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Pier 1 Imports Inc. (NYSE:PIR)

Q1 2010 Earnings Call

June 17, 2010 11:00 AM ET

Executives

Alex Smith – President and CEO

Kelley Buchhorn – Director, Investor Relations

Cary Turner – EVP and Chief Financial Officer

Analysts

Brian Nagel – Oppenheimer

Budd Bugatch – Raymond James and Associates

Brad Thomas – KeyBanc Capital

Operator

Good morning, ladies and gentlemen. This is Pier 1 Imports quarterly conference call. At the request of Pier 1 Imports, today's conference call is being recorded. All lines will be in listen-only mode. I would now like to introduce Mr. Alex Smith, President and Chief Executive Officer for Pier 1 Imports. Mr. Smith, you may begin, sir.

Alex Smith

Thank you, Sarah. Good morning everyone and thanks for joining us today. Cary Turner, our Executive Vice President and Chief Financial Officer is with me today as is our new Director of Investor Relations, Kelley Buchhorn. Kelley has been with Pier 1 Imports for 20 years. Congratulations Kelley. And we're delighted to have her in her new role. So Kelley, please get us started.

Kelley Buchhorn

Thank you, Alex. Good morning everyone and thank you for joining us. Earlier today, we issued a press release which included the detailed financial results for the first quarter ended May 29, 2010. In just a few moments, Cary will discuss the first quarter financial results and Alex will follow with a more in-depth discussion about our business. We will end with a brief question-and-answer period.

Before we begin, I need to remind you that certain comments made during this call may contain forward-looking statements within the meaning of section 21E of the Securities Exchange Act of 1934 and can be identified by the use of words such as may, will, expect, anticipate, believe and other similar words and phrases. Our actual results and future financial condition may differ materially from those expressed in any such forward-looking statements as a result of many factors that may be outside of our control.

Please refer to our SEC filings including our annual report filed on Form 10-K for a complete discussion of the major risks and uncertainties that may affect our business. The forward-looking statements made today are as of the date of this call and we do not undertake any obligation to update our forward-looking statements. If you do not have a copy of today's press release, you may obtain one along with copies of prior press releases and all SEC filings by linking through to the Investor Relations page of our website, pier1.com. I would now like to turn the call over to Cary who will provide the detailed results of our first quarter.

Cary Turner

Thank you, Kelly. Earlier today, we reported net income of $7.7 million or $0.07 per share for the first quarter, compared to $29.3 million or $0.32 per share reported for the same period last year. Results for the first quarter last year included a $47.8 million gain on the convertible debt transactions and the receipt of $10 million from a litigation recovery.

Total sales for the first quarter increased 8.9% to $306.3 million from $281.1 million in the year-ago quarter. Comparable store sales increased 14.3% compared to a comparable store sales decline of 7.5% last year. The sales increase for the quarter was the result of an increase in store traffic, conversion rate and average ticket. Our Pier 1 Rewards card continued to do well and was 25.9% of total U.S. sales for the quarter, versus 25.2% of total U.S. sales last year.

Merchandise margins for the quarter were $179.6 million or 58.6% of sales, a 440-basis point improvement over $152.3 million or 54.2% of sales reported for the same period last year. The improvement in merchandise margins continued due to decreased clearance activity, reduced vendor and supply chain cost and well-managed inventory levels.

Store occupancy cost of $65.2 million declined from $67.5 million last year, due to the reduced store count and negotiated rental rate reductions with our landlords in existing stores. Gross profit for the quarter calculated by deducting store occupancy costs from merchandise margin, improved $29.6 million to $114.4 million or 37.4% of sales from $84.8 million or 30.2% of sales in the first quarter of last year.

As detailed in today's press release, first quarter SG&A expenses totaled $101.1 million. During the period, SG&A consisted primarily of $13.6 million in marketing costs, $69.6 million in payroll and $17.9 million in other G&A costs. SG&A expenses for the quarter included $1.2 million in special charges relating to lease termination and other costs, offset by a gain of $1.7 million resulting primarily from the company's sale of its distribution center near Chicago.

Last year, the company recorded $7.1 million in special charges resulting primarily from lease termination costs. As a percentage of sales, ongoing SG&A costs showed a 180-basis point improvement compared to last year as they declined to 33.2% of sales from 35.0% of sales last year.

