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Cost Plus Inc. (NASDAQ:CPWM)

Q2 2009 Earnings Call

August 27, 2009; 4:30 pm ET

Executives

Barry Feld - Chief Executive Officer

Jane Baughman - Executive Vice President & Chief Financial Officer

Ann Morante - Vice President of Finance

Analysts

Budd Bugatch - Raymond James

Anthony Chukumba - FTN Equity Capital

Operator

Good day ladies and gentlemen and welcome to the second quarter 2009 Cost Plus earnings conference call. My name is Dimali and I will be your operator for today. At this time, all participants are in listen-only mode. We will be facilitating a question-and-answer session towards the end of today’s conference. (Operator Instructions)

I would now like to turn presentation over to your host for today’s conference Mr. Barry Feld, Chief Executive Officer, please proceed.

Barry Feld

Thank you. Good afternoon and thank you for joining us to discuss our second quarter 2009 results and ongoing turnaround initiatives. With me today for the conference call are Jane Baughman, Executive Vice President and Chief Financial Officer and Ann Morante, Vice President of Finance.

Following my opening remarks, Jane will discuss the financial results in more detail, after which I will make some concluding remarks and then we’ll open up the call for questions. Before beginning today’s discussion, Ann will read the company’s Safe Harbor statement.

Ann Morante

Certain forward-looking statements regarding the company’s future performance and initiatives will be made during this conference call and we usually be preceded by words such as belief, anticipates, projects or expects. Any such forward-looking statements such as, but not limited to future liquidity position and financial guidance are subject to known and unknown risks and uncertainties that could cause actual results to differ materially from those expressed or implied by these statements.

Examples of such risk factors include, but are not limited to the following. Changes in economic conditions that affect consumer spending, timely introduction and customer acceptance of merchandise offerings, changes in the comparative environment, foreign and domestic labor market fluctuations, interruptions in the flow of merchandise, complications or delay in the store closing processes, increases in fuel and transportation costs, currency fluctuations, unseasonable weather, terrorist acts or our nation’s response thereto, a material unfavorable outcome with respect to litigation, and changes in accounting rules and other regulations and more complete listing of risk factors is included in the company documents on file with the Securities and Exchange Commission.

Barry Feld

Thank you, Ann. Our sales results for the second quarter were with in our guidance range and inline with our peers and better than many other furniture only retailers. Despite the decline in same store sale, we meaningfully reduced our second quarter EBIT loss and our net loss from continuing operations versus the second quarter of last year. Our operating results were also within our guidance range.

Merchandise margin increased due to tighter inventory controls, which led to lower shrink expense. Additionally, our merchants have made significant progress, lowering our cost of goods structure and are achieving the plant improvements in IMU that will ultimately restore margin.

However, rather than the grading the quality and authenticity of our products, we have elected to continue promoting certain merchandised categories, in order market share, incumbent the unprecedented level of promotional activity occurring across the entire spectrum of home furnishings retailers.

The short term impact of the average ticket margin rate, are acceptable trade off to ensure the longevity of the brand. We also made significant reductions to our SG&A expense year-over-year and are exceeding the planned level benefits from the measures taken last January to rationalize operations.

These cost reductions coupled with disciplined inventory management, have resulted in lower borrowings under our credit facilities in the year ago, providing the liquidity necessary to meet planned expense, inventory purchases and maintenance capital expenditures. We have three years remaining our $200 million asset based credit facility, which expires in the mid 2012.

During the second quarter, the company successfully sold through its seasonal outdoor merchandise with no residual inventory remaining in our stores. We drove positive comp increases in outdoor furniture, seasonal textiles candy & drinks. These results together with successful Easter decor and consumable business bode well for the expected customer response to our Halloween fall harvest and holiday assortments in the second half of the year.

Our textile business, which includes tabletop textiles, floor covering, window treatments and pillows have performed extremely well in the first half of the year. We attribute this improvement and changes made in our trend development process and a consumer trend towards decorating for less with accent pieces rather than replacing entire room settings with higher price into our furniture.

However, we expect our business within the higher priced indoor furniture category to remain challenging for the foreseeable future, which is reflected in our third quarter guidance. Our fall in holiday merchandise has arrived at our distribution centers and is flowing to stores. Our merchandise just priced to deliver clear and recognizable value to customers and our assortments and in store visual merchandising have never looked better.

I would now like to turn the call over to Jane, after which I’ll make some concluding remarks.

Jane Baughman

Thank you, Barry. As a reminder, the income statement included in this afternoon’s press release clearly breaks out the results from continuing and discontinued operations for both the current year and prior year period. The company’s balance sheet presentation remains unchanged.

