99 Cents Only Stores' CEO Discusses F3Q 2014 Results - Earnings Call Transcript

| About: 99 Cents (NDN)

99 Cents Only Stores (NYSE:NDN)

F3Q 2014 Earnings Conference Call

February 11, 2014 11:00 AM ET


Stephane Gonthier – President and CEO

Frank Schools – SVP and CFO


William Reuter – Bank of America

Ali Rudensky – Cantor Fitzgerald


Good morning, afternoon, evening. My name is Christine and I will be the conference operator today. At this time, I would like to welcome everyone to 99 Cents Only Stores Third 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 today’s call 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 news release which went out today before the market opened. If you haven’t received 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 on today’s call will be referring to a management analysis of the company’s financial results that can be found at the end of today’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 measured in addition and are not 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 on 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 of 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 company’s asset improvement plan, the results of operations for 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-Q and 10-K filed with the SEC or posted on the company’s website.

I will now 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 third quarter results and recent developments at the company. Frank will discuss our financial results for the third quarter in more detail. Then I will come back with some thoughts prior to opening up the call for questions.

Overall, I’m pleased with the progress on our growth plans and the strategies we have put in place to address some of the factories that have negatively impacted our results. Simply put, I’m confident that we are moving in the right direction in terms of growing the business while working through the issues that have caused us to increase results.

Turning to today’s results, we are pleased with the continued positive sales momentum in our business as well as the foot traffic at our stores. Third quarter comps increased by 3%. Our results were also positively impacted by our improving product cost, as part of a shift in our product mix.

However, our financial results were negatively impacted by increases in certain reserves including in our excess and obsolete inventory reserves based on a comprehensive review our inventory is designed to address slow moving items. I will get into more detail in our action plan to improve our growth and EBITDA margins that are in the call.

We are encouraged by the performance of our new store openings and our pipeline of new store openings is strong. During the third quarter of fiscal 2014, we accelerated new store openings with a net of 11 new stores, all in existing markets. We have now opened a total of 27 net new stores in the 10-month fiscal 2014 that ended on January 31, 2014.

In addition, we have three stores that are opening this Thursday. I’ve been spending a lot of time in the field and touching the dirt and I’m very impressed with the quality of the real-estate we have been selecting.

To support this growth, we opened a new cold warehouse in Commerce last month. This facility which will serve all of our stores in California, Arizona and Nevada will allow us to capture unfound efficiency and to improve and extend our gross margin.

At this point, I would like to turn the call over to Fred for additional remarks about the financial performance including a discussion of the increases in reserves that are included in our financial results. Frank?

Frank Schools

Thank you, Stephane. Total consolidated net sales for the third quarter of fiscal 2014 were $487.9 million, and a 11% increase compared to net sales of $439.5 million for the third quarter of fiscal 2013.

As Stephane mentioned, same store sales for the third quarter of fiscal 2014 increased 3.0% over last year. The 3.0% increase in same store sales resulted from increased transactions and slightly higher average ticket. This 3.0% comp increased in the current third quarter is on top of a 4.3% comp increase in the third quarter of last year for a two-year stock comp increase of 7.3%.

For the first three quarters ended December 28, 2013 net sales were $1.37 billion, a 10.7% increase compared to net sales of $1.23 billion for the first three quarters of fiscal 2013. Same store sales for the first three quarters of fiscal 2014 increased 3.9%.

As Stephane just mentioned, we opened 11 net new stores in the third quarter of fiscal 2014, bringing the total to 340 stores with 245 stores in California, 45 in Texas, 33 in Arizona and 17 in Nevada.

As of this Thursday, our new total will be 346 stores, with 246 stores in California, 47 in Texas, 35 in Arizona and 18 in Nevada.

Our adjusted EBITDA for the third quarter of fiscal 2014 was $52.6 million, compared to $51.0 million in the third quarter of fiscal 2013. Our adjusted EBITDA margin was 10.8%, compared to 11.6% over the same period of last year.

Our adjusted EBITDA for the first three quarters of fiscal 2014 was $113.6 million, compared to $122.0 million for the first three quarters of fiscal 2013. The company’s adjusted EBITDA margin was 8.3% compared to 9.9%, over the same period. Please note that the definition of adjusted EBITDA is in our earnings release.

