West Marine, Inc. Q3 2009 Earnings Call Transcript

West Marine, Inc. (WMAR)

Q3 2009 Earnings Call Transcript

October 29, 2009 12:00 pm ET

Executives

Deb Ajeska – Operations Controller

Geoff Eisenberg – President and CEO

Tom Moran – SVP and CFO, Finance

Analysts

Doug Ruth – Lenox Financial

Presentation

Operator

Good morning. My name is Regina, and I will be your conference operator today. At this time, I would like to welcome everyone to West Marine's third quarter 2009 operating results conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question-and-answer session. (Operator Instructions) Thank you.

I will now turn the call over to Deb Ajeska, West Marine's Operations Controller who will read the Safe Harbor statement.

Deb Ajeska

Thank you, Regina. I would like to begin the call with a special note regarding forward-looking statements. The statements in this conference call that relate to future plans, events, expectations, objectives, or performance of forward-looking statement that are predictive or expressed expectation that depends on future events or condition, and include among other thing, statements that relate to West Marine’s future plans, financial results, future growth, earnings expectations, objectives, performance and similar projections, as well as facts and assumptions underlying these statements or projections.

These forward-looking statements may involve known and unknown risks and uncertainties that may cause West Marine’s actual results and performance to be materially different from any future results or performance suggested by the forward-looking statements in this conference call.

Factors that may affect future plans, results, and performance include risks associated with West Marine's ability to effectively execute on our key initiative, improve cash flows and our balance sheet and continue challenging market and industry conditions, as well as the other factors set forth in West Marine's annual report on Form 10-K for the fiscal year ended January 3rd, 2009. Except as required by applicable law, West Marine assumes no responsibility to update any forward-looking statements as a result of new information, future events, or otherwise.

And now I will turn the call over to Geoff Eisenberg, our Chief Executive Officer.

Geoff Eisenberg

Good morning, everyone. Thanks for joining us today to discuss our results for the third quarter of fiscal year 2009. With me today are Tom Moran, our Chief Financial Officer; Deb Ajeska, Our Operations Controller; Trisha Grobeck, our Financial Controller.

We've prepared some remarks, and then we'll be happy to take any questions. First I would like to deviate from our standard agenda. While it's no doubt uncommon to begin an investor teleconference by addressing my comments not to professional investors but to the 4,266 West Marine associates, many listening in on phones and Internet connections, I'm nevertheless compel to do so.

The impressive third quarter results we will be discussing this morning, are directly attributable to the progress our amazing teams have been making, and it seems fitting to me that in this forum I shine the spotlight where it belongs and acknowledge your collective performance.

I wanted to use this unique opportunity to publicly congratulate you and express a most sincere thank you.

Moving on to our third quarter results. We've discussed over the past year and a half that we're reengineering our business using conservative sales assumptions. We've been extremely mindful of creating a financial structure that was not set to an optimistic sales plan. To recast our sales to support the conservative sales expectations we implemented numerous difficult changes. We completed most of those changes before the beginning of this year.

Using a conservative sales plan, as the basis for restructuring our business, of course, has risk and reward. One significant risk is that if demand from merchandise exceeds our sales plans, we could be faced with lower than desired in-stocks. And one of the rewards is that if we can beat our sales plan, we have an excellent chance of pushing significant incremental dollars to the bottom line.

As we reported in the first half of 2009, and we are once again reporting for the third quarter, our sales did, in fact, exceed our own expectations and by a meaningful amount.

Though the market for boating equipment has been challenged to say the least, and the recessionary impacts on our industry have been extreme. We've been able to navigate ourselves to revenue levels that generated improved profitability even though our total sales dollars have been less than they were in recent years.

The impact of the calendar shift from 53 weeks last year to 52 weeks this year is significant for our business. We benefited from that shift during first part of the year, and we were negatively affected and how we report the third quarter and will be again in the fourth quarter. Because we have such a seasonal business, peaking in summer, it does take a bit of analysis to understand our calendar adjusted comps. We do have a thorough explanation of the calendar shift impact included in the non-GAAP financial information section of our Q3 earnings release, which can be found on the Investor Relations section of westmarine.com.

