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Heelys, Inc. (NASDAQ:HLYS)

Q3 2008 Earnings Call

November 6, 2008 5:00 pm ET

Executives

Donald K. Carroll - President & Chief Executive Officer

Lisa K. Peterson - Chief Financial Officer & Senior Vice President

Analysts

Mitch Kummetz - Robert W. Baird & Co., Inc.

Operator

Good afternoon, ladies and gentlemen, and thank you for standing by. Welcome to the Heelys, Inc. third quarter fiscal 2008 earnings conference call. (Operator Instructions)

Before we begin, I would like to remind everyone of the company's safe harbor language. Please note that this call will include forward-looking statements within the meaning of the securities laws. All forward-looking statements included in this call are based on information available on the company - I'm sorry, available to the company on the date of this call, the company's current expectations, and various assumptions.

The company believes that there is a reasonable basis for its expectations and beliefs, but they're inherently uncertain. The company may not realize its expectations and its beliefs may not prove correct. For a list of important factors that could cause the company's actual results to differ materially from the forward-looking statements in this call, please refer to the company's public filings with the SEC, including the risk factors contained in the company's annual report on Form 10-K. You're encouraged to read that section and all of the company's other filings with the SEC.

The company intends that all of the forward-looking statements in this call will be protected by the safe harbor provisions of the Securities Exchange Act of 1934. The company undertakes no obligation to publicly update or revise any forward-looking statement as a result of new information, future events or otherwise. All subsequent written and oral forward-looking statements attributed to the company or persons acting on the company's behalf are expressly qualified in their entirety by the cautionary statements contained throughout this call and the company's filings with the SEC.

I would now like to turn the conference over to the Chief Executive Officer, Don Carroll. Please go ahead, sir.

Donald K. Carroll

Thank you, Operator. Good afternoon, everyone, and thank you for joining us. I'm Don Carroll, the company's President and Chief Executive Officer, and joining me on the call today is Lisa Peterson, our Chief Financial Officer.

Our third quarter sales, margins and expenses, which Lisa will historical in more detail in a few minutes, were basically in line with our expectations. As you know, the retail environment throughout the United States, Europe and other parts of the world has been challenging for several months. We are maintaining tight controls over inventory and expenses, but, until we generate higher sales volumes, operating margins will continue to be depressed relative to historical results.

That being said, we are controlling what we can, and we are making progress with our three strategic initiatives - first, inventory management; second, product margin; and third, demand generation.

On inventory management and product margins, we've taken aggressive action to reduce inventory levels in the retail channel and bring our own aged inventory down to minimum levels. In addition, many of our customers have shifted their purchasing patterns to at-once orders rather than longer lead-time pre-bookings. With lower inventory levels and just-in-time reorders, promotional pressures and price discounting has eased, and we've seen retail price points move back up. This, in turn, has improved our gross margins, which have moved back up to over 30%.

On demand generation, our focus continues to be on more trend-right product and more targeted advertising. Our newest styles continue to be our bestselling line items, and we found that prelining product with major retailers early in the development cycle has improved the collaborative process.

We'll be launching a new advertising campaign on November 10th. This campaign consists of new television, radio and also digital and Internet elements.

Now I'll turn the call over to Lisa Peterson to run through the quarter in more detail.

Lisa K. Peterson

Hello, everyone.

Net sales for the third quarter were $23.8 million, and this is comprised of $14.4 million domestically and $9.4 million internationally. Third quarter sales were considerably below third quarter sales of $49.9 million last year, but represented an increase from second quarter sales of $18.2 million.

Gross profit was $7.9 million compared to $15.9 million last year and $4.2 million in the second quarter this year.

Gross margin was 33.3% compared to 31.9% last year and 23% in the second quarter. As Don said, our gross margin benefited from less discounting and promotions due to the lower inventory levels in the retail channel and a higher mix of full-pricing selling due to the steps taken to clean up our inventory.

Total SG&A for the quarter was $6.8 million compared to $6.3 million last year and $5.4 million in the second quarter. Although sales and marketing expenses were down, general and administrative expenses increased over the prior year period and on a sequential quarterly basis due to incremental infrastructure and operating costs associated with our direct international business. We also experienced higher legal and other professional fees.

Operating income for the quarter was $1.1 million. This compares to operating income of $9.6 million last year and an operating loss of $1.2 million in the second quarter.

