99 Cents Only Stores' CEO Discusses F2Q2014 Results - Earnings Call Transcript

| About: 99 Cents (NDN)

99 Cents Only Stores (NYSE:NDN)

F2Q 2014 Earnings Call

November 07, 2013 02:00 pm ET

Executives

Stephane Gonthier - President, Chief Executive Officer, Director

Frank Schools - Chief Financial Officer, Senior Vice President, Treasurer

Analysts

Mary Ann Manzello - Angelo Gordon

Jeff Kao - RBC Capital Markets

Operator

Good morning. My name is Adriane and I will be your operator today. At this time, I'd like to welcome everyone to the 99 Cents Only Stores Second Quarter Fiscal Year 2014 Conference Call. All lines have been placed on mute to prevent any background noise. As a reminder, this call is schedule to be one hour in duration. (Operator Instructions).

On the call today from the company are Stephane Gonthier, President and Chief Executive Officer and Frank Schools, Senior Vice President and Chief Financial Officer.

By now, everyone should have access to the new release which went out Wednesday, November 6 at approximately 1:30 p.m. Pacific Time. If you did not receive the release, it is available on the Investor Relations portion of 99 Cents Only Stores website at www.99only.com.

Please note that the speakers in today's call will be referring to a management analysis of the company's financial results that can be found at the end of Wednesday's earnings release. This analysis summarizes certain information regarding results of operations presented on a non-GAAP basis.

We caution these financial measures should be reviewed in addition and not as an alternative to the company's complete consolidated financial statements, and financial notes prepared in accordance with generally accepted accounting principles. A reconciliation of these non-GAAP measures to their most directly comparable GAAP measure is included in the earnings release.

Before we begin today, we would like to remind everyone of the Safe Harbor statement under the Private Securities Litigation Reform Act of 1995. The following prepared remarks contain forward-looking statements and management may make additional forward-looking statements in response to your questions.

The words expect, estimate, anticipate, plan, predict, believe, intend and similar expressions and variations thereof are intended to identify forward-looking statements. Such statements include comments regarding the intent, belief or current expectations of the company with respect to, among other things, trends affecting the financial condition or results of operations of the company, the business and growth strategies of the company, including new store openings, the results of the company's operational and other improvements, including pursuant to the company's profit improvement plan, the results of operations of future periods and potential uses of capitals.

These statements do not guarantee future performance and therefore undue reliance should not be placed upon them. For a more detailed discussion of the factors that can cause actual results to differ materially from those projected in any forward-looking statements, we refer you to 99 Cents Only Stores most recent 10-Qs and 10-K filed with the SEC or posted on the company's website.

I'd like now to turn the conference over to Mr. Gonthier. Please go ahead, sir.

Stephane Gonthier

Thank you, operator. Good day, everyone, and thank you for joining us. On today's call, I will comment on our second quarter results and recent developments. Frank will discuss our financial results for the second quarter in more detail, but first I would like to make a few introductory comments.

Over the past two months since being appointed CEO, I have been meeting with company's senior management and other members of the 99 Cents Only team to review the business and assess the company's opportunities.

I have also been touring many of our stores and warehouse and distribution facilities in California and Texas, as well as meeting with our employees and some of our other strategic partners.

As you may know, prior to coming here, I served for six years as a Chief Operating Officer at Dollarama, a dollar store chain in Canada that operates more than 800 stores. Prior to that, I served in various executive positions at a global convenient store chain best known as the operators, the Circle K stores in the U.S. I plan to utilize this significant operational experience to outgrowing the company to the next level as it continues to pursue its successful growth strategy as one of the leading, extreme value retailers in the U.S.

When I joined 99 Cents Only Stores, I have made a significant personal investment in the company. I am here to do everything I can to move this company forward by building upon the legacy of the company's commitment to our [cost]. I was initially attracted to 99 Cents Only for five reasons. The attractive industry fundamentals, 99's differentiated retail concept, our strong supplier relationships and sourcing expertise, our long history of consistent strong operating performance and our leading store footprint in the Southwestern U.S.