The big picture view of our sales results is that stores have done better than we expected while wholesale and direct have done about as we expected. Stores are by far largest business channel; the relative strength in retail has had a favorable impact on us. We believe the largest causes of these favorable sales results have been people use their boats more this summer. Last year when gas prices were higher and the daily news was so bleak, boat usage plummeted in many areas. What we don't believe boat usage is back to the level seen in times gone by; we think there has been a significant increase this year versus last.

The weather was favorable in more places than it was unfavorable. The northeast had an extremely tough spring and early summer but most market enjoyed good boating weather in the third quarter. The hurricane season did not compare to previous years, so we fortunately had no stores closed or significantly damaged due to weather, and overall the negative impact from storms were relatively light. That allowed people to use their boats instead of simply protect them.

The closure of the Boater's World chain of stores provided us with a great opportunity to try and reach a large group of customers that had not been shopping with us. Boater's World had focused on customers with smaller, trailerable boats, generally intended for water sports and fishing uses, and thus offered a selection of merchandise that had a bit different focus than the assortments normally found in West Marine stores.

Starting in spring time, we worked hard to fulfill more of the needs of the typical Boater's World customer and have been very leased with the volume of business that appears to have been transferred to us.

In late 2008, with the significant economic downturn, we assumed there would be a material shift to more do it yourself product. We planned for what we thought would be a shift in product buying patterns during 2009 and put more emphasis on core categories like maintenance, electrical, plumbing, and engine repair, and less on higher ticket merchandise like electronics, inflatable boats and outboard motors.

Fortunately for us the demand shift from customers did in fact occur, and we've benefited by having been well prepared. I should also note that the do it yourself categories carry larger gross margin opportunities than did the higher ticket electronics boat and motor categories, so that worked to our advantage as well.

Our multiyear strategy to optimize our fleet of stores, which really is just in its infancy is a story of so far so good. Our larger store formats, whether they be in the 15,000 to 18,000 square foot size, or on the 25,000 to 30,000 foot flagship size have done a better job serving customer needs and wants than the smaller size stores they replaced.

Providing larger assortments and a more interesting, more educational, more exciting shopping experience has appeared to please customers and they have rewarded us improved sales results. While it's too early in the life of this major strategy to make any bold predictions, I can state that our confidence is high that we are on the right track with our multi-year store optimization plan.

With all the good things to report, of course, there are areas that have not fared so well. Our revenues were adversely affected throughout the season by less than desired in-stock levels. There's no question in our minds that in some cases we disappointed customers.

Our results reflect a combination of factors affecting the key area.

The two most significant being higher demands than forecasted, which was difficult to react quickly to and poor fulfillment from a number of key suppliers. We have been and are continuing to work very, very hard to improve our supply chain flexibility so we can better react to demand fluctuations in the future.

Another area that's struggled during the third quarter it was portion of our wholesale business tied to new boat manufacturing and new boat sales. Though there was some amount of positive press during the summer regarding these segments, the fact of the matter is that the declines were still dramatic versus last year.

We are indeed fortunate that we have diversified ourselves enough that new boat manufacturing and sales do not have too large an impact on our overall business.

I'd like to note that when we see a return to significant activity in this segment, we will dedicate resources and seek to once again maximize the opportunities in this area.

I should point out that in contrast to our third quarter results in this area, we are seeing some very recent numbers is hope regarding new boat sales. Some of the fall boat shows have experienced pretty good attendance and many boat dealers have reported stronger order books from the shows.

Whether the orders translate to completed sales remains to be seen, but there's no doubt that the mood of the shows is much improved and we do have a somewhat higher level of optimism regarding these segments going forward. Because our sales were better than we expected and our teams of associates did such a wonderful job managing our business, we were able to generate better earnings than in the recent past. Many aspect of our business have been tightened up and improved, and we've been able to raise our productivity throughout the organization.