Overall, the increase in sales, improved merchandise margins and controlled expenses resulting in operating income for the quarter of $8.3 million, a $35 million improvement over the $26.7 million operating loss reported last year. Inventory at the end of the first quarter was $303.2 million or $37 per retail square foot compared to $294.2 million or $35 per square foot last year.

Inventory was in line with the company's planned expectations and management continues to strategically manage its inventory purchases and monitor its inventory levels to keep in line with consumer demand. At the end of the quarter, cash and cash equivalents were $204.8 million, a $59 million increase over last year's first quarter and a $16.9 million increase from year-end.

For the quarter, cash flow from operations was partly used to fund capital expenditures which totaled $6.3 million and was primarily spent on technology and existing stores. In addition to cash, our secured credit facility had a calculated borrowing base of $218 million at the end of the first quarter. After taking into account all reserve amounts and expanding letters of credit of $74.8 million, $113.2 million remained available for use by the company for working capital purposes.

We did not utilize the secured credit facility during the first quarter for any purpose other than our letters of credit needs, which have declined from last year. Taking into account both the cash and cash equivalents and the availability under the line of credit for cash borrowings, our total liquidity at the end of the first quarter was $318 million.

Total debt as of the end of the quarter, including the current portion, was $35.5 million and consisted of $19 million of industrial revenue bonds and $16.5 million of 6.375% convertible notes net of discounts. As I stated earlier, the company finalized the sale of its distribution center near Chicago for a purchase price of $11.8 million and with the proceeds, we intend to repay $9.5 million of the industrial revenue bonds related to the distribution center in the second quarter. The 6.375% notes will be repaid during the fourth quarter this year and at the end of the year, our total debt will be $9.5 million.

During the first quarter, we opened two Pier 1 stores and closed six stores. We ended the quarter with 1,050 Pier 1 Imports stores with 971 stores in the U.S. and 79 stores in Canada with 8.3 million retail square feet.

During our fourth quarter conference call in April, we provided a detailed framework which you can build a P&L model. We have a few updates to provide today. First, sales in the second quarter will be slightly lower than historical trends and merchandise margins in the second quarter will be slightly higher as our clearance event will not be as big as in the past. Alex will discuss this in more detail with you later.

For the year, merchandise margins should be at least 56% of sales. Marketing expenses in the back half of the year will be slightly higher than our original plan and Alex will further discuss our margining initiatives with you shortly.

We still anticipate opening three to five stores and closing 10 to 15 stores this year. Operations are expected to generate positive cash flow for the year and will be used in part to fund capital expenditures of approximately $25 million. And, as we reported in our 10-K, we have an NOL tax carry-forward of approximately $92 million and we will use this carry-forward to offset future taxable income. Once the NOL tax carry-forward is fully utilized, the effective tax rate will be approximately 37% to 38%.

Now, I'd like to turn it back over to Alex.

Alex Smith

Thanks, Cary. We are delighted with our first quarter results and as we said in our press release, we have first quarter operating income for the first time in six years. Based on everything that we see happening in our business, our attractive assortments, our carefully managed cost base, our improved in store experience and strong customer focus, we believe that our results will continue to improve.

We know how to keep the momentum going. Brand-new customers, returning customers and customers who have never left us are enjoying shopping at Pier 1 Imports. They are visiting more, purchasing more frequently and spending more.

As I said on our last call, we have for some time demonstrated that we can run a tight ship and expand our merchandise margin. What has been harder to demonstrate, thanks to the recession, is our ability to grow sales.

Over the last three quarters, with some help from the economy, we've shown that we can grow sales. To remind you, we had a 13.7% comp store sales gain in quarter three last year, a 6.5% comp store gain in quarter four last year and now a 14.3% gain for the quarter just ended. We know that we have the ability to grow comp store sales. We are planning our business accordingly. The comparisons do get hard as we progress through the year so we're planning a more modest comp store sales gain for the balance.

We are seeing improved sales and profitability in all merchandise areas. It's great to see the consistency throughout the store which is something we've been striving for, for some time. We are getting this consistency because our buying team and our planning allocations team continue to execute better, not only as individual teams, but equally importantly as a cohesive unit.