Excluding the impact of a charge for excess and obsolete inventory, consolidated gross profit margin for the third quarter was 40.2% versus 39.9% for the third quarter of the prior year. This 30-basis point increase in gross profit margin was primarily due to a shift in the product mix towards higher margin general merchandize.

GAAP gross profit in the third quarter was negatively impacted by a non-cash excess and obsolete inventory reserve charge of $9.6 million. Consequently, consolidated GAAP gross profit for the third quarter of fiscal 2014 was $186.5 million compared to $175.3 million for the third quarter of the prior year.

Consolidated GAAP gross profit margin was 38.2% for the current third quarter versus 39.9% for the third quarter of the prior fiscal year. Excluding adjusted EBITDA items, operating expenses for the third quarter of fiscal 2014 were $143.2 million or 29.4% of sales versus $124.5 million or 28.3% of sales for the third quarter of the prior year.

Retail operating expenses increased by 30 basis points primarily due to higher payroll related expenses with smaller increases and other expenses such as rent, utilities and outside servicing.

Distribution and transportation costs were 50 basis points higher compared to last year primarily due to increased rent expense for additional warehouse space including our new cold warehouse as well as higher labor costs. Corporate operating expenses slightly increased during the quarter.

GAAP operating expenses for the current quarter were negatively impacted by three items. Number one, an increase in our worker’s compensation reserves of $38.1 million primarily as a result of an increase in severity of existing open legacy claims. Number two, severance and other charges of $4.3 million relating to the workforce reduction at our corporate office as we discussed with you last quarter. And number three, an increase in our legal reserves of $2.9 million primarily related to open general liability cases.

As of the end of the third quarter of fiscal 2014, we held $43.6 million in cash and total debt was $856.8 million with no borrowing under our revolving credit facility.

As previously reported, we completed the re-pricing of our first lien term loan facility and borrowed $100 million of incremental term loans on October 8, 2013. Additionally, the Gold-Schiffer purchase was completed for an aggregate consideration of approximately $129.7 million on October 21, 2013.

Inventories at the end of the third quarter of fiscal 2014 were $195.7 million versus $225.9 million at the end of the third quarter of fiscal 2013. The decrease was primarily due to moving items into excess and obsolete inventory reserves.

As a reminder, back in December, we announced a change in our fiscal year. Previously, our fiscal year ended on with Saturday closes for the last day of March. Now, our new fiscal year ends on the Friday, closest to the last day of January with each successive quarterly period ending on a Friday, closest to the last day of April, July, October and January.

This means it’s a full year and a forward interim period of 2014 fiscal year ended on January 31, 2014. In accordance with SEC rules, we will present the 10-month transition period in our next form 10-K which will be for the fiscal year ended January 31, 2014.

We are changing our fiscal year to end in January, in order to need more in line with our peers in the retail industry. In addition, we have aligned our payroll work week with our fiscal calendar. Our payroll work week now begins on Saturday and ends of Friday.

Starting our work week on Saturday, will allow us to better plan our in-store labor and should help us improve our labor productivity in the future.

Turning to capital expenditures, we estimate that the total will be – in the next 12 months will be approximately $75 million comprised of approximately $60 million for lease hold improvements, fixtures and equipment for new and existing stores and approximately $15 million primarily related to information technology and supply chain infrastructure.

In addition, we are firming up our plans regarding our supply chain which could increase capital spend in this area over the next 12 months.

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

Before turning the call back to Stephane, I would like to address our worker’s compensation reserves in more detail. While, we have recently been experiencing a decrease in the frequency of worker’s compensation claims, there has been a significant increase in the severity of existing claims that we have had to address during the course of the first three quarters of 2014. These claims are primarily legacy claims which originated a number of years ago, and the majority of which are being litigated.

Cost related and litigated worker’s comp claims are difficult to predict and therefore controlled compared to administrative claims, especially since open claims can increase in their severity over time as they are being litigated.

We take worker’s compensation claims very seriously. And we have dedicated new resources to execute a comprehensive action plan. While these steps will likely be a multi-year effort, we believe that the following action plan will reduce our current liability and improve our worker’s comp experience over time.

It consists of specific emphasis on our olden legacy claims with the Gold of expedited resolution more intense upfront attention to new worker’s comp claims with the Gold presenting them from developing and to litigate the cases and enhance safety and return to work programs in all our facilities.