While earnings are, of course, a primary objective for us, a result I would also like to focus on for a moment is our debt situation. I've been involved with West Marine since March of 1976. During all those years we have always had debt. Sometimes the debt was very, very significant, and sometimes not, but it was always there.

Of course, we tried to manage debt very well and we used it to invest in various strategies that helped fuel our growth. As the economy began to get ugly in 2008, a lot of retailers were having tough times and the companies that didn't make it often appeared to fail because of their debt loads. And so, we put into motion a significant array of plans that focused on improving what had already been a reasonably healthy balance sheet despite the tough sales environment.

We reported each quarter about this focus and were able to make significant progress in reducing debt, increasing credit available, improving the quality of our inventory, and being extremely careful with our capital investments.

With all the commotion going on about economy, the banking and credit systems, potential economic catastrophes and the like, the areas we knew could challenge our financial health were cash, debt, and credit.

We did not turn the capital spigot off, hence our ability fund and create our larger store strategy, expand merchandise selection and invest in targeted limited number of key strategies. As we stopped issuing earnings guidance last year we did not discuss our intention of beg debt-free at the end of the third quarter of this year. But we certainly focused on it inside the company. And this was a great challenge for our teams.

As you would expect, we have seasonal fluctuations in our cash flow, and thus our debt needs. However, while we will incur debt when we build up our inventories for spring, I have to say it is really quite satisfying to look at our balance sheet today and see a zero on the debt line.

West Marine has made good progress so far this year, strategically, operational, culturally and financially. As we head interest our off season and focus our efforts on holiday and our preparations for next year, we're extremely excited about the future.

After sailing many thousands of Blue Water miles, I know better than to ever proclaim that we've weathered a storm, but I will finish off this somewhat corny metaphor by saying that West Marine is in ship-shape condition as we get set for the next leg of our journey.

Tom will now review the key financial measures of this business with you.

Tom Moran

Thank you, Jeff, and Good morning, everyone. I will begin by reviewing our 2009 third quarter financial results. West Marine recorded net income of $8.5 million or $0.38 per share for the 13 weeks ended October 3rd, 2009. This was a $5.1 million or 148% improvement compared to net income last year of $3.4 million or $0.16 per share.

Last year's quarterly results did reflect some impact from significant events. These included $1.7 million pre-tax in restructuring charges, and a non-cash charge for impairment assets of $200,000 pre-tax. There was also a $200,000 after tax impact of having a full valuation allowance taken against our deferred tax asset.

The combined third quarter impact of these items last year on net income was $1.4 million, or $0.07 per share. There were no significant items affecting the third quarter of this year, and even considering last year's events, we are pleased to report that our earnings have improved considerably.

Net revenues for the third quarter of 2009 were $168.2 million, which was a decrease of $12.1 million or 6.7% compared to net revenues of $180.2 million for the same period a year-ago.

Revenues in the stores segment were down $8.4 million and comparable store sales declined by 4.3%.

In the Port Supply segment, revenues were down $2.4 million or 24%, and revenues in the direct sales segments were down $1.3 million or 12%. Building on what Jeff said earlier, to understand our sales, our reported sales results in Q3, it's important to note that comparisons to last year were affect by the impact of a fiscal calendar shift resulting from the extra week in fiscal 2008. As we've said, West Marine sales were pretty seasonal, and typically increased week-over-week leading up to the peak of the boating season in the middle of the summer.

This calendar shift translated to having fewer of these peak season days being reflected during Q3 this year. A particularly large sales driver was having the 4th of July holiday move out of Q3 and back into Q2 this year where as that holiday fell into Q3 last year.