They are doing a good job of balancing careful thought and analysis with an entrepreneurial merchant spirit. I know they'll get even better. We want (inaudible) complexion of our inventory and assortment.

For example, reorder merchandise gives a good level of predictability and stability to both our sales and margins. We constantly raise the bar on the sales volume expected from a reorder skew and expect this part of our assortment to continue as important sales and margin driver.

New and seasonal products keep us looking fresh and current and provide us with a reservoir of potential reorder SKUs. Our moderate level of permanent markdowns and promotional pricing provide our customers with great bargains.

Going forward, we need to carefully balance our promotional and regular priced business to give us the best combination of sales, margin rate and margin dollars. Our strong merchandise margin was obviously an important driver of our first quarter results. The improvement was as it has been for some time a result of improved merchandise selection, improved quantification of the buy, lower first costs, lower freight costs, lower markdowns. In other words, every contributor to merchandise margin is positive.

As Cary mentioned, if we look at the dynamic between sales and margin in the second quarter, we do expect a little bit of pressure on sales because in the traditional summer clearance period, we have so much left to clear, compared to last year. In fact, we are not having a Pier 1 sale imports sale this year, just a seasonal clearance. So the margin rate will be above last year's.

That said, please don't expect a 58.6% margin in the second quarter. Another significant contributor to our sales and conversion rates is the in-store experience and Customer Service. The store leadership team has done an excellent job improving the look of our stores and the Customer Service level. Also, we have much improved consistency store to store.

Let me talk about marketing for a few moments. We are, as I told you in the last conference call, spending more on market research and we are now getting clearer and better insights to our customers and potential customers' requirements and shopping patterns.

We are using this data to refine our already strong creative and our media buy in order to inspire both new and loyal customers to visit our stores. Our media plan of course is layered so we have multiple opportunities to reach our customer. But we have not been using radio as part of that layering.

So we tested radio advertising over Memorial Day in 14 markets throughout the U.S. We got a good response. Consequently, we plan to further test radio advertising nationally in June and July. Our FY 2011 media spend places more emphasis on attracting new customers and reactivating lapsed customers, especially our rewards card holders than in previous years. However, the biggest percentage of our spend is still aimed at our active customer base. Initial signs are positive for both reactivation and attracting new customers.

Given our stronger business and the responses we are getting from our marketing, we will increase our marketing spend by approximately $3 to $4 million this year, which will be used to fund incremental fall and holiday television advertising.

We will review our marketing budget again at the end of the second quarter to determine if further investments in marketing are appropriate. Currently, then, our forecasted marketing spend this year is now approximately $65 million.

We are so happy to be making capital investments in our company again. We recently completed installing new fixtures and revised floor sets to 24 stores. Although it is early, we are pleased with the initial results and the implementation of a second wave of approximately another 20 stores is starting now.

The new fixtures allow our merchandise assortments to be displayed more effectively and as a result make it much easier for our customers to shop our assortments. Our sales per square foot are now $155 and as you know, our target is to exceed sales per square foot of $200 over time.

The new fixturing is another piece of the jigsaw that will help get us there. We are also investing improvements to our systems throughout the company. We have IS projects in stores, merchandise planning and supply chain.

We constantly look for ways to make our business more efficient and effective. We are very excited that now we can have more technological solutions to help us do that. New systems will also simplify our IS infrastructure over time, by reducing the number of technologies which we use to run our business.

Pier1.com is looking great and as we discussed last time, we are investing in the site to update the pre-shopping and marketing experience for our customers. By September, our entire assortment will be online and available for pre-shopping. This is an important precursor to any form of e-commerce.

We are now clear that our initial return to e-com will be site to store, which will allow us to leverage our store base without any of the complexities around payments and fulfillments. We believe this is a natural and low risk extension of our business reach and brand.

We ended the quarter with 1,050 stores, which we believe is a little below the optimum size of our portfolio today. Also within individual markets, there are some opportunities to focus on improving either the distribution and/or the quality of our locations.

We anticipate net new store openings over the next few years as we move our store base towards 1100 stores and reconfigure markets where required. Cost continues to be controlled very well throughout the organization.

As you saw, our SG&A expenses were well leveraged. Our attitude to expenditures of any description will not change just because our business is getting better. That said, we have added additional headcount very carefully and strategically in key areas, such as buying, marketing, and the planning functions which we know is a good investment and, in our stores, to provide ongoing great Customer Service.

