Eddie Bauer Holdings, Inc. Q4 2008 Earnings Call Transcript

Eddie Bauer Holdings, Inc. (EBHI)

Q4 2008 Earnings Call

April 8, 2009 1:00 pm ET

Executives

Neil Fiske – President, Chief Executive Officer & Director

Marvin E. Toland – Chief Financial Officer

Analysts

[John Harold – Harold & Associates]

Analyst for Mimi Bartow – Telsey Advisory Group

[Scott Mills] – Citigroup

Presentation

Operator

Welcome to the Eddie Bauer Holdings, Incorporated fourth quarter conference call. A recording of this call including the question and answer session will be available for replay later today. Information on how to access the replay is available in the fourth quarter earnings conference call announcement issued earlier this week, a copy of which has been posted at www.EddieBauer.com.

At this time I would like to turn the call over to Mr. Neil Fiske, President and CEO of Eddie Bauer.

Neil Fiske

Thank you for joining the Eddie Bauer fourth quarter earnings call. Today we want to cover three topics: our fourth quarter and year end results; the recently signed amendment to our term loan; and our view of 2009. For the fourth quarter our financial results were dramatically impacted by the sharp and severe downturn in the economy which began at the end of September. This was the worst economic and retail environment in decades.

Mall traffic was down 13%, competitive promotional activity was desperate, deep and widespread and consumers pulled back sharply on spending concentrating their purchases on the best available deals. Against this backdrop total sales for Eddie Bauer were down 5.7% for the quarter. Comp store sales were down 5.9% excluding the impact of Canadian exchange rates for retail stores while the outlet channel is down 5.4%. Direct sales fell 3.2% for the quarter and benefitted from the 53^rd week in 2008.

Margins were pressured by the high level of promotional activity in the market with gross margin dropping 290 basis points from the prior year to 40.9%. Fortunately, our aggressive cost cutting initiative in 2008 helped us offset much of the decline in sales and margin. Excluding the $7.5 million impairment charge against store leasehold improvements SG&A costs were down by $16.8 million.

Adjusted EBITDA for the quarter was $54 million down $9 million from the fourth quarter of last year. Inventories ended the quarter and year down 13.8% overall and 8.2% on a per store basis. We ended the year with $60.4 million in cash up from $27.6 million at the end of 2007. Operating loss increased by $155.8 million for the quarter largely driven by a non-cash impairment charge of $144.6 million against trademarks and goodwill. In addition, we recorded $7.5 million in leasehold improvement impairment charges.

These impairment charges did not affect our cash flows or loan covenants. Excluding the impairment charges operating income was down $3.8 million to $43.7 million versus last year. While we were disappointed in our results for the quarter, our declines in sales and EBITDA were far less pronounced than many retailers in the specialty sector.

Turning to full year results, Eddie Bauer was one of the few retailers to post a year-over-year gain in EBITDA in 2008 with adjusted EBITDA increasing $10.8 million to $52.7 million. In spite of the recession, we showed significant progress in operating performance and brand revitalization. We believe our five point turnaround program was a good buffer against the economic storm.

Total revenues for the year were down 2%. Retail same store sales in 2008 declined .9% excluding the impact of Canadian exchange rates while outlets posted a 1.5% decline in same store sales. Gross margin for 2008 feel 90 basis points to 35.3%.

For the year we cut SG&A costs by $46.9 million excluding one-time items from both 2007 and 2008 as well as the 53^rd week impact in this past year. This was substantially better than our announced goal of cutting $25 to $30 million out of the operating cost structure of the business on the same basis. On a 52 week comparable basis SG&A cost feel 310 basis points to 39.9% of sales.

We also cut net capital spending this year from $36.9 million to $16.8 million, a reduction of $20.1 million. For the full year operating profit feel $114.5 million to a $142.9 million loss again, largely because of the non-cash impairment charge in the fourth quarter. Excluding all impairment charges, operating income improved by $37.5 million to $9.2 million.

Looking ahead, we see a very difficult year in 2009. There is no sign yet that the economy has hit bottom and is beginning to turn. In our view the first quarter of this year will be the most negative with revenues declining about 15% versus last year. We anticipate improvement in each of the successive quarters but comp store sales are likely to stay negative until at least the fourth quarter of this year and possibly the first quarter of 2010.

With that outlook combined with the ratchet down of covenants in our original term loan agreement we felt compelled to negotiate and amendment to the term loan that would give us operating flexibility to get a clean opinion on our financial viability form the company’s auditors while consuming a minimal amount of short and medium term liquidity. The amendment that we signed last week gives us substantial relief on our loan covenants. We acknowledge that the price of this flexibility is very high and well above what would have been considered market rates even a year ago.

