Eddie Bauer Holdings Inc. Q1 2009 Earnings Call Transcript

Eddie Bauer Holdings Inc. (EBHI)

Q1 2009 Earnings Call

Mary 14, 2009 4:30pm ET

Executives

Neil Fiske – President, Chief Executive Officer

Marvin Toland – Chief Financial Officer

Analysts

[Rob Wolgemas – Inside Investments]

Mimi Bartow – Telsey Advisory Group

[John Harrel – Harrel and Asssociates]

[Jason Alper – Concordia Advisors]

Presentation

Operator

Welcome to the Eddie Bauer Holdings Incorporated first quarter conference call. A recording of this call including the Q&A will be available for replay later today. Information on how to access the replay is available in the earnings press release, 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

Good afternoon and thank you for joining the Eddie Bauer first quarter earnings call. The first quarter was a difficult one because of the sharp downturn in the economy took its toll on our sales and the promotional retail environment pressured margins.

We continue to focus on cost cutting and cash flow management which helped mitigate the impact of lower sales. Total revenues for Eddie Bauer were down 15.7% for the quarter. Comp store sales were down 11.3% when adjusted for the impact of Canadian exchange rates.

For the retail channel, comps were down 14.7% excluding the impact of Canadian exchange rates while the outlet channel was down 5.8%.

Direct sales fell 10.7% for the quarter on 22.6% fewer circulated pages. Catalogue productivity improved 11.2% as we were more targeted in our mailing.

Gross margins dropped 310 basis points from 27.6% to 24.5% due almost entirely to the lower sales basis over which to spread fixed volume and occupancy costs.

Merchandise margin rates were roughly comparable to the same quarter last year. Inventories ended the quarter down 6.2% overall and 8.9% on a per store basis.

SG&A costs were down by $14.7 million or 15.4% for the quarter including severance costs associated with the January 2009 reduction in work force. Excluding severance costs from both this year and last, SG&A costs were down $13.4 million for the quarter or 14.4%.

Adjusted EBITDA for the quarter was a loss of $19.5 million an increased loss of $7 million from the first quarter of last year. Adjusted EBITDA excludes the cost associated with the April 2009 amendment of our senior term loan and severance charges.

Operating loss rose slightly to $28.2 million from $25.4 million a year earlier. Excluding severance for both years, operating loss increased $4.1 million on a comparable basis.

Lower net merchandise sales and gross margins for the quarter were offset by a $14.7 million decrease in SG&A expenses. We remain focused on our turn around agenda. This past April, we launched our First Ascent line of Expedition outer wear and gear online through the Eddie Bauer website and a stand along First Ascent site.

First Ascent was built in close collaboration with a dream team of world class mountaineers. It's two door heritage as America's expedition outfitter. The first stage of our go to market plan was targeted at professional and avid participants in the outdoor segment.

In our last call we stated that we expect 2009 would be a very difficult year but there is not sign yet that the economy has hit bottom and that the first quarter of the year would be the most negative. We reiterate this view and while we anticipate some improvement in each of the next quarters, we believe that comp store sales are likely to stay negative until at least the fourth quarter of this year, and possibly the first quarter of 2010. The high level of uncertainty in the retail environment, financial markets and overall economy require caution.

The single biggest issue facing this company is our debt burden. Our capital structure simply has too much debt for the economic reality we now face. We have secured four quarters of covenant relief with a new term loan amendment. We are concerned that the first quarter of 2010 leverage ratio covenant which ratchets back down to 3.25 may not be achievable.

This coupled with a difficult credit environment makes our current capital structure an issue we need to address. The easiest way to start would be to get at least 75% of our $75 million of convertible notes to convert to equity. Any agreement on the conversion would like include extended covenant relief on the term loan and possibly the right to buy debt on the open market.

This would give us a tool set with which to work on our capital structure. Discussions are ongoing with the convertible note holders. Progress is slow and time is of the essence. We have explored potential sources of new equity into the company without a change to our current capital structure, further equity raise is unlikely.

We reiterate that our first preferred path to restructuring our balance sheet is a conversion of our convertible notes. With that, let me turn it over to Marv for a more detailed financial review.