Also as I said, we will increase our marketing spend somewhat. It was a very good first quarter but our feet are firmly on the ground. We still have much work to do to get our company to the level of sales and profitability that we know is achievable. Our business model and strategies are sound. Our execution, while improved, is not yet flawless.

We will continue to do what we always do, rebuild Pier 1 Imports one SKU and one customer at a time. Thank you for listening to us today and we're now happy to take questions.

Question-and-Answer Session

Operator

(Operator Instructions) The first question will come from Brian Nagel with Oppenheimer.

Brian Nagel – Oppenheimer

Hi, good morning.

Alex Smith

Good morning, Brian. Hi.

Brian Nagel – Oppenheimer

Hi. Congratulations on another nice report here.

Alex Smith

Thanks.

Brian Nagel – Oppenheimer

Couple questions. First off, with regard to expenses, you touched upon this a bit but we have had a few quarters now of some outsized sales gains. Where are you with respect to staffing your stores and to what extent if any do we have to assume if sales continue to pick up from here that there will be have to be, sort of, say reinvestment of employees in the stores or elsewhere in the business?

Alex Smith

Okay. I'll let Cary take that one.

Cary Turner

Brian, I think I told you and everyone in the fourth quarter conference call, as you build the model, as you increase sales and whatever that comp rate that you're using, I would take the variable expenses up about half the comp and keep the fixed cost relatively fixed. You saw that the fixed cost went up a little in the first quarter. But I think that does allow us the biggest variable cost is store payroll and that allows us to add people as we see fit.

Brian Nagel – Oppenheimer

Okay. So the -- the guidance just stays the same. Thanks for that. With respect to sales, some concerns in the marketplace over the last few weeks and particularly today, sales in retail and particularly the home category. We obviously had your sales reported a couple weeks ago but maybe a little more detail on the sales progression through the quarter, particularly in late in the quarter in May and then to any extent, any comments you can make about sales here in June? Thanks.

Alex Smith

Sure. Well, certainly we didn't see any deterioration in the quarter. I mean, I think we released our March sales. So you know what March was. There was a little dip in April, just because of the Easter shift and then May came back strongly and that aggregated out to the 14.3. If we look, we're halfway, exactly halfway through the month of June and if you look at June month to date, our comps are actually slightly ahead of the first quarter comp percentage.

So, so far, we're seeing no deterioration. What we've got to just work our way through the next month is the Pier 1 Imports sale that we had last year and as I just said in the prepared words, we have so much less clearance last year that we think we'll take a little bit of a fallback on sales, on the one hand. On the other hand, we're going to pick it up on average ticket. So we'll see. But I mean, we're certainly confident for the balance of the month.

Cary Turner

And margin will be higher than last year.

Alex Smith

How could I forget margin? Margin will clearly be well above last year.

Brian Nagel – Oppenheimer

Very helpful. Congrats and thanks. Talk to you next quarter.

Alex Smith

Okay. Thanks.

Operator

The next question will come from Budd Bugatch with Raymond James and Associates.

Budd Bugatch – Raymond James and Associates

Let me add my congratulations to the quarter. It's nice to see a profit in the first quarter returning.

Alex Smith

Well, thanks, Budd.

Budd Bugatch – Raymond James and Associates

Alex, when you look at merchandise margin, which was outstanding at 58.6 and you've quantified or you've told us the factors that helped that with reduced clearance. Can you maybe give us a little bit more color in terms of what were the most important factors that led you to that number and then just obviously, I'm going to add on to how sustainable is that. I know you're saying 56% for the year or at least 56% for the year but I'm curious to know what might be the deteriorating factors to get you down that low?

Alex Smith

Well, let me deal with the sustainability question first. Yeah, the margins are absolutely sustainable. There's nothing that we see or that we know or that we're doing that would lead us to believe that they're absolutely not sustainable. I mean, frankly, that's what we've been working on for the last three years to make sure we have margin rates that are sustainable.