So adjusting our sales comparison to remove this calendar shift impact gives a clearer picture of our results compared to last year. So on this adjusted basis our overall revenues actually increased slightly versus last year by $300,000, and our comp store sales were up by 3.7% or $5.1 million versus last year. For easy reference we've included our calculations in this calendar shift impact in the non-GAAP measures section of today’s earnings release.

Gross profit dollars were $47.5 million, down by $2.3 million versus last year on the lower sales. However, gross profit rate improved to 28.2% or up 60 basis points. This was driven by lower unit buying and distribution costs resulting from reduced inventory levels that having a 47 basis point improvement impact, and we had better inventory shrink results with an impact of 39 basis points.

These improvements were partially offset by occupancy expenses which de-leveraged 38 basis points on the sales decline given their relatively fixed nature.

Selling, general, and administrative expense for the quarter were $38.6 million, a decrease of $5.2 million or 11.9% compared to $43.9 million during the same period last year. Our expense is leveraged by 150 basis points.

The dollar decline in expenses was driven by the following items. We had a $2.1 million impact related to stores closed since Q3 of last year, a $1.6 million reduction in variable selling and marketing expense. A $1.5 million decrease in support overhead, including the year-over-year impact of costs related to the now closed SEC investigation. And a $1.2 million favorable impact of foreign currency fluctuations this year versus last year. These above items were partly offset by $1.2 million in higher bonus expense reflecting the improved performance of the business versus budgeted expectation.

The impairment expense line reflects no impairments in long-lived assets this year versus $200,000 in the third quarter of last year. Interest expense declined by 73% from $300,000 to $100,000 due to lower average interest rate and the fact that we were debt free for most of the quarter this year. We also earned a nominal amount of interest income on short-term investments as we built the cash balance this quarter.

All of this resulted in a pre-tax profit for the quarter of $9 million, which was up $5.3 million or 143% compared to last year. The impact of income taxes for the third quarter was substantially flat to last year as a result of the full valuation allowance taken against our net deferred taxed assets during the second quarter of last year. The impact of the valuation allowance keeps our effective tax rate low. Income taxes this year reflect state taxes as well as the impact of accounting for uncertain tax positions relating to prior years.

Looking at year-to-date results, West Marine recorded net income of $25.2 million, or $1.13 per diluted share for the first nine months of fiscal 2009. This was a $35 million improvement compared to the net loss last year of $0.45 per share. As with the quarter, the year-to-date numbers for last year were affected by the same significant events.

These included $2.4 million pre-tax in asset impairment charges on 40 stores, restructuring expenses of $1.7 million pre-tax, and expenses related to the now SEC, now settled SEC investigations of $2.1 million pre-tax.

Net income was further affected by the non-cash valuation allowance taken against our deferred tax assets with an after tax impact of $14.8 million.

On a year-to-date basis these items decreased last year's net income by $18.6 million or $0.85 per share. There were no significant items affecting this year's results year-to-date as well.

Net revenues for the first nine months ended October 3, 2009, were $484.5 million which was a decrease of $35.7 million or 6.9%, compared to net revenues of $520.2 million in the corresponding period of 2008. Of this, $22.7 million was attributable to closed stores with another $14.4 million due to a comparable sales decline of 3.4%.

The fiscal calendar shift which we have described earlier did not have a material affect on our year-to-date sales comparison to last year.

Gross profit was $142.5 million, a decrease of 8.2 million compared to the same period last year. As a percentage of net sales, gross profit for the first nine months improved by 40 basis points to 29.4%. This was driven by higher product margins with an 88-basis point impact, and favorable inventory shrinkage results of 20 basis points. Partial offsets were higher unit buying and distribution costs, 32 basis points, and de-leveraging occupancy of 34 basis points.

