Golfsmith International Holdings, Inc. Q2 2010 Earnings Call Transcript

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 |  About: Golfsmith International Holdings, Inc. (GOLF)
by: SA Transcripts

Operator

Good day, everyone and welcome to the Golfsmith International Holdings Inc. second quarter 2010 earnings conference call. Today's call is being recorded. For opening remarks and introductions, I’d like to turn the call over to Melissa McKay. Please go ahead, ma'am.

Melissa McKay

Thank you. Good morning, everyone. Thank you for joining us today to discuss Golfsmith's second quarter fiscal 2010 results. As a reminder, our presentation includes and responses to various questions may include, forward-looking statements about the company's financial results and about future plans and objectives.

Any such statements are subject to risks and uncertainties which could result – which could cause the actual results and implementation of the company's plans and operations to vary materially. These risks are discussed in the company's Annual Report on Form 10-K fiscal 2009 filed with the SEC.

We issued a press release this morning. If you’ve not receive a copy, you can find it on our website or by calling Investor Relations at 203-682-8200. Presenting on the call today, we have Golfsmith's Chairman and CEO, Martin Hanaka, as well as Chief Operating Officer and Chief Financial Officer, Sue Gove. And with that, I'll turn it over to Marty.

Martin Hanaka

Good morning. Thank you for joining us this morning. With me in New York is Sue Gove, our Chief Operating Officer and Chief Financial Officer as well as Jim Eliasberg [ph], our new General Counsel, who is a very, very welcome addition to our team and remotely from Austin, Janette Ramirez, our Controller.

We’re actually disappointed as we missed our quarter but also encouraged by several transient factors underlying our results. First, our overall club business overcame enormous drive for unit sales last year, which was stimulated by free fairway, hybrids and similar promotions. Those promotions were not repeated by the OEM vendors and if you look at Golf Datatech, dollars were down 11%, down 8%, down 9%, each of the three months in the quarter on an industry basis.

We were essentially flat. Strong iron sales and wedges also produced a good quarter although our quarter on the topline that was shorter by Golf. Clubmaking dropped 10% but the business really bottomed out and is essentially a shaft in great business today. The bottomline, the quality of our sales are better and not mostly driven by giveaways and we did not participate in the perpetual discount that we saw from some corners of the industry.

Secondly, we continue to take share current Golf Datatech. While the way of gain has slowed a little bit, we’re still 4% to 4.5% better than the industry across the seven categories we track in the off course space. So bottomline there is, we really believe that our good market strategy is sound.

Third, our geographic trend is stable except for California where 15 of our 77 stores compete. Rounds play were roughly flat year over year, are down measurably in California. So the bottomline is we’re a function of where we compete, it’s kind of interesting, New England was up 11% of rounds played, while we don’t have any stores there. So really function of our geography and that feels very good except for California, what’s happening across the chain.

Next, our efforts to improve conversion are improving monthly and reached a year-to-date high in the month of June. Conversion in Q2 actually resulted every region of our company versus Q1. Next, our proprietary mix continues to improve and we are extending our internal goal to get the 15% instead of 12% over the next three years, up from 9% last year and we’re basically 1% better than LY.

And finally and very importantly, our direct business unit driven by the web has reversed it several quarter negative trend. This is the best demand creation we’ve had in about two years and that’s with 8.7% fewer pages and 5% last circulation. So we’re very encouraged there. Bottomline, our efforts to improve selection, our marketing service and technology are paying on.

Now, before I turn it over to Sue, in June, we also hired a new Chief Merchandising Officer, Mr. Eli Getson. Eli joins our team after substantial experience at Polo, Perry Ellis, Bon-Ton, and most recently Cabela's. His success in expertise in a payroll, product development and similar were only enhanced achievement of our strategic direction. That job was vacant since January.

So now we’ll discuss the numbers in detail after which I’ll discuss current trends to the market, July and our expectation going forward. Sue.

Sue Gove

Okay. Thanks Marty. Good morning everyone. For the second quarter, net revenues increased 2.8% to $118 million compared to $114.8 million in the second quarter of 2009. The sales growth was driven by the addition of four new stores into the store base, three during the second quarter of 2010.

This was slightly offset by a 0.4% decline in comparable store revenue and a 0.3% decrease in our direct-to-consumer channel. As Marty mentioned, traffic trends were challenging particularly on the west coast but we were pleased to see the sequential improvement in our comp performance through the quarter, driven in large part by our increase in conversion rates due to the store operation or improvement.

Also as Marty mentioned rounds play for the five months ended May 2010, decreased 3% as compared to 1% – 1.6% increase during the same period in 2009. And a sequential improvement from the quarter ended April 3, in which rounds play were down 12.4% according to Golf Datatech.

Gross margin for the second quarter increased 10 basis points for 35% as compared to 34.9% for the same period last year. The gross margin improvement consisted of a 40 basis point increase associated with lower mark downs in the current year quarter as well as a sales mix shift towards proprietary brands and apparel. This was partially offset by a 30-basis point decrease in vendor allowances which were shifted to offset direct advertising costs this year.