As far as the components, I mean, this will sound like a really vanilla answer but it actually is the truth. It is everything. So we are seeing improvements. We are seeing improvements to the forecast. Although -- obviously, there's a few price pressures building there. We are seeing reductions in our freight costs. We are seeing reductions in the distribution center and the outbound freight. And of course, we are seeing big decreases in the markdown. I suppose numerically the biggest one is the reduction in the markdown but that in no way negates the huge importance of all the other pieces.

Budd Bugatch – Raymond James and Associates

I understand.

Alex Smith

Does that help?

Budd Bugatch – Raymond James and Associates

That helps greatly.

Cary Turner

Budd, just one more thing. If you remember, in the fourth quarter conference call we told everybody at least 55 and now we've raised that to at least 56.

Budd Bugatch – Raymond James and Associates

I understand, Cary. I just don't want to get too far carried away without good reason to be getting too far carried away. I know, you're working on the logistic side of the business, the reduction in the Chicago DC has been an important part of that and obviously, that does impact overall landed cost. I think you have a process in place now to examine logistics. Can you maybe give us a slight update on that?

Alex Smith

I just missed that. Can you say that last bit again? Budd, please.

Budd Bugatch – Raymond James and Associates

Yeah, sir. I think you have an optimization and distribution of supply chain optimization process under way right now or examination of that process. And I wondered if there was any update to that program?

Alex Smith

Well, we -- I mean, not really. We did work with some outside folks, just to look at the shape of the network and really we wanted -- we thought it was pretty good and we just wanted some third party validation, if you like and the guys came in and they scrubbed it all and did all the little maps and things that they do and our fixed DCs are really very well located so, that was the good news. So there's going to be no major network changes.

Cary Turner

But I think maybe in the next call what we'll do is update you with some other efficiencies…

Alex Smith

Yeah.

Cary Turner

… that we continue to see in the supply chain.

Alex Smith

Yeah. And, again, on going as we sort of move these costs down and we talked about our ability to spend money now on technology, there are things we can do in our DC and distribution systems that will give us more flexibility, which will continue to reduce costs.

Budd Bugatch – Raymond James and Associates

Are you still in a place where two-thirds of the inventory is essentially now in the stores and only a third in the DCs and on order? Is that about the right balance today?

Alex Smith

You're not far out.

Budd Bugatch – Raymond James and Associates

Okay. And finally, just talk a little bit about mix and merchandising. I know that -- I don't think you're going to have much in the way of carrying going forward, which I think had been a previous drag on probably some margin. Can you talk a little bit about what your thoughts on mix and maybe some of the merchandising initiatives?

Alex Smith

I really don't want to be too specific about merchandise initiatives, Budd, if you don't mind, for obviously reasons. You're right, we did come out of the (inaudible) and when we looked at what we were getting in terms of dollars per square foot of sales and then the margin on it was not up to our standards. So we knew we could use that space more effectively with other products, which we did. Our furniture, non-furniture mix is holding really steady. We're really happy with that. Our kind of furniture business at around 40% of our mix.

And we're very pleased as well, I think, I talked about this on the call before, where historically we used to have this big delta between the merchandise margin on furniture, compared to our shelf goods. That we have closed really substantially, so now there is very little difference between the departments. Our goal and our requirement is that all the departments are the same.

Budd Bugatch – Raymond James and Associates

Well, thank you very much and again, congratulations. It's certainly very nice to see.

Alex Smith

We're thrilled.

Operator

The final question will come from Brad Thomas with KeyBanc Capital.

Alex Smith

Hey, Brad.

Brad Thomas – KeyBanc Capital

Thanks. Good morning. Good morning, Alex. Good morning, Cary. Congratulations on a great quarter here.

Alex Smith

Thank you.

Brad Thomas – KeyBanc Capital

Just in terms of a little bit of -- just to follow up on the sales trends and the not doing a clearance activity this year. Could you help us maybe quantify how much of a negative impact that could have on the second quarter comps?

Alex Smith

Well, not really, because here's the truth. I don't actually know. And all -- and if I did, you know, we would try and be a little more specific about it. We think may -- so let me just walk you through the components and just tell you our thinking. We think there may be a slight -- we may see a slight deterioration in traffic in the last two weeks in June because we won't have the big signs in the windows, screaming sale, so that's a negative.

On the one hand, our average ticket is going to be significantly above last year, so that's a positive. Our conversion rate we know is going to be above last year because that's a -- so that's a positive. So and we know our margin's going to be increased. So really, the question is, is how much fruitful we lose as a result of really not screaming, sale.