Given the dislocation in the credit markets we believe it was the best available option for the company and its stakeholders. Prior to signing this amendment, we put forward two alternatives to our term loan holders which were not approved. Importantly, this amendment gives us a window of 90 days to improve our capital structure before the escalation of payment in kind interest and additional warrants.

Over the next few weeks we will be reaching out to convertible note holders to discuss possible terms for conversion of their notes. While the amendment provides us short term financial relief our longer term goal is to improve our capital structure by substantially reducing our long term debt. Meanwhile, we need to stay focused on our turnaround agenda. That means playing both offense and defense through the downturn. Defense is about cutting costs and managing capital for maximum cash flow.

We expect to cut an additional $10 to $15 million of cost out of SG&A this year while capital spending will be targeted at around $15 million. We have already put actions in place to accomplish these goals. For the remainder of 2009 we plan to close one store during the second quarter and open three new stores in accordance with our contractual lease obligations. Offense means pushing forward aggressively on our new product and marketing initiatives rebuilding the outerwear and men’s categories, aligning the merchandise to our positioning as an active outdoor company, bringing back the great Eddie Bauer heritage, improving quality, style and value, remerchandising our stores and launching First Ascent as one cornerstone of the new brand positioning.

We are pleased to announce that the First Ascent launched this week as part of the first phase of our go to market plan targeted at professionals and avid participants in the outdoor segment. You can see the new line at www.FirstAscent.com.

We remain focused on the fundamentals of our turnaround. Much work still needs to be done but we have a clear direction, a clear set of priorities and a newly rebuilt management team capable of executing the plan. With that, let me turn it over to Marv for a more detailed financial review.

Marvin E. Toland

I’ll spend the next few minutes reviewing key financial results in more detail. Then, we’ll open the lines for questions. I recommend you read our annual report on Form 10K filed last week for additional details and explanations. Revenues for the fourth quarter ended January 3, 2009 were $369.9 million compared to $392.4 million in the fourth quarter of 2007.

The revenue breakdown versus prior year fourth quarter is as follows: net merchandise sales of $356 million compared to $377.6 million; shipping revenues of $9.6 million compared to $9.3 million; licensing and royalty revenues of $2.5 million compared to $3.4 million; and royalty revenues from foreign joint ventures of $1.7 million compared to $2 million. The revenue breakdown for the full year 2008 is as follows: net merchandise sales totaling $971.3 million compared to $989.4 million in 2007; shipping revenues of $34 million compared to $34.2 million in the prior year; licensing revenues of $12.8 million compared to $13.8 million in 2007; and foreign royalty revenues of $5 million compared to $6.3 million in the prior year.

Gross margin; for the fourth quarter gross margin declined by $19.7 million to $145.6 million compared to $165.2 million in the prior year comparable period. Gross margin percentage for the fourth quarter declined to 40.9% down from 43.8% in the prior year comparable quarter. Contributing to the 290 basis point decline in the gross margin percentage are the following: a 170 basis point decrease in merchandise margins driven primarily by higher mark downs spurred by the overall increase in promotional activity by our competitors during the holidays; a 60 basis point decreased due to higher decline and buy in costs as well as less of these costs being capitalized in inventory due to lower inventory levels; and a 50 basis point decrease due to higher customer loyalty program costs for earned rewards resulting from a higher percentage of customer participation.

For 2008 gross margin was $343.1 million, a decrease of $15.4 million. Gross margin percentage for 2008 declined to 35.3% compared to a gross margin rate of 36.2% in 2007. The 90 basis point decrease in the company’s gross margin included a 100 basis point decline in our merchandise margins driven by an increase in markdowns to promote sales slightly offset by their costs.

SG&A; on a comparable basis SG&A was down $46.9 million or 11% versus 2007. This comparison adjusts for the following: it excludes severance and other onetime items in both years of $16.4 million in 2007 and $10 million in 2008; and it excludes a 53^rd week in 2008 which was approximately $5 million. Primary contributors to the decrease include the following: $20.3 million due to headcount reductions and lower professional fees; $12.4 million in reductions in marketing and advertising expenses; $4.8 million in sales volume related expenses; a $3.8 million decrease in employee compensation; and $5.6 million in net other cost reductions.

Adjustments to EBITDA; as Neill mentioned, adjusted EBITDA for the fourth quarter was $54 million and $52.7 million for the year excluding non-operational and non-recurring items as compared to $59.9 million and $41.9 million for the comparable periods in 2007. Adjusted EBITDA takes out certain non-recurring non-operational and non-cash items. These include for the fourth quarters of 2008 and 2007 we excluded from adjusted EBITDA the fair value adjustments of the embedded derivative liability on our convertible debt.