With strong same-store sales and a leading presence in California, we are already positioned for significant growth. However, I also see some opportunity to build on this growth by dedicating our efforts to [educational] excellence in order to be the best-in-class extreme value retailer across all key metrics, sales performance, margin enhancement and expense management.

Our company has a unique entrepreneurial spirit that allows for quicker comprehensive decision making and execution and I am looking forward to maintaining and fostering that competitive advantage as we grow the company.

Turning to today's results, we are pleased with continued sales momentum in our business. Second quarter comps increased by 5.9%. Comps were driven by higher sales of fresh produce and grocery as well as certain discretionary non-food departments. However, in line with recent trends, our gross margins declined as our customers favored our lower margin consumable items. I will comment further on our action plans to improve our gross margins later in the quarter. We are encouraged by the performance of our new store opening, which continues to be successful and our pipeline of new store opening is robust.

During the second quarter of fiscal 2014, the company opened seven net new stores and we plan to open approximately 26 to 30 stores in fiscal 2014, out of which will be in our existing markets. We continue to see many highly attractive real estate opportunities in our core markets that are expected to generate attractive returns and are consistent with historical store openings. We also plan to explore more aggressive expansion of our store base with similar attractive returns on investment.

At this point, I would like to turn the call over to Frank for additional remarks about our financial performance. Frank?

Frank Schools

Thank you, Stephane. Total consolidated net sales for the second quarter of fiscal 2014 were $443.9 million, a 12.9% increase compared to net sales of $393.4 million for the second quarter of fiscal 2013.

As Stephane mentioned, same-store sales for the second quarter of fiscal 2014 increased 5.9% over last year. Approximately two-thirds of the same store sales increase was attributable to an increase in transaction counts, and approximately one-third of the increase was attributable to our higher average ticket. This 5.9% comp increase in the current second quarter is on top of a 4.0% comp increase in the second quarter of last year for a two-year stat comp increase of 9.9%.

For the first half of fiscal year ended September 28, 2013, net sales were $877.8 million, a 10.5% increase compared to net sales of $794.3 million for the first half of fiscal 2013. Same-store sales for the first half of fiscal 2014 increased 4.5% versus the same period last year. This was despite not having the benefit of Easter seasonal sales due to an earlier Easter this year when compared to last year.

As a reminder, Easter in calendar 2013 occurred on March 31st, which fully fell into our fourth quarter of last year, compared to April 8th in calendar 2012, which fell into our first quarter of last year.

We opened seven net new stores in the second quarter fiscal 2014, and as of September 28, 2013, we operated 329 stores with 238 stores in California, 43 in Texas, 31 in Arizona and 17 in Nevada.

Our adjusted EBITDA was $25.6 million in the second quarter of fiscal 2014, compared to $31.7 million in the second quarter of fiscal 2013. Our adjusted EBITDA margin was 5.8%, compared to 8.1% over the same period of last year. Please note that the definition of adjusted EBITDA is in our earnings release.

Our adjusted EBITDA was $61.0 million in the first half of 2014, compared to $70.9 million in the first half of fiscal 2013. The company's adjusted EBITDA margin was 7.0% compared to 8.9%, last year.

Consolidated gross profit for the second quarter of fiscal 2014 was $166.8 million, compared to $150.7 million for the second quarter of the prior year. The company's consolidated gross profit margin was 37.6% for the second quarter versus 38.8% for the second quarter of the prior year. This 70-basis point decrease in gross profit margin was primarily due to, one, diary, galley and produce scrapping spoilage rage increasing 30 basis points. Two, in-bound freight cost had increased by 20 basis points.

Excluding adjusted EBITDA items, operating expenses were $140.4 million or 31.6% of sales for the second quarter of fiscal 2014 versus $118.6 million or 30.2% of sales for the second quarter of the prior year.

Retail operating expenses increased by 50 basis points, primarily due to higher utilities, the smaller increases in other expenses such as rent, advertising, and outside service fees.

Distribution and transportation costs were 40 basis points higher compared to last year, primarily due to increased rent expense for additional warehousing space as well as higher labor costs. Corporate operating expenses increased by 50 basis points, primarily due to higher outside professional fees with smaller increases in other expenses such as corporate payroll and legal.