And it may be a little bit. It may not be very much at all. And we're in sort of new territory, if you like, not having a sale. So that's kind of how we're thinking of it, I mean, we're not concerned about it at all and it's not going to impact our profit numbers.

Cary Turner

And I think the other way of looking at it, net, net, net, the margin dollars will probably be higher.

Alex Smith

Yeah, yeah.

Cary Turner

So…

Alex Smith

I mean, that's without a doubt, yeah.

Brad Thomas – KeyBanc Capital

Okay.

Alex Smith

You know, we will see. We're as intrigued as you to see how that kind of plays out. Because it's a big thing, not to get rid of an annual sale is a big deal as far as we're concerned.

Brad Thomas – KeyBanc Capital

It certainly seems to be a good problem to have, if you would even call it a problem, I don't know. But to that point, could you just talk a little bit more about inventory levels. Was it a case where in the first quarter you had really planned things perfectly or were you a little bit light and how are you planning inventory going forward?

Alex Smith

Well, I'll let Cary talk about going forward. I'll just talk about at the end of the quarter and I've got Michael and Cathy here with me today who run the buying and the planning organizations, and I would say our inventories came in at the end of the quarter, spot on, absolutely good job, guys.

Cary Turner

And then looking forward, at the end of the second quarter we may be up about the same as we were for the first quarter. We're looking at getting seasonal receipts a little earlier than last year. But then as we look through the rest of the year, there's no change to the guidance that we see at the end of the year, having inventories about where we ended last year.

Brad Thomas – KeyBanc Capital

Okay. And as we think about the current trends, obviously we've had a nice home buying backdrop supported by the homebuyer tax credit. That's rolled off and it's possible the housing trend could change a little bit going forward.

How long is your lead time as we think about buying for holiday and how much information will you have about sort of the third quarter trends and sort of late two quarter trends before you have to make a bigger commitment around the holiday as you start to get up against some tougher comparisons?

Alex Smith

Well, the holiday is sort of on the water and so our seasonal merchandise ships as we're speaking. I mean, the containers are being loaded today. So, we took a view several months ago as to what we thought it was, what we thought our sales would be on the seasonal merchandise.

On our reorder merchandise, which as you know from what I said is an important part of our business, we're looking at our inventory levels and our sales forecasts on that all the time. So we have the ability to place orders weekly, monthly, whatever as required.

The other thing I would say, you don't forget, our inventory turns are not exactly blistering. So we have a lot of what I like to call elasticity in our inventory. So we can support a significantly higher sales number than we have planned and all that causes us to do is just places orders a little bit earlier on the back-end so it takes. So we're not concerned about that. With the seasonal merchandise, if we've undercooked it, we'll just sell-through it quicker and if we lose a few sales we'll make it up in the margins, so, we're happy.

Cary Turner

And on the other side, we feel we've been very conservative with how we're looking at it.

Alex Smith

Yeah.

Brad Thomas – KeyBanc Capital

Great. And you definitely deserve credit for a great job managing inventory. One last question, if I may. You alluded to getting back into the internet channel. Could you just talk a little bit more about the steps that you take as you research some of the different options that you may have and the timing that we might see that investment in that re-launch really take fold?

Alex Smith

Well, what I'd like to do, I mean, we've made the decision we're going to do it. That much you know. We're going to do site to store. That much I've told you. I mean, what we will probably do, I mean, we're working through our detailed time scales at the moment. I think we probably do, what we absolutely will do, is we'll get it systemically working and then we'll do a soft launch in a number of stores to kind of iron out all the kinks, there's bound to be some. And then we'll do a full launch after that. But what I prefer to do is just give you a more fuller update on that at the end of the next quarter, if you don't mind.

Brad Thomas – KeyBanc Capital

Okay. That sounds find. Thanks so much, Alex. Thanks, Cary and congratulations again on a great quarter. Really excited to see how this year plays out.

Alex Smith

Thanks Brad.

Cary Turner

Thanks to you.

Alex Smith

Thank you, everybody. That's the end of the questions. Thanks for being with us today. We'll see you next time.

Operator

Ladies and gentlemen, thank you for participating in today 's conference call. You may now disconnect.

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