This fair value adjustment does not affect our cash flow, operating profit or bank covenants. We have been required to make this adjustment quarterly since Q2 2007. For 2007 we excluded an adjusted EBITDA the following non-recurring items: CEO severance charges; merger termination costs; a litigation settlement totaling $16.4 million in the first quarter; debt extinguishment costs of $3.3 million in the second quarter; and the $9.3 million gain on the sale of sack receivables during the fourth quarter.

For 2008 adjusted EBITDA excluded non-recurring charges in the first quarter totaling $2.5 million of severance charges for the reduction of workforce; $3.9 million of non-cash costs for the impairment and termination of our German joint venture; $0.6 million in receivables write off related to the terminated German joint venture during the second quarter; for the fourth quarter $7.5 million impairment of store leaseholds; $3.7 million in impairment of our Japanese joint venture; and a $3.9 million curtailment gain for retiring medical benefits.

Net loss; turning now to net income and net loss including and excluding impairment charges. Excluding all non-cash impairment charges totaling $155.7 million of goodwill, trademark and other assets, net income increased by $46.5 million to $28.2 million for the fourth quarter of 2008. Including the non-cash impairment charges, net loss for the fourth quarter increased by $109.3 million to $127.5 million. These impairment charges do not affect our cash flow or loan covenants.

For the full year non-cash impairment charges for $159.6 million excluding these full year impairment charges net loss for the full year improved by $95.8 million to a full year net loss of $5.9 million. Including impairment charges net loss for 2008 increased by $63.8 million to $165.5 million.

Inventories, total inventories at the end of 2008 were $136.4 million as compared to $158.2 million at 2007 year end. Inventory write down reserves were reduced by $1.3 million to $7.5 million. Inventory reserves as a percentage of yearend inventory balances remain unchanged.

Senior term loan, now let’s turn to a review of our recent loan amendment to the recent term loan which we executed on April 2, 2009. I want to be clear that we did not adopt this amendment because we have a liquidity problem, we generated positive cash flow. The issue facing us was compliance with the tightening of our leverage and fixed charge ratio covenants. In order to avoid violation of these covenants and to protect the company against sustained economic downturn we were forced to renegotiate the senior term loan. This was strictly a covenant issue not a liquidity issue.

The covenant relief provided by the new amendment is substantial. This covenant relief benefits the company by providing us with the flexibility to work with a convertible note holders to discuss possible conversion terms and allowing us time to explore other options to reduce our long term debt. The new covenant also gives us substantial cushion against a downside scenario to our operating plan. The new senior secured leverage ratios are as follows: for the first quarter of 2009 a change from 4 to 1 to 6.25 to 1; for the second quarter of 2009 it changed from 4 to 1 to 8 to 1; for the third quarter of 2009 it changed from 3.75 to 9 to 1; and for the fourth quarter of 2009 it changed from 3.5 to 7.75 to 1. We also received release for the fixed charge covenant ratio covenant.

I would emphasize these covenants are not based on our operating budget but rather reflect a prudent buffer to protect against a downside scenario. Key terms and costs for the amendment to the agreement include the following: at signing establish a LIBOR floor of 300 basis points; an increase in LIBOR margin of 200 basis points from 325 to 525 for loans based on LIBOR; a consent fee earned at closing of 300 basis points of which 100 basis points were paid at closing and 200 basis points are due November 30, 2009; a payment in kind or PIK amendment fee of 500 basis points which will be added to the outstanding principal balance of the senior term loan; allowing the lenders to recommend two independent directors of the total of seven board members; and penny warrants to the senior term lenders for 19.9% of the common stock with protection for dilution.

At 90 days if at least 75% of the $75 million of the convertible notes are not converted to common stock or we have not raised $50 million in new capital with proceeds used to pay down the outstanding principal balance of the term loan the following will occur: an additional amendment PIK fee of 500 basis points; penny warrants to the senior term lenders for an additional 15% of common stock with protection for dilution; and allowing the lenders to recommend an additional independent board member to increase the total board size to eight members.

At 150 days if the convertible notes have not converted or we have not raised additional new capital the following will occur: an additional PIK fee of 500 basis points; and penny warrants to the senior term lenders for an additional 15% of common stock with protection for dilution. At 210 days if we are not successful at converting the convertible notes or raising new capital the following will occur: a 500 basis point PIK fee.

Interest accrues on the PIK fees and will be payable in 2014. At January 3, 2009 the outstanding principal balance on the senior term loan was $192.8 million. On April 1, 2009 we made a free cash flow payment of $14.7 million reducing the outstanding principal balance to $178.1 million. At closing we paid $1.9 million in consent fees and increased the loan principal balance by $9.6 million to $187.7 million. An additional $3.8 million is due on November 30, 2009.