SG&A for the first nine months was $116 million, a decrease of $23.6 million or about 17% compared to $139.6 million for the same period last year. SG&A as a percentage of sales for the first nine months was 23.9%, a decrease of 300 basis points compared to 26.9% last year. The expense decline was driven by the following items

An $8.3 million reduction in variable selling and marketing expense, an $8.2 million decrease in selling and support overhead and professional services expense, $5 million related to store is closed since the beginning of last year, a $3.1 million year-over-year impact of cooperation with a now closed SEC investigation, and finally we had a $2.3 million favorable rents due to the higher foreign currency gains this year versus last year. These items were partly offset by $3.4 million in higher bonus expense accrued to date.

Interest expense declined by over 60% from $1.9 million to $0.7 million, driven both by lower borrowing levels this year and lower average borrowing rates. The impact of income taxes for the first nine months was substantially favorable as a result of the impact in the second quarter of last year of taking the full valuation allowance against our net deferred tax assets.

As discussed earlier, the impact of valuation allowance keeps our effective tax rate relatively low.

Turning now to the balance sheet, inventory levels at the end of the quarter decreased in total by $45.3 million, for almost 19%, and were down 16% on a per square footage basis. The inventory reduction versus last year was driven by our focus on inventory productivity, by having fewer stores year-over-year, and due to the closure of our Hagerstown, Maryland distribution center.

Accounts payable at the end of the third quarter were down by $11.8 million versus the same period last year with the primary driver being lower inventory receipts year-over-year.

Our cash provided by operating activities in the first nine months of the year was $71 million, which was more than double last year’s $33.9 million. At the end of the quarter, the Company had paid off all outstanding debt, down from $29.3 million this time last year, and we had built up a cash balance of 22 million as compared to $6 million at the end of Q3 last year.

Taking a look at real estate, we are continuing to make progress on our optimization program, which reflects our strategy of evolving towards having fewer, but larger and more dominant stores.

West Marine began the year with 344 company-operated stores. So far, this year, we’ve opened eight new stores. These consist of our two flagship stores located in Jacksonville, Florida and Brick, New Jersey. A large format store in Charleston, South Carolina and three standard stores located in Lewisville, Texas, Slidell, Louisiana, and Melbourne, Florida.

We also relocated two stores, one within the same center in Oakville, Ontario by mutual agreement with our landlord, and another in Seattle, Washington due to an eminent domain proceeding. We have closed 15 stores year-to-date, and all but two of these closures have been related to our real-estate market optimization program. This brings our company operated store count to 337 at the end of the quarter. But so far this year, our total selling square footage is about flat despite the store count reduction, and this reflects the larger average size of the stores being opened.

In addition to the company operated stores, during the quarter we also added a second franchise store in Bodrum [ph] Turkey, bringing the total store count to 339 at the quarter’s end.

Next, I would like to review our expectations for the rest of 2009. As we have mentioned previously, given the unsettled economic circumstances of the day, we decided early this year to follow the lead of many public companies who have suspended communicating specific earnings guidance.

However, we still wish to give some visibility to our expectations, and therefore we are, once again, speaking to a more general outlook rather than specific financial guidance we have communicated in past years.

Despite recent improvements in sales versus our expectations, we are maintaining our previously communicated view that sales this year overall will still fall slightly below those of last year.

However, due to the restructuring actions we took last year, and by continuing to carefully control expenses and manage our working capital, we continue to anticipate generating positive cash flow for the year.

Operator, we are now prepared to take any questions.

Question-and-Answer Session

Operator

(Operator instructions). Our first question comes from the line of Doug Ruth with Lennox Financial.

Doug Ruth – Lenox Financial

Congratulations to the whole team there that -- that you really exceeded my expectations. That was really a beautiful report.

Geoff Eisenberg

Thanks, Doug.

Doug Ruth – Lenox Financial

Could you talk some about the inventory and your possible inventory goals for the rest of the year or possibly through the next year?

Geoff Eisenberg

Well, we don't really communicate actual inventory budgets, but we are trying to expand inventory to fulfill the customer segments that we think we should pursue. We're trying to make our inventory more efficient. We're trying to have the quality of it be very high.