Marvin Toland

I'll spend the next few minutes reviewing key financial results in more detail, and then we'll open the line for questions. I recommend you read our quarterly report on Form 10-Q filed today for additional details and explanations.

Revenue; revenues for the first quarter ended April 4, 2009 were $179.8 million compared to $213.2 million in the first quarter of 2008. The revenue break down versus prior year first quarter is as follows; net merchandise sales, $168.9 million compared to $198.3 million, shipping revenues of $7.3 million compared to $9.1 million, licensing, royalty revenues of $2.5 million compared to $4.1 million, royalty revenues from joint ventures of $1 million compared to $1.6 million.

Gross margin; for the first quarter gross margin declined by $13.3 million to $41.4 million compared to $54.7 million in the prior year comparable period. Gross margin percentage for the first quarter declined to 24.5% down from 27.6% in the prior year comparable quarter.

Contributing to the 310 basis point decline of gross margin percentage are the following; a 240 basis point increase in our occupancy cost as a percentage of net merchandise sales driven by a lower sales base over which to spread our fixed occupancy costs, a 60 basis point increase in buying cost as a percentage of net merchandise sales as well as less of these costs being capitalized into inventory due to lower inventory levels, a 50 basis point increase in customer loyalty program costs as a percentage of net merchandise sales for earned rewards resulting from a higher percentage of customer participation which were offset by a 50 basis point improvement in our merchandise margins.

SG&A; SG&A was down $13.4 million or 14.4% versus 2008 excluding net severance costs of $2.5 million in 2008 and $1.2 million in 2009. For the first quarter, SG&A as a percentage of net merchandise sales, decreased by 40 basis points to 47.6%.

Primary contributors to the decrease include the following; $4.1 million in salaries and benefits expense including reductions of approximately $2.4 million in corporate personnel expense, $0.9 million in store personnel expense and $0.8 million due to one time savings.

The reductions in salaries and benefits were due to head count reductions, benefit plan modification and volume related decreased in our stores. A $2.3 million decrease in shipping costs due to lower sales volume, lower costs associated with our new shipping agreement and decreased warehouse and distribution expenses. A $1.7 million reduction incentive and bonus plan accruals for corporate and store employees.

A $0.7 million decrease in advertising costs due to planned reductions and unproductive catalogue circulation. A $0.7 million decrease in professional services and legal fees and a $0.05 million increase in SG&A costs capitalized into inventory.

Previously, we had provided you with the guidance of an estimated SG&A savings of $10 million to $15 million for the full year. We realize that we came close to achieving this savings in the first quarter of this year; therefore, there may be some upside for increased savings.

However, in contrast to last year, we expect the majority of our cost savings to happen early in the year rather than later.

Adjusted EBITDA; adjusted EBITDA for the first quarter was a $19.5 million loss excluding non recurring items and non operational items as compared to $12.5 million loss for the comparable period in 2008. Adjusted EBITDA takes out certain non recurring, non operational and non cash items.

These include; for the first quarter 2009, we excluded a non cash loss of $10.3 million due to modification of interest rates for our senior term loan. As a result of the modification, the fair value of our interest rate hedge on our term loan now runs through the income statement instead of the balance sheet. This adjustment does not affect our cash flow, operation profit or bank covenants.

For the first quarters of 2008 and 2009, we excluded $2.5 million and $1.2 million of net severance charges respectively. For the first quarter of 2008, we excluded from adjusted EBITDA non recurring charges totaling $3.9 million of non cash costs for the impairment and termination of our German joint venture.

Also excluded was a $3.9 million gain on the fair value adjustment of embedded derivative liability on our convertible debt. This fair value adjustment does not affect our cash flow, operating profit or bank covenants. We are no longer required to make this adjustment.

Net loss; net loss for the first quarter increased by $25.2 million to $44.5 million. Two non cash items were primary contributors to the increased net loss; a $10.3 million non cash accounting loss on the senior term loan interest rate hedge and an $11 million lower non cash income tax benefit primarily due to no tax benefit being recognized on our losses from U.S. operations because of full valuation allowance against net operating loss carry forwards.