As of today, the total amount owed to the senior term loan lenders inclusive of outstanding principal balance, additional consent fees due in November, 2009 and PIK amendment fees is $191.5 million. The overall cost of this amendment if the convertible note holders do not convert and we are unable to raise new capital over the next 12 months is as follows: an estimated increase of $40 to $45 million in the outstanding principal balance from PIK and accrued PIK interest; additional cash interest payments and fees estimated at $10 to $14 million; and ownership of 49.9% of common stock.

I want to emphasize that we understand how expensive this amendment is. Our goal was to create a window where long term debt can be reduced via the conversion of the convertible notes to common stock and their raising new equity before additional major escalation of term loan costs. If the convertible notes choose to convert we will explore the potential to reduce long term debt by raising additional equity.

That concludes my remarks Neil.

Neil Fiske

Operator, with that I think we’ll open up the lines for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from [John Harold – Harold & Associates].

[John Harold – Harold & Associates]

I’ve got a question about dilution, if in fact the note holders chose to convert to common stock it appears that right now the outstanding shares is somewhere around 31 million, how would that impact the outstanding share count, up to what figure?

Marvin E. Toland

We do not have an offer currently on the table to our convertible stock but I would note that the maximum outstanding shares allowed under our articles of incorporation are 100 million shares.

[John Harold – Harold & Associates]

Would there be a chance of having to raise the authorized share count?

Marvin E. Toland

Raising authorized share count would require a shareholder vote.

[John Harold – Harold & Associates]

So the worst case scenario would be the outstanding shares would rise from about 31 million up to 100 million.

Marvin E. Toland

That’s the maximum allowed under our bylaws.

Operator

Your next question comes from Analyst for Mimi Bartow – Telsey Advisory Group.

Analyst for Mimi Bartow – Telsey Advisory Group

Could you talk a little bit about what expense areas you are targeting with the $10 to $15 million in SG&A reduction that you mentioned?

Neil Fiske

Sure, as you may recall we went through in January of this year another reduction in force where we laid off a substantially large number of employees again this year bringing our total I think over the last two years of reduction in force to something like 310 employees. So, the reduction in force is a big piece. We are also continuing to optimize our marketing spending and expect to take a fairly good chunk of money out of marketing that could be more effectively spent. Then, just across the board reductions in every functional areas budget for the year.

Analyst for Mimi Bartow – Telsey Advisory Group

If I could follow up just for a second, on marketing could you talk a little bit more on what you’re planning to do there?

Neil Fiske

One of the things that we’re having some real success in now is getting more precise about the science if you will behind our catalog mailings which as you know is the dominant part of our marketing budget. We believe that the productivity gains that we generated last year in sales per page circulated we can continue to generate this year by more effectively targeting our catalogs segmenting them, reducing pages to only the targeted segments where those pages make sense. So, it’s really a combination of optimizing, circulation and segmenting our catalogs more precisely.

Operator

Your next question comes from [Scott Mills] – Citigroup.

[Scott Mills] – Citigroup

I’m a new shareholder on board and my question regarding marketing is, is there any corporate sponsorship with your product line? An example would be Disney with McDonalds? I know this is a specialty product but I’m curious are you involved in any kind of sponsorships with your product line, perhaps other corporations or individuals athletes?

Neil Fiske

We have a couple of sponsorships as part of the launch of our First Ascent line. The first is that we are partners now with Rainier Mountaineering which is the largest mountain guide service in the United States, one of the best in the world. They have over 80 mountain guides on mountains all over the world from Rainier, to McKinley to Everest to Aconcagua in South America and as of this spring Eddie Bauer will be the official outfitter for RMI and all those 80 guides and a lot of their clients too by the way will be in our new First Ascent gear line.

We’ve also assembled what we humbly call the dream team of mountaineers that have worked with us to develop First Ascent and these athletes and mountain guides include Ed Viesturs, probably the biggest name in American mountaineering right now, the only American to climb all 14 8,000 meter peaks without the use of supplemental oxygen. Dave Hahn, who we’ve also sponsored has climbed Mount Everest 10 times more than any non-Sherpa. Peter Whittaker, who runs Rainier Mountaineering and then three up and coming superstars that we think are going to be big names in the future.

That’s really where we’ve chosen to concentrate our sponsorship activity. We will also be bringing on as part of our First Ascent team a couple great names to help us develop a ski platform that will come under the same brand name of First Ascent.

Operator

There are no further questions at this time. I’d like to turn the conference back over to our speakers for any additional or closing remarks.

Neil Fiske

I think that will conclude the call operator if there are no other questions. Thank you for calling in.

Operator

That does conclude our conference for today. We appreciate your participation. You may disconnect at this time.

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