We're trying to have the obsolete discontinued, et cetera, segment of it become a continuingly smaller portion of it. We're trying to increase our fill rates, so when customers come in to shop or they shop online or they shop on the phone that we fulfill their needs immediately. So, we have a lot of initiatives related to maximizing our investment in inventory for the benefit of the customer, but we don't really have any numbers that we have to offer. Does that approach your question?

Doug Ruth – Lenox Financial

Yes, I understand. Is it reasonable to think overall that you might be able to focus the inventory lower, or can you not comment on that?

Geoff Eisenberg

We can't really comment on it. We've taken a lot of improvement over the last 18 months or so, and it's in pretty good shape.

Doug Ruth – Lenox Financial

Okay. And can you talk some about the footprint of the stores and what you were thinking about international and how that might change in the future?

Geoff Eisenberg

What we think larger stores are better for customers, and so we will open larger stores. We'll continue to replace smaller stores in markets with larger stores, and we expect to do that wherever we operate. We do it on a market-specific basis, but we have a very long range plan, so we're going to execute it.

Doug Ruth – Lenox Financial

What kind of feedback are we getting on the second international store? Were you pleased with the initial results?

Geoff Eisenberg

Yes.

Doug Ruth – Lenox Financial

Okay.

Geoff Eisenberg

Turkey is a good market for us where West Marine is well known over there. And we believe we can add value to Turkish boaters, retail, wholesale, et cetera, and so, yes, we're extremely happy.

Doug Ruth – Lenox Financial

Okay. Are the international sales picking up some, that you noted earlier that they were a little bit weak in a prior -- one of your prior reports.

Geoff Eisenberg

With the exchange rate, as you know with the dollar euro and the dollar against various currencies, people in international environments are advantaged to purchase from the US right now, and so, yes, we've seen an uptick in international business.

Doug Ruth – Lenox Financial

Okay. Can you comment any more about what is happening with -- is there any improvement now with the boat dealers, or the boat builders?

Geoff Eisenberg

A little bit, yes.

Doug Ruth – Lenox Financial

So it's somewhat better.

Geoff Eisenberg

Yes.

Doug Ruth – Lenox Financial

And what about Internet sales? How is that been progressing?

Geoff Eisenberg

I'd say as expected.

Doug Ruth – Lenox Financial

Okay.

Geoff Eisenberg

It's a major strategy for us. It's a major long-term strategy for us. We're investing significantly. Now and in the future in our Internet resources and Internet capabilities, and so it's going fine, and it's -- we believe it's an important part of this company, so we'll continue to invest in it.

Doug Ruth – Lenox Financial

Okay. Can you give us some color as far as what's happening with the flagship stores, the new flagship stores that were specifically opened this year and what kind of feedback you've been hearing?

Geoff Eisenberg

They're going quite well, and the feedback is very good.

Doug Ruth – Lenox Financial

Okay.

Geoff Eisenberg

Based on what the customers are telling us, the customers like shopping there, and so we want to do what customers like, so that makes us happy, too.

Doug Ruth – Lenox Financial

Yes. And would investors expect to see more of these type of flagship stores being built over the next few years?

Geoff Eisenberg

I would think investors would expect that.

Doug Ruth – Lenox Financial

Okay. Wonderful report, and it's really nice to see how well everybody at West Marine worked together, and it's really terrific. Congratulations.

Geoff Eisenberg

Thanks. It's a remarkable team that it's an honor to be a part of, I'll tell you that.

Doug Ruth – Lenox Financial

Thank you. That was the end my questions.

Geoff Eisenberg

Thank you.

Operator

(Operator instructions). And there appear to be no further questions at this time. Are there any closing remarks?

Geoff Eisenberg

Sure. Thank you all for joining us today. Our fourth quarter 2009 earnings conference call is currently scheduled for Thursday, March 4th, 2010. We’ll look forward to talk to you then. Thanks a lot.

Operator

Ladies and gentlemen, this does conclude today's conference. Thank you all for participating. You may now disconnect.

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