Total net sales for the second quarter of fiscal 2009 were $183.4 million, a 13% decrease from the second quarter of fiscal 2008. Same store sales for the second quarter decreased 10.9%. The average transaction decreased to $33.57 or 7.7% below last year and customer account deceased by 3.4%.

Conversion rate increased 40 basis points. The eastern region continues to outperform the western region. The mix between home and consumables as a percentage of total net sales was 65% and 35% respectively for the second quarter of 2009 versus 67% and 33% respectively for the second quarter of 2008. Consumables continued to outperform home furnishings, particularly in cookie, candy, beverages and drink mimes.

Year-to-date net sales of $367.6 million or 10.9% lower than the fist half of fiscal 2008. Same store sales for the first half decreased to 9.9%. Gross profit rate for the quarter decreased 80 basis points to 26.2% versus 27% last year. The decline was entirely due to decrease leveraged of fixed occupancy expenses on lower same store sales, partially offset by 50 basis points net improvement in merchandise margin.

The net improvement in merchandise margin with the result of lower shrink expense offset by the current level of promotional activity needed to compete with aggressive discounting in the marketplace. Additionally, a sale mix more heavily weighted to our consumables has put pressure on merchandise margin rate.

Second quarter SG&A expense as a percentage of net sales was 35.2% versus 36.2% last year, a decrease of 100 basis points. Year-to-date SG&A expenses as a percentage of net sales were 35.1% versus 36% for the same period last year. The decrease in second quarter and first half SG&A expenses with the result of lower payroll, advertising, and other controllable expenses related to the company’s cost cutting initiatives including store closures.

During the second quarter of fiscal 2009, the cost related to closing the eight stores classified within continuing operations totaled $300,000 million and $6.1 million for the year-to-date period. There was no store closure cost in the first or second quarter of fiscal 2008, relating to closed stores that were classified within continuing operations.

Continuing operations depreciation expense in the second quarter of fiscal 2009 was $7.6 million, compared to $8.6 million for the same period last year. Year-to-date continuing operations depreciation expense was $15.4 million in fiscal 2009 and $17 million in fiscal 2008.

Year-to-date capital investments for 2009 projects were $1.1 million versus $6.2 million last year. Capital spending for fiscal 2009 projects is projected to be approximately $3 million for the full year. There were no pre-opening expenses for the second quarter of fiscal 2009, compared to $1.3 million for the second quarter of fiscal 2008.

The company did not open any new stores in the second quarter of fiscal 2009, compared to seven new stores in the same period last year. Year-to-date there were no pre-opening expenses for fiscal 2009, compared to $3.1 million for the same period last year, with no stores openings this year, compared to 15 for the first half of last year.

For the second quarter of fiscal 2009, the company reported a loss from continuing operations before interest and taxes or EBIT loss of $16.8 million, a decrease of 18.5% versus a loss of $20.6 million last year. The company’s guidance range was an EBIT loss of $14 million to $21 million. The net loss from continuing operations for the second quarter of fiscal 2009 decreased 16.5% to $19.8 million or $0.90 per diluted share, compared to a net loss of $23.7 million or $1.07 per diluted share last year.

Net interest expense was $2.9 million for the second quarter of fiscal 2009 compared to $3.2 million for the second quarter of fiscal 2008. Year-to-date net interest expense with $5.7 million, compared to $6.2 million from the same period last year. The decreased in the first half interest expense was due to a lower interest rate on the company’s asset based credit facility.

The loss from discontinued operations was $900,000 for the second quarter of fiscal 2009, compared to a loss of $2.9 million for the second quarter of fiscal 2008. The loss from discontinued operations in the second quarter of fiscal 2009 was primarily due to cost to exit the store leases.

Total inventory decreased $81.1 million or 30.4% to $185.8 million, when compared with last year. The reduction and inventory is the result of store closures and planned to decreases in SKU count and weeks of supply. Accounts payable was $52.1 million versus $68 million last year.

The company continues to pay its vendor partners according to agreed upon terms, which are typically 60 days terms on open account with the exception of certain state regulated merchandise categories. Days payable were 41 at the end of the second quarter of 2009 and flat to last year.

At the end of the second quarter there were $65.3 million in borrowings and $9.5 million in letters of credit drawn under our $200 million asset based credit facility. As inventory levels in our corresponding borrowing base increase with received as good in advance of the holiday selling are projected peak borrowings requirements will be below last year and be well within our credit lines capacity.

In this afternoon’s press release, we have provided our outlook for the third quarter of fiscal 2009. Our guidance anticipates continuing pressure on the furniture business in the current level of economic volatility. For the third quarter of fiscal 2009, the company expects net sales in the range of $177 million to $186 million, based on the same store sales decreased in the range of 6% to 11%.