SG&A expense increased 6.3% to $33.8 million in the second quarter compared to $31.8 million in the same quarter last year. As a percentage of net revenue, SG&A increased to 28.6% in the current quarter compared to 27.7% in the prior year. The increase in SG&A dollars was primarily due to four new stores, three of which opened during the second quarter of this year which affected SG&A by 40 basis points as well as an increase in advertising expense which also affected SG&A by 40 basis points.

So pre-opening expenses were $208,000 in the second quarter of 2010 compared to $45,000 in the second quarter last year. We ended the quarter with operating income of $7.3 million for the second quarter fiscal 2010 compared to operating income of $8.3 million for the second quarter last year.

Provision for income tax for the second quarter totaled $859,000 as compared to $1.1 million last year, same quarter. Income tax expense for the period deferred from the amount which were within recorded using the U.S. statutory rate of 34% due to changes in our valuation allowances.

Net income totaled $6.2 million or $0.36 per diluted share based on $17.2 million fully diluted shares outstanding as compared to net income of $6.8 million or $0.42 per diluted share based on 16.1 million fully diluted shares outstanding in last year’s second quarter. Note the share account increased had a $0.02 diluted – dilution effect which was the result of the treasury method calculation on stock options impact given the rise in our share price year-over-year.

As of July 3 this year, total inventories were $95.3 million as compared to $93.1 million at the end of Q2 ‘09, the increase being attributable to the new stores. On an average store basis, inventory decreased 1.3% compared with the second quarter of 2009, following significant reductions in prior quarters.

I also want to call out that we’re extremely pleased with our inventory position having the lowest markdown ratio in our company’s history which should bode well for future gross margins. We had $27.6 million of outstanding borrowings under our credit facility and borrowing availability of $44.5 million. This compares to $28 million of outstanding borrowings under the credit facility and $41.7 million of borrowing availability at same time last year.

You may have seen in our recent press release announcing we have extended our credit facility by 48 months resulting in no write-off of previously capitalized or unamortized debt cost and an enhancement to our capital structure for our future growth needs.

Turning to our progress on recent strategic initiative, as Marty commented, we’re encouraged – we’re very pleased with the higher conversion rate. We achieved, which we believe demonstrates our continued focus on improved selling techniques and better tracking of in-store metrics. We also benefited from enchantments to our merchandize assortment, particularly soft lines and better inventory management.

Second initiative; new store growth. Again, encouraged, we opened; Overland Park, Kansas and Brea, California stores in April and Brookfield, Wisconsin open in late May. We're please with the early signs we’re seeing from these new stores and expect to open one additional store in November 2010. Our new stores typically reached profitability in year one in our cash flow positive. We continue our plan for up to seven new store openings in fiscal 2011 and have one leased – new leased sign today.

Third, system investments we’re in the midst of our Oracle ERP system implementation which will enhance our decision making capabilities and provide the foundation for new merchandize in systems. We’re on track and expect to be converted by the beginning of the new calendar year. Overall, we feel good about the execution of our strategic plan; our operational initiatives are driving higher conversion rates, fall initiative in our direct business particularly the improved selection and in stock position and yielding positive results.

Furthermore, gross margin grains continue to result from the increase in proprietary penetration mix and improved apparel business and better inventory control. We’re encouraged by the progress we’ve made despite this macro – difficult macro environment and we remained confident that we’re moving the business in the right direction to deliver the long term sales and earnings growth needed in the business.

Martin, you want to – have few additional comments.

Martin Hanaka

Great. Thank, Sue. Now some additional comment before Q&A. Number one, our current sales trends are solid we don’t for nearly talked about this, but the last five weeks have been very encouraging and it has been the best trend we’ve had in a couple of years. Not only that I just don’t want to get – we did that conclusion but it’s very solid and we again are pleased with it.

Next, this new stores are ramping nicely and total four, three this year, one we open in Q4 last year based on the current run-rate, every new store will make money, at least breakeven it’s first four year, now that counts as well. Next, we have a four management team in place. Sue is still wearing two hats for now, but all senior slots are filled that’s the first time we can say that in a long time.

And then finally, Q2 was a short follow our expectation, since the recovery is going to be a little longer and somewhat slower then we thought, but we’re still committed to reach our three year plan and I need to recalibrate, it would take a next couple of months to do. On October 14th, we will be conducting investor conference in conjunction with our annual vendor conference in Austin, Taxes to go through our plan for the next three years.

With that comment, I’d like open it up to questions, please.

Question-and-Answer Session

Operator

(Operator Instructions) And we’ll take our first question from Derek Leckow with Barrington Research.

Derek Leckow – Barrington Research

Thank you. Good morning.

Martin Hanaka

Good morning.

Derek Leckow – Barrington Research

Marty, looking at my model, gross profit came in almost on my target. But then I’m looking at my operating expense line and you had that 7% increase there and I apologize if you covered this in your prepared statement, but what were the main component of the increase in SG&A?

Martin Hanaka

Yeah. One of the main components was advertising. We spent almost $800,000 more than we planned. As we got into Q2 and looked at the share of voice we had and what was happening around us, we actually added a postcard on Memorial Day. We added four pages to a mailer in June and that was it. So we felt we needed to do that and you never know if – what the impact of that is. I think our topline would have probably been worse had we not done it and that was