As Stephane will discuss later in the call, we have taken some immediate steps to reduce SG&A expenses and plan to supplement those actions with longer term plans to enhance our margins as well as reduce our SG&A expenses as a percentage of sales.

As of the end of the second quarter fiscal 2014, the company held $77.4 million in cash and total debt was $754.5 million with no borrowings under the revolving credit facility. As previously reported, on October 8, 2013, the company completed the re-pricing of its first lien term loan facility and borrowed $100 million incremental term loans. Additionally, on October 21, 2013, the Gold-Schiffer purchase was completed for an aggregate consideration of approximately $129.7 million.

The company's inventories at the end of the second quarter of fiscal 2014 were $197.5 million versus $211.7 million at the end of the second quarter of fiscal 2013. The decrease was primarily due to the previously disclosed increases in excess and obsolete inventory reserves.

We estimate that the total capital expenditures in fiscal 2014 will be approximately $69 million, representing approximately $44 million for new store openings and existing stores, approximately $14 million for information technology projects and approximately $11 million for other capital projects.

We intend to fund our liquidity requirements for fiscal 2014 from net cash provided by operations, cash on hand and our revolving credit facility if necessary.

I will now turn the call back to Stephane for additional remarks.

Stephane Gonthier

Thank you, Frank. We are pleased with our top line results and continued strong traffic in our stores. In addition, we feel good about our [apartment] of new stores. We have accelerated the rollout of our Christmas setup and we are pleased with our Christmas seasonal offering. However, our EBITDA margin has been pressured by consumers favoring our lower margin consumable categories as well as our SG&A expenses as a percentage of sales.

Regarding gross margin, our Chief Merchandising Officer, Michael Kvitko, and I have already made trips to Europe and China, in efforts to extend and enhance our global sourcing capacity. We expect our global sourcing robust to supplement our private label consumable offerings which would enhance the category margin, expand breadth and depth of our seasonal offerings, which is our highest margin category, go direct to obviously factories to increase our closeout opportunities.

In addition, in December, we will be opening our new modern cold warehouse facility in (Inaudible). This will have a positive impact on daily produce and frozen scrap and spoilage waste. This will also make us more efficient for those items. We recently completed a companywide review of our corporate staffing and cost base. As a result of that review, we executed a reduction enforce at our corporate offices in October as well as a reduction in overall operating expenses.

We expect to bring our SG&A expenses as a percentage of sales more closely in line with other retailers in our competitive space. No employees or mangers of our stores were impacted by this reduction enforce and we are confident that this action will position us to more effectively compete for the long-term.

In summary, I want to reiterate our strategy going forward. One, continue our accelerated store growth plans, primarily in our existing markets to strengthen our sales against competition. Two, achieve sustainable increases in sales and margin through improved store execution, optimizing our product mix and expanding our global sourcing of merchandise. Three, deliver superior key metrics by becoming a more effective retailer with simplified business processes and organization.

Our industry is undergoing a dynamic period of change and we are well positioned by making the right decisions regarding our product mix as well as SG&A expenses. We will continue to review our ability to deliver superior merchandise and customer service at the store level, while pursuing our desire to be a best-in-class retailer on all important metrics, including sales, margin and SG&A as a percentage of sales. Let me reiterate that I am more excited today than when I started at the company two months ago.

Thank you and we will now take open up this conference call for questions. We would like to remind everyone to limit your questions to one with one follow-up. Thank you.

Question-and-Answer Session

Operator

Thank you. We'll now begin the question and answer session. (Operator Instructions) We have Mary Ann Manzello from Angelo Gordon on line for question. Please go ahead.

Mary Ann Manzello - Angelo Gordon

Yes. Hello. I am taking a look at the EBITDA margins and your EBITDA margins as you had stated went from 8.1% to 5.8%. That's 230 basis points reduction about 70 basis point change from cost of goods sold. That's about 160 basis points from SG&A. Could you talk a little bit more about how that breaks down and exactly what you should plan on doing to reverse that increase?

Frank Schools

Okay. You are talking about the SG&A?

Mary Ann Manzello - Angelo Gordon

Yes.