Inventories; total inventories at the end of the quarter were $139 million as compared to $148.2 million at 2008 quarter end. Inventory write down reserves were reduced by $2.3 million to $5.4 million. Inventory reserves as a percentage of quarter end inventory balances decreased to 4.6% from 6.0% in the comparable prior year period.

Capital expenditures; capital spending for 2009 will be approximately $15 million net of landlord contributions. Approximately 80% of our capital spend links to new stores and remodels including approximately $5 million for the launch of the First Ascent shop We closed six stores in the first quarter and opened one store in April.

For the remainder of 2009 we plan to close one store in July, open one store and relocate one store in accordance with our lease obligations.

Debt; at April 4, 2009 outstanding principal balance on the senior term loan was $187.8 million. On April 1, 2009 we made an excess 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 that increased the loan principal by $9.6 million in pick fees to $187.8 million. An additional $3.8 million cash fee is due on November 30, 2009.

As of today, the total amount owned to the senior term lenders inclusive of outstanding principal balance, additional consent fees due in November 2009 and pick amendment fees, is $191.6 million. The company is in compliance with its loan covenants.

Our revolving line of credit increased to $31.9 million at the end of the first quarter from $9.3 million at the year ago period. The increased amounts are primarily due to $14.7 million mandatory excess cash flow payment to the term loan and the timing of funds clearing for future period expenses.

As Neil said, this remains a highly uncertain economic environment. While we made operating progress in dealing with the recessionary economy, the uncertain credit environment is creating external pressure that could impact future liquidity. This underscores the need to address our current capital structure.

That concludes my remarks.

Neil Fiske

With that, let's open up the lines for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first call comes from [Rob Wolgemas – Inside Investments]

[Rob Wolgemas – Inside Investments]

A couple of quick questions, one is about the convertible note holders. Is it possible to convert them without diluting the stock significantly?

Marvin Toland

I think I can only give the facts in this case. We do have $100 million authorized shares for the company. There's slightly more than 30 million currently outstanding and somewhat less than five million tied up by RSU option grants and future option grants.

Another approximately 20 million in our 19.9 million are in warrants given to term loan. Those are really the only rules that regard the conversion of the convertible holders.

[Rob Wolgemas – Inside Investments]

Is it possible with the convertible note holders to give them cash?

Marvin Toland

No. Our loan agreements don't allow that.

[Rob Wolgemas – Inside Investments]

Is there anyone at the company who you would say is protecting the rights of shareholders, either on your Board or on your management team?

Neil Fiske

I think as a Board and as a management team we have a set of very clear obligations to all of our stakeholders and we think about every stakeholder in all of the discussion we've had and the options we're pursing, and again I think from a shareholder standpoint, we believe that the path that we're on trying to get the converts to convert is the first step of restructuring our balance sheet is in the long term interests of the company and the shareholder because it doesn't do any of us any good to have a structure with too much debt on the balance sheet.

[Rob Wolgemas – Inside Investments]

We feel positive about the company, the product all that kind of thing. We just feel like in these kinds of situations, shareholders a lot of times get the short end of the stick especially in light of the fact that your business is in many ways improving and has over the last couple of years because of good decisions you've made in terms of the product.

So my other question was really more around the length of time that you got from the senior debt holders. Was it not possible to get more than one year relief because it seems like you gave up a lot really just to get 12 months of relief. Just interested to hear your comments on that.

Neil Fiske

I think as we acknowledged in our last call, the amendment was an expensive one. We did get four quarters of relief which we thought was a good thing to get as a bridge hopefully through the most difficult quarters of the recession. We knew that 2010 first quarter, the covenant would ratchet back down and that would be a significant challenge for the company.

But I guess the bottom line on this; we tried two prior amendments that weren't successful. We did our best to negotiate the best terms we could possibly negotiate for the company and we ended up where we ended up. And again, as we said in the last call, what this amendment really does is it gives us a window of time to pursue options to improve our capital structure, and that was first and foremost our goal in striking the amendment.

[Rob Wolgemas – Inside Investments]

Are you negotiating with anyone to buy out the company? There were some rumors about that.