For the third quarter of fiscal 2009, the company has projecting a loss from continuing operations before interest and taxes or EBIT loss in the range of $19 million to $24 million versus $21 million loss of last year. Depreciation expense is projected to be $6 million and interest expense is projected to be $3 million for continuing operations.

The company will open two new stores in Arizona and begin the liquidation of one store in Cleveland market during the third quarter. As that from recent store closures will be use to outset the two new stores. To-date the company’s aggressive rent abatement program has generated $8 million in rent reductions and cash flow savings. We will continue working with our landlords to lower occupancy cost during this challenging economic time.

I will now turn the call back over to Barry, for his concluding remarks.

Barry Feld

Thank you, Jane. With unemployment projected to reach 10% by early next year and savings rate have record highs. Our cautious outlook for fiscal 2009 remains unchanged. We continue to retool our merchandising assortments and evolve marketing strategies to maximize the non-furniture business, for which World Market is in destination, specifically consumables, seasonal merchandising gifts.

World Market stores offer inexpensive and creative entertaining home decor and gift solutions to its customers including the strong value proposition in food, wine, and kitchen tools for in-home entertainment, fresh trend right products and textiles, floor coverings, tabletop and seasonal decor items, enabling customers to redecorate for less and thousands of unique authentic, and affordable gifts that are relevant for any occasions.

We will continued to respond appropriately to competitive pressures by taking the necessary steps to maintain traffic levels in the midst of the dramatic reduction and customer spending, a results for the second quarter validate this approach. We have carefully positioned ourselves to emerge from the consumer recession as a healthier organization and with Cost Plus, World Markets brand promise intact.

With that, I would like to turn the call over to the operator, for the Q-and-A portion of the call.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Budd Bugatch - Raymond James.

Budd Bugatch - Raymond James

I guess to start off with the sequential guidance in terms of the sales. I can understand, having a little bit less EBIT than the second quarter. If your sales are below, I think you bracketed sales range is actually above second quarter and yet you’re projected EBIT loss of $19 million to $24 million, is worse than what you had in the second quarter. What would of that, Jane?

Jane Baughman

Second quarter sales were a $183 million in our ranges at the high end $186 million. So on the low end $176 million, so significantly below. Also we have higher advertising in the third quarter and higher payrolls as we start to build for the seasonal business.

Budd Bugatch - Raymond James

So its payroll and advertising at the upper end of the sales guidance that would cause that $3 million delta to the second quarter EBIT loss?

Jane Baughman

Correct, and on the lower sales base, you have further pressure on your fixed occupancy cost from a leverage perspective.

Budd Bugatch - Raymond James

On the rent abatement of the $8 million, when do we start to see that?

Jane Baughman

It’s over a period of probably 18 months to up to three years. Some of it has begun and we’ll continue for the next 36 months, but some of it is currently reflected in the numbers. Unfortunately, the way we accounting work, is that you have straight line it, so you’ll see it from a cash flow savings point of view, but you won’t see it so much actually on the P&L.

Budd Bugatch - Raymond James

That’s where I always going next, so can you give us kind of a feel of what does to the P&L over the next quarter over the next couple of years?

Jane Baughman

To the P&L, we won’t show the reflected savings from the rent abatement that you would anticipate. So our occupancy cost will remain relatively flat despite the savings or you’ll see it is on the cash flow piece.

Budd Bugatch - Raymond James

On the inventory change, are you attributed that to both SKU count reduction or SKU reduction and the stores that are gone?

Jane Baughman

Correct.

Budd Bugatch - Raymond James

You kind of segment that for us. Give us a color of how much is where?

Jane Baughman

Store count in round numbers is down 10% year-over-year and then the balance of it would come from a reduction in SKU count, as well as lower weeks of supply.

Budd Bugatch - Raymond James

So when you say, you’re going to come on less, you’re going to peak in the third quarter, and I would guess you’d peak just about at the end of the third quarter maybe a week or two, later if I?

Jane Baughman

That’s right. We’ll peak about the second week of November.

Budd Bugatch - Raymond James

Where do you think inventory peaks in?

Jane Baughman

In terms of dollars, we don’t really give that out. I know where you headed with regard to the borrowing base and obviously the borrowing base increases as we build inventory in advance of holiday selling, but we will absolutely be well within the line of the credit capacity of the $200 million facility.

Budd Bugatch - Raymond James

I was trying to get to a way to calculate that are come up with that number might be, because I think your borrowing base at the end of last years third quarter is about a $118 million, if I have the numbers right? So when you say well within, can you kind of help us quantify well.