Frank Schools

This is Frank. In the SG&A, as we talked about in the call, was affected by a lot of items including our distribution and transportation costs, some of which is the additional rent expense for the cold warehouse, which we are currently building out on the interior and the labor cost, so that's part of that reason. Then the other part is the corporate operating expenses and we talked quite a bit about that we had a reduction enforce and reduction in cost which we expected to improve on those results in the future.

Mary Ann Manzello - Angelo Gordon

The 160 basis points increase in the SG&A causes this breakdown kind of [half in half] year, which mean the distribution and transportation costs in the corporate operating expenses?

Frank Schools

Not exactly half in half, but close to it.

Mary Ann Manzello - Angelo Gordon

To adjust the higher corporate operating expenses, you said you had the headcount reduction, but what about the higher distribution and transportation costs. Is there anything that can be done there or this is just a new normal?

Stephane Gonthier

I am sorry. This is Stephane. First of all, we have talked about a reduction enforce, but it is also a reduction in terms of operating expenses as far as the corporate office is concerned. Second of all, as far as distribution is concerned, our new cold facility is going to have an impact not only on the scrap rates, but also will make us more efficient as far as labor productivity is concerned as well as distribution cost.

Now, as far as in-bound freight, we are currently working on that piece of the business. We are actually at the end of current contracts and we will soon be renegotiating our rates for the coming years, so we should see some improvement on that front as well.

Mary Ann Manzello - Angelo Gordon

So, the cold warehouse will be done soon and you won't see incurring that higher rent expense. Is That what you are saying?

Stephane Gonthier

No. That rent expense is going to continue. That's a non-comparable, because we have made an investment in the new warehouse and so like a year from now, when we would anniversary that, that's not the entire reason for the increase in the distribution costs, but it is part of it.

The important thing to know is that that warehouse is non-operational yet, but from an accounting GAAP perspective; because we are building it out we have to start incurring the expense in our income statements. The current targeted date for that is mid-December for that warehouse to be operational.

Mary Ann Manzello - Angelo Gordon

Okay. Benefits then from that warehouse would be seen in your numbers?

Frank Schools

Yes. It should. The benefit should be in the gross margin as well as distribution and labor productivity.

Mary Ann Manzello - Angelo Gordon

Okay. Great. Thank you.

Frank Schools

You're welcome.

Operator

We have (Inaudible) on line with the question. Please go ahead.

Unidentified Analyst

Yes. Hi. Can you talk about your thoughts about the reductions, net benefits which kicked in November 1st and the long-term unemployment benefits, which are expiring at the end of this year, would that impact maybe on you?

Frank Schools

This is Frank again. Regarding the SNAP, you know the reduction in the SNAP is scheduled to take effect on November 1st as you probably know, and those cuts range from $11 per month for single person to $36 a month for family of four, and that $36 cut for family of four is approximately 5% of their total monthly benefit of $668.

As you also probably know this is the first time that we have ever experienced the SNAP reduction that affects all recipients in the program, so it's kind of difficult for us to predict what the effect of this reduction will have on our business. I mean, we do feel that by being a extreme value operator that our customers rely on us to stay within our budget and that this would help minimize any negative effect of the reduction in SNAP and I guess that that would kind of be the same thing about the unemployment as well. We are known as a place to go, where you can keep with your budget at $0.99 only.

Unidentified Analyst

You are not offering whether you think it's going to be a benefit or hurt or ho0w much of a hurt? What's the lever?

Stephane Gonthier

I think that the short answer is that it's actually not very significant.

Unidentified Analyst

Okay.

Stephane Gonthier

…we don't foresee any significant adverse impact on our business.

Unidentified Analyst

You cited that transportation is one of the cost that was a headwind and was cause for a drop of EBITDA. Now that gas prices are at or under $3 a gallon in certain states, is that going to be a tailwind in the fourth quarter?

Frank Schools

The majority of our truck fleet force is actually natural gas, compressed natural gas. We converted that to that last year and we think that that gave us a real advantage in terms of our transportation expenses, because I think as you might have been reading there's a natural gas kind of surplus going on and that should give us advantages in the future, but we haven't kind of tried to quantify that.

Unidentified Analyst

Okay. Do you have the actual dollar amount of cost at the cold storage was in the quarter, so we can take that number out from an EBITDA perspective, so it really should be a non-recurring number.