Neil Fiske

There have been some rumors and speculation. As a matter of policy we don't comment on rumors and speculations.

Operator

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

Mimi Bartow – Telsey Advisory Group

I had a question about the inventory, the complexion there and how you're feeling about how its still coming down but we're starting to anniversary up against some of those initial significant reductions. I'm just wondering about the complexion there.

Neil Fiske

We are starting to move towards anniversarying of lowering inventories and so the ability for us to continue the pace of being significantly below prior year will be limited. But in this case also, we were able to reduce substantially the excess inventories, particularly the quantities in Canada.

Mimi Bartow – Telsey Advisory Group

In reference to the ongoing discussion with the convertible note holders I think it was Neil mentioned the ability then to buy back some of the term loan. Would that be the priority there if you do get that done?

Neil Fiske

It's difficult to comment on that for a couple of reasons. One, the discussion on the convertible notes is really a discussion that will be driven by them and clearly they will interact with our term loan holders on that. What is and is not in the scope of those discussions I think we're not prepared to comment on at this point in time.

What we would say is that from our perspective, an ideal outcome would be to get the converts to convert, to get extended covenant relief and to be able to buy debt on the open market and again, from the company perspective, that would give us a tool set to go out and work on the capital structure.

It may or may not happen. Those discussions are ongoing and really about all we can say about it at this time.

Mimi Bartow – Telsey Advisory Group

Have you looked at buying the debt in the open market previously?

Neil Fiske

That's not allowed either of our prior term loan agreement or under the amendment.

Operator

Your next question comes from [John Harrel – Harrel and Asssociates]

[John Harrel – Harrel and Asssociates]

Back on April 7, Amazon.com came out with a press release talking about how their third party sales were booming. They mentioned Eddie Bauer Holdings. It looks like in the press release that Eddie Bauer sells its products on Amazon.com through Mercent. Can you comment with regards to how sales are going in that avenue?

Neil Fiske

I can help clarify a little bit though I don't have any Amazon numbers in front of me. First, we do sell product via Amazon as you said. Second, Mercent isn't involved but to help us select which items and what communication channels are used to promote that. So they're not an agent or a part to the sale, they're a communication and a URL firm.

And yes, I do believe the sales are higher on Amazon, but it's not a material portion of our revenue.

Operator

Your next question comes from [Jason Alper – Concordia Advisors]

[Jason Alper – Concordia Advisors]

I was wondering if you could comment on any sales trends you're seeing so far in the second quarter either in terms of sales or mall traffic. Also I was wondering about your projections for SG&A going forward if you extrapolate the improvement this quarter for the quarters going forward for the rest of the year, and then regarding your fixed component of your cost of goods sold. What portion are facilities that potentially there is some ability to monetize such as the Groveport facility or any others that may be out there.

Neil Fiske

In terms of the sales trends, as you would expect we don't give out that month by month indication of where we are within the quarter. What we have said and reiterated today is we expect that the first quarter of this year to be the most negative, that there would be some improvement in each of the successive quarters and we would confirm that basic statement.

But other than that, I think it's premature to give out any indication how the second quarter is going to shape up. We have an awful lot of it still ahead of us including our big semi annual sale through June that will end up driving a good part of the quarter's results.

With regard to SG&A, I think we are pleased with our progress on SG&A. We continue to have a very disciplined and aggressive approach to taking cost out of the business. I would be mindful of what Marv said about the timing of the savings of SG&A in contrast to last year where a lot of decisions were back end loaded. This year a lot of the savings are front end loaded.

We would confirm our target of taking an additional $10 million to $15 million of SG&A out of the operating cost structure of the business. As Marv said, there may be a little bit of upside but I think the important thing to remember is just the timing of when we're going to get those benefits sooner in the year compared to last year.

Lastly with regard to the fixed costs, and in particular, I think you asked a question about Groveport, I'm going to turn that back over to Marv.

Marvin Toland

We remain obviously open to options to monetize Groveport or to enter into 3PL or drive services to third parties but at this point; we haven't found a transaction that makes sense for any of our stakeholders.

Operator

That concludes today's call. We do appreciate everyone's participate. Have a great day.

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