With that, I would like to turn the call back over to Stephane for some additional remarks.

Stephane Gonthier

Thank you, Frank. Since the last time we were on this call together, we have begun implementing our three-part strategic plan, which is focused on number one, accelerating our store growth, concentrating additional locations in key geographic regions primarily California, Arizona and Nevada.

Number two, improving sales and margins through enhancing the consumer shopping experience, optimizing our product mix and expanding our global sourcing. Number three investing in our people and processes to deliver superior key metrics.

For this plan, to generate the results that we expect, I felt that we needed to address a critical back-up in old slow moving inventory in our stores, which resulted in the increase in our excess and obsolete inventory reserves announced today.

New rules of engagement have been implemented with regard to our buying decisions, which stress better management, visibility and reporting as well as better accountability from our buys (ph).

In terms of our store growth plan, we are pleased with our pipeline of new stores and the rate at which we are opening them. We anticipate that we will open approximately 30 to 35 stores over the next 12 months. We will focus on increasing the density of our store locations in California, while continuing to expand in our other existing markets.

Overall, I’m pleased with the quality of real-estate that we’ve been securing. And we’re expecting maintaining our current payback of less than three years in each of these new stores.

Regarding part two of our strategy, which relates to improving our stores and maximizing profitable sales, we apply the three-step plan. Number one, raising the height of the shelving to create a dramatic canvas for visual merchandizing. Number two, optimizing the layout and space a location to drive sales and margin. And number three, remodeling store interior and exteriors to attract new customers.

The first step is our go-taller program which will fit our stores by raising our shelving to 78 inches from the current 54 inches. This initiative will improve the customer experience by placing more products at eye level. Our displays will be cleaner and our store appearance will be more appealing. This will also increase the amount of merchandize on our shelf.

We have already transformed 10 of our stores to go taller and we are very excited about our results in these stores in terms of increased sales, improved margins and positive feedback from our customers. We expect to have the go-taller program completely rolled out to the entire chain by September of this year.

In terms of our product mix, we are increasing our focus on sourcing globally integrity (ph) which will help us to supplement our private label consumable offerings which will boost the category margin, become the go-to seasonal destination by extending our offerings which is our highest margin category. And go directly to obviously factories to increase our closeout opportunities and margins.

The first results of our efforts to expand our global sourcing would be evident in our upcoming Halloween offering this year, where we will offer a significantly broader and excitement assortment of seasonal items at very attractive margins. In addition, we are also focused on the savings it will provide, including optimizing our in-bound logistics.

Our third core strategic initiative focuses on delivering superior key metrics and by simplifying our business. Our reduction in force which we discussed last quarter is expected to produce approximately $10 million per year in savings. With more savings to come as we continue to streamline our business processes.

We are also working to upgrade and leverage our IT and supply chain infrastructure as well as to build and to develop our management and field operation schemes.

In summary, I want to reiterate our strategy going forward. Number one continued accelerated store growth plans, primarily in our existing markets where we get the most bank (ph) for our buck. Number two, achieve sustainable increases in sales and margins to improved store execution including our go-taller program, optimizing our product mix and expanding our global sourcing. And number three, deliver superior key metrics by becoming a more effective retailer as we continue to simplify and optimize business processes and organization.

To close my remarks, I want to stress that 99 Cents Only is better positioned today than it was when we first met a quarter ago. We are making the right decisions regarding our product mix and growth strategy with the objective to open between 30 and 35 new stores over the next 12 months.

We also expect that our EBITDA margin will begin to rebound at the results of improving our gross margin and reducing our SG&A expenses. With our new sourcing initiative, we will expand our merchandize offerings and we expect to start to capture the benefits of this global sourcing initiative by Halloween.

By cleaning out old and slow moving inventories from our stores, we have been able to improve our productivity and customer service at the store level. Hence, our commitment is to be a best-in-class retailer on all important metrics including sales, margin and SG&A expenses as a percentage of sales.

I want to thank all of our employees for their dedication and hard work.

We will now open up this conference call for questions. Thank you.

Question-and-Answer Session


Thank you. (Operator Instructions). Our first question comes from William Reuter from Bank of America. Please go ahead.