Frank Schools

I don't have it with me. For the quarter, it wasn't for the full quarter and I don't know if that would be something that we would want to give out.

Unidentified Analyst

Okay. Thank you very much.

Frank Schools

Thank you.

Operator

We have Jeff Kao online with the question. Please go ahead.

Jeff Kao - RBC Capital Markets

Just on your global sourcing initiatives, I was just wondering if you could give us a sense of maybe some of the magnitude of the benefit and maybe the timing as to when you guys would realize some of your sourcing initiative benefits.

Stephane Gonthier

Jeff, this is Stephane. Obviously, the advantage of this expansion, the expansion of sourcing is this is basically kills two birds with one stone approach, because the expectation for this offering is to improve both, our top line as well as our gross margin, so in terms of short-term focus is on the private label consumable and seasonal products and I am back from China actually a couple of days ago and I was part of the buying trip looking at Halloween for example, so you are going to see most of these benefits as far as seasonal is concerned at that time, so with the introduction of Halloween 2014, at the end of next summer as far as our private label consumable offering is concerned, we started to work on that more than a month ago.

You are going to see the introduction of a flurry of new items at the beginning of next calendar year. It's hard now to tell what would be the exact impact. I mean, it's going to be a significant over time, obviously. As we have set aggressive target as far as the percentage of the mix, but it's going to be a slow ramp up over the next two or three quarters I would say.

Jeff Kao - RBC Capital Markets

What is the percentage of the mix now and where do you kind of want it to be over time?

Frank Schools

Well, seasonal is an important part of our business, but we really haven't broken down.

Stephane Gonthier

I would say that the short answer, I don't think we have disclosed any specific numbers. It actually doesn't represent a significant percentage of our mix, so there should be a significant increase over time and therefore a significant impact on the gross margin. It's just a matter of timing. You need to build it out, right?

Jeff Kao - RBC Capital Markets

Okay. Just to follow-up on the transportation and labor costs. I remember back on the road show, you guys were doing all sorts of route optimization, power optimization things of that nature. Are you guys still looking at that? Is there any opportunity to reduce some of your transportation cost over time?

Stephane Gonthier

Well, there's absolute room for improvement as far as the supply chain is concerned. Starting with, first of all, being with the cold facility, I mean, this is going to help us to look at transportation as far as the outbound is concerned becoming more efficient as far as the delivery to our stores of cold and [rice], but clearly there's more room for improvement short-term is on the inbound and not on the outbound.

I don't think we have seen all the benefits of the outbound yet, but since we are currently employing a significant number of containers and will increase the number of containers over time. We need to pull our muscles and get better rates with the foreign carriers and we are working on it as we speak, so you should see some improvement as far as this expense is concerned.

Jeff Kao - RBC Capital Markets

Great. Thank you.

Operator

We have James (Inaudible) Capital on line with the question. Please go ahead.

Unidentified Analyst

Yes. Thanks. I was wondering if you guys could just talk about competitive environment for store openings and kind of what you are seeing relative to other competitors in terms of any change in cadence for store openings, maybe new entrants into the market kind of how you view that relative to your cadence for store openings over the next rest of this year and maybe next year.

Stephane Gonthier

I have been there walking the fields for a couple of months now with the real estate team. There doesn't seem to be any shortages of opportunities as far as we are concerned. We have a very strong pipeline to deliver this year on that range of 26 to 30-some stores. We also feel confident about our pipeline to deliver a similar target some new openings next year. My real estate team doesn't feel that there is more pressure now than there was last year, so I guess its business as a main concern.

Frank Schools

This is Frank. I think, we've talked about this in our past. I mean, we do take competition seriously. The important thing to remember is that we compete already against a broad variety of retailers in every one of our stores whether it's the discount grocer or the names that are out there in the dollar space and we are monitoring our comp sales in those stores to make sure that we are on top of it and we are not seeing anything that would be a cause of concern at this stage.

Unidentified Analyst

Given the strategic decision to kind of move into existing market, I guess, do you feel comfortable with your targets for store expansion and maybe talk about the risk of potential cannibalization as you kind of add this level of stores into existing markets?

