helpers, Local Union 578, affiliated with the International Brotherhood of Teamsters, covering hourly employees in the Company’s distribution center. The Company had previously negotiated an extension of the contract through August 31, 2006. As a result of the current extension, the contract with Local 578 covering the distribution center employees will now expire on August 31, 2007. The Company has a separate contract with Local 578 relating to certain store employees, and that contract expires on August 31, 2006. The Company intends to commence negotiations relating to the contract covering store employees in the near future.

     On August 9, 2006, Big 5 Corp. entered into a Severance Agreement with Barry D. Emerson, the Company’s Senior Vice President, Chief Financial Officer and Treasurer, providing for the payment of one year of base salary and one year of health coverage for Mr. Emerson and his family in the event Big 5 Corp. terminates Mr. Emerson’s employment other than for “cause” (as defined). The Severance Agreement was entered into pursuant to the terms of the employment offer letter between Big 5 Corp. and Mr. Emerson, which was previously disclosed by the Company.

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.