William Reuter – Bank of America

Good morning, guys.

Stephane Gonthier

Good morning.

William Reuter – Bank of America

As you’ve talked about putting more emphasis on private label and seasonal carriers on which categories you guys are going to be putting less emphasis on. And it’s pretty obvious that those are higher margin categories. But how do you think they could impact your sales, productivity and the speed with which you sell product?

Stephane Gonthier

Well, this is Stephane. Thank you for this question. I don’t think that it’s a matter of putting less emphasis on other categories. It’s doing – it’s focusing as on everything that we’ve been doing because we’ve been doing a lot of things right. And we want to do more of that.

And then it’s leveraging actually the current business concept adding to it. Becoming a goal to seasonal destination means that they will be really focused on the seasonal. We’ve been doing a good job we want now to do a great job. And the reason for improvement as you know global sourcing, I mean, we source approximately 6% of goods sold currently. So there is room to increase it significantly.

And obviously, consumable, where definition for consumable would be this is an opportunity to first supplement our private label consumable offerings, which will enhance the category margin. And then expand the breadth and depth of our seasonal offering as I just mentioned, which is our highest margin category. And finally we do believe that we should go direct to factories to increase our closeout opportunities, being a close out destination.

William Reuter – Bank of America

Okay. You made a comment regarding the potential need to use your revolver to fund the supply chain initiative which it seems like you guys, haven’t clearly defined at this point the total costs. Is your expectation that likely you overcome cash flow negative for a period of time to fund that large CapEx initiative?

Frank Schools

This is Frank. Well, I mean, the revolving credit facility is always out there for SCU if we need it. What we need to do is kind of finalize our plans on the supply chain before I can really tell whether or not we would be going into the revolving credit facility. Certainly that’s why it’s there.

William Reuter – Bank of America

Okay. And then just lastly from me, I was curious if you could provide some general commentary. We’ve been hearing about struggling well and consumer. And I’m curious I guess what you guys are seeing. And how is sales of some of your more discretionary categories have trended versus maybe more staples and consumables and such? Thanks.

Frank Schools

Well, we’re really not going to comment on our current sales trends. As we mentioned in our call, in the script, we have a shortened fiscal year. So we’re going to have our announcement for January, even full year comp sales when we report the 10-month period.

But right now we think our excellent value is compelling to our consumers. And that’s why we’re kind of focused on cost and cost for our consumers. We think that that’s focused on value is a long-term trend which plays directly to our strength. Our Christmas seasonal results were positive and we met our expectations. So, we think that that place draw strength as well.

William Reuter – Bank of America

Great. That’s all from me. Thank you.

Stephane Gonthier

You’re welcome.


Thank you. Our next question comes from Ali Rudensky from Cantor Fitzgerald. Please go ahead.

Ali Rudensky – Cantor Fitzgerald

Yes, first of all, congratulations on a nice bounce-back in the quarter. I have a quick question on the snap benefits, when they were lowered did you see higher sales after that or lower sales after that?

Frank Schools

Well, we kind of talked about that the last quarter. The snap is a very small part of our business. So we didn’t really – it didn’t make a noticeable impact on us either way.

Ali Rudensky – Cantor Fitzgerald

Okay. And the second question is, why is the reserve for obsolescence, why is that added back to EBITDA, and that is in the normal part of the operating performance of the company?

Frank Schools

Well, because this one was as a result of the change in merchandizing direction as we talked about in the script. And so therefore, we consider it to be a one-time non-cash charge.

Ali Rudensky – Cantor Fitzgerald

Okay. Were you able to put it back to the manufacturers or you just don’t need it, what did you do with that?

Frank Schools

The merchandize itself?

Ali Rudensky – Cantor Fitzgerald


Frank Schools

Well, we took the reserve charge and we’re now going to be kind of working through the merchandize whether we – however we decide to liquidate them. We haven’t finalized those plans yet.

Ali Rudensky – Cantor Fitzgerald

Okay. All right, congratulations again. Thank you.


Thank you. (Operator Instructions). We have no further questions at this time.

Stephane Gonthier

Okay. Well, thank you everybody for joining our call today. And we’re going to go ahead and disconnect. Thanks.


Thank you. And thank you ladies and gentlemen. This concludes today’s conference. Thank you for participating. You may now disconnect.

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