Jane Baughman

At the end of the third quarter last year, our borrowing base was $200 million.

Budd Bugatch - Raymond James

The outstanding was $118 million, I think if I’m not mistaken.

Jane Baughman

Correct.

Budd Bugatch - Raymond James

The base was $200 million that was the maximum. I guess I don’t know what exactly the base was?

Jane Baughman

Yes, we were capped at the $200 million, because we had inventory exceeded that, but the facility is capped at $200 million.

Budd Bugatch - Raymond James

They do a haircut to that too.

Jane Baughman

Correct, that’s right.

Budd Bugatch - Raymond James

Can you quantify, what you think the borrowing will come in at the end of the third quarter?

Jane Baughman

Last year the company’s borrowings peaked at $125 million in the second week of November and we believe we will peak below that. If you just hold the current delta that we’ve got, that’s the reasonable number, that’s in year-over-year.

Budd Bugatch - Raymond James

Fourth quarter I know that you haven’t given guidance on that, but I’m sure you’re looking ahead there, what should we expect? That’s for Barry.

Barry Feld

Budd, when we move into the holiday season, obviously that place into our strength because the percentage of gifting and consumable far outstrips the reliance on number of the furniture categories. So given what we have seen with our historical seasonal performance in this fiscal year, we remain cautiously optimistic, we’ll have a rational holiday season.

Additionally, in the fall of last year, as we’re all aware, there was a disproportion on a consumer pressure placed out there with what happened in the financial markets in October and November. So the same store sales comparisons are significantly reduced from last year.

So we anticipate a rational holiday season, we only putout quarterly guidance, but again given the fact that we won’t be as reliant on several of the furniture categories and place into our strengths. We’re cautiously optimistic as we move through the year.

Budd Bugatch - Raymond James

In last years second quarter, if the home furnishings were what about 65% of sales?

Barry Feld

Correct.

Budd Bugatch - Raymond James

67% last year, is that right 67%? I’ll do that math and comeback at you with that later, okay.

Operator

Your final question comes from Anthony Chukumba - FTN Equity Capital.

Anthony Chukumba - FTN Equity Capital

A couple of questions, first I guess I was a little surprise to see that you’re going to be opening a couple of new stores this year. I believe, your previous guidance was poor, no store opening. So I guess, I was just wondering sort of what led you to change your mind. I was also a little bit surprised that these are in Arizona. It looks like one is right outside of Phoenix; one is right outside of Tucson, not exactly sort of great housing markets? So I guess, I was just wondering, what sort of the mind set was there?

Jane Baughman

I’ll take that one. As we alluded to early, the company has an aggressive rent abatement program underway. We’re working with all of our landlords on a variety of options, whether its rent savings, renewal, preferential treatment in leases, co-tenancy issues as well. We were able to work a deal, which unfortunately it’s under our confidentiality agreement with one of our significant landlord to reduce rents in multiple stores, while we opened the two stores in Arizona.

One of them was planned to open in 2010 and we pullback forward and then the other one seems to make sense with the way we’re located in the market and our ability to leverage some of the advertising expense there. So what I can tell you is that the deal is measurably accretive from a cash flow savings to the company and a meaningful portion of the numbers that we called out in our press release.

Anthony Chukumba - FTN Equity Capital

Then the other thing, I know that part of this clearly is some store closing. I know part of this is just being sort of more conservative in terms of inventory purchases, but as I look at your inventory position, it’s down 30% year-over-year. If I look at your year-to-date sale was down 11%. So are you concerned with all that you actually leaving money off the table by not necessary having as much inventory as you could to drive sales?

Barry Feld

I think the rate that’s going to a lot of retailers walk, Anthony. In our particular case, given the metrics that we have continue to see with living furniture and some of the other home categories, we have taken a very conservative approach.

There’s always some of level of risk associated erring on the conservative side, but we believe managing for predictable of cash conservation and remaining healthy and sustainable and viable in that direction really offsets or mitigate some top line risk at certain categories that are under pressure in this environment.

Additionally, as we have re-fixture our stores, it’s been an ongoing supply chain initiative to edit out SKUs and edit out a number of merchandise categories and so now that these stores are fully reset and that our two DCs are operational with new supply chain. We have been able to systematically eliminate or reliance on much longer weeks of supply. So the combination of all those things in addition to what Jane said earlier, with reduced store count has reduced our inventory levels to this degree.

Operator

Due to no further questions, I would now like to turn the call back over to Barry Feld for closing remarks, please proceed.

Barry Feld

Thank you, operator. Again we appreciate all your participation and we will certainly look forward to reporting our continued results on the third quarter, when we bring everybody back together in November. Thank you very much.

Operator

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect. Have a good day.

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