Stephane Gonthier

I think, because I obviously look at this. This is Stephane. Over the past couple of months again, I mean, without getting into the detail the first question that I have been asking myself looking at the numbers was actually our own experience as far as cannibalization is concerned. Then given my own experience in the past, I would say that the team understands very well the impact of cannibalization on our stores and what's required in terms of population density and in order to sustain or to open a store delivering similar sales turnovers.

Clearly, locking the fields, looking at our current pipeline and with a better understanding of the market, there seems to be plenty of opportunities to identify further the market in California, and there is always more competitive intensity. While you have new entrants, you have a fresher needs, you are going bankrupt, pulling out fiscal putting out in the markets, so it's a very dynamic market and therefore I guess we don't foresee at this time, at this stage of the game any obstacles that we wouldn't be able to overcome to deliver on a similar target in terms of new openings over the next couple of years.

Unidentified Analyst

Great. Thanks.

Stephane Gonthier

You're welcome.

Operator

We have no further questions at this time. Actually, we have one last question from Mary Ann. One moment.

Mary Ann Manzello - Angelo Gordon

Thank you very much. Yes. Hi. I have a follow-up question. Thank you very much. Regarding the higher distribution and transportation costs, it's actually the reason the behind the higher SG&A costs I guess in it and that comprise of the higher rent expense in your corporate operating expenses?

Frank Schools

No. Sorry. The corporate operating expense is additive to that, so there are two different things. We had talked about the fact that the distribution, transportation cost 40 basis points higher. Then the corporate operating expenses were 60 basis points higher.

Mary Ann Manzello - Angelo Gordon

Okay, but your SG&A was higher by 160 basis points.

Frank Schools

Well, it gets a little bit confusing, because I think you are talking on adjusted SG&A, so I think the adjusted SG&A is a smaller number.

Mary Ann Manzello - Angelo Gordon

That's right, but the adjusted when you are adding that stock comp?

Frank Schools

Correct.

Mary Ann Manzello - Angelo Gordon

Okay. When you are looking at it from an non-adjusted standpoint, where would the additional 60-basis point increase come from?

Frank Schools

Well, I don't have adjusted versus unadjusted in front of me. I think you mentioned the stock comp. That's a fairly big adjusted EBITDA item in the quarter and that relates to the valuation of put for the Gold-Schiffer family, where in the fourth quarter of last year we put $5.9 million expense in adjusted EBITDA and adjusted EBITDA line item that is starting to reverse this year and will be completely reversed in the third quarter with the completion of Gold-Schiffer purchase.

Mary Ann Manzello - Angelo Gordon

Okay. That's a non-cash adjustment?

Frank Schools

Yes.

Mary Ann Manzello - Angelo Gordon

Okay. Then you had mentioned the inbound freight, so is that part of the corporate expense line or is that part of the distribution, transportation cost?

Frank Schools

That's a neither. That would be gross margin, so that's in our gross margin numbers.

Mary Ann Manzello - Angelo Gordon

I see, and you were saying with the inbound freight is where you have started negotiations and you should see some improvement coming soon in terms of lower rates, in the form of lower rates?

Frank Schools

Yes.

Mary Ann Manzello - Angelo Gordon

Then regarding then the corporate operating expenses, what's higher there and what can you do to address that? Is that the headcount reduction that you were referring to before?

Frank Schools

Yes. Two things, we mentioned the headcount reduction and then we also mentioned that we reduced corporate operating expenses. There was a natural kind of reduction of expense that goes with headcount reduction whereas the spending on travel cell phones and other expenses would also go down, so that's all part of it.

Mary Ann Manzello - Angelo Gordon

If we are looking at Q3 for instance, what would change in Q3 versus Q2?

Frank Schools

Well, the reduction and by the way that's more than one follow-up, so I'll answer this question, but the reduction enforce was executed in late October, which would be, you know, that's the first month of the quarter, so that is going to be a partial effect in Q3. As we go through the quarters and we disclose our results, we will discuss the savings when we disclose in the Q3 and beyond. Okay.

Operator

We have no further questions at this time.

Frank Schools

All right. Thank you, everybody, for joining us today and good bye.

Operator

Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.

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