Interest and other income was $57,000 and includes a foreign currency translation loss of $455,000.

Net income for the quarter was $755,000 or $0.03 per diluted share compared to net income of $6.6 million or $0.24 per diluted share last year and a net loss of $394,000 or $0.01 per diluted share in the second quarter.

On the balance sheet at September 30th we had cash and cash equivalents of $93.2 million, accounts receivable of $10.9 million, inventories of $18.4 million, of which $11.6 million was domestic, and no debt.

Now we'll turn the call back to Don.

Donald K. Carroll

Before we turn the call over to the operator for questions, I want to touch on one final item.

Yesterday, as you probably saw, the company announced that it has retained Houlihan Lokey to assist the company's Board of Directors in an analysis and consideration of a broad range of possible strategic alternatives to enhance shareholder value. There is no assurance that this process will result in any changes to the company's current business plans or lead to any specific action or transaction, and so it is important to reiterate that the company does not intend or expect to disclose any developments regarding this process until when, if ever, a definitive agreement is entered into or the Board determines to terminate the process.

Additionally, as indicated in the press release, during the process we will not provide any new earnings guidance nor would we update or comment further upon any earnings guidance previously provided.

So at this time, I'd like to turn it back over to the operator and open it up for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Mitch Kummetz - Robert W. Baird & Co., Inc.

Mitch Kummetz - Robert W. Baird & Co., Inc.

I've got a few questions; let me start with the announcement that you made yesterday. And I'm just curious, it wasn't that long ago that you received an unsolicited bid from Sketchers and now you've made the decision to engage Houlihan Lokey to consider strategic alternatives, so what has changed over that period of time that's prompted you to now do what you're doing today?

Donald K. Carroll

I think, as stated in our press release, we're going to be looking at a wide range of strategic alternatives that could enhance shareholder value. We don't know what all these alternatives are going to be and we don't know where this process could take us. In fact, there is no assurance that this process will result in any changes or actions or transactions. So once it's been initiated, we'll also not be providing any updates until the process has terminated or a definitive agreement is reached. So there's nothing really more to say about the announcement.

Mitch Kummetz - Robert W. Baird & Co., Inc.

Let me ask you a couple of questions about your operations for the quarter, then. Lisa, you mentioned that G&A was up largely because of [debts] and infrastructure and operations in your international business. If I did the math right, I mean, I think your sales in your international business were roughly flat to last year; I think down a little bit from the second quarter. Could you talk a little bit about how you're proceeding with your international business given that you're investing in the business, but it wouldn't seem like you're getting much of a payoff, at least yet.

I know that you'd previously talked about expecting international sales to be up over last year. Is that still the expectation?

Lisa K. Peterson

We're not really giving any guidance on expectations as far as sales levels or really any guidance, but just to kind of talk generally about international and the expenses, one of the things that I would note is that there are some kind of year one operating costs that we're incurring such as SOX compliance costs, although definitely not the total increase. But that is additional kind of year one expenditures that we're bearing the cost of in Q3 and into Q4 that are year one costs. But we'll be continuing to analyze that model and try to create efficiencies going forward.

Mitch Kummetz - Robert W. Baird & Co., Inc.

And then lastly, I know you don't want to comment about your outlook but, you know, off your last call you did say that you expect your sales to increase sequentially on a quarterly basis over the course of the year, which you have done through the third quarter. Is that still the expectation for the fourth quarter? And then you also kind of roughly outlined your kind of gross margin views and improvement of the retail situation, inventory situation at retail, kind of [had to set] in the 31% to 35% range as kind of a target and sort of normalized target once inventory cleans up at retail, which you achieved that in the quarter.

Is that still kind of the expectation for the gross margin under sort of normal retail conditions?

Lisa K. Peterson

I think, as we said in the press release, we're not going to update any of that prior guidance, even the directional guidance that we gave, either update it or provide new guidance at this time.

Operator

(Operator Instructions) Mr. Carroll, I show no further audio questions.

Donald K. Carroll

All right. Thank you, Operator. On behalf of Heelys, we appreciate everyone for joining the call today. We look forward to talking to you in the next quarter. Thank you very much and have a good evening.

Operator

Thank you. Ladies and gentlemen, this concludes Heelys, Inc. third quarter fiscal 2008 earnings conference call. Once again, we'd like to thank you for your participation. You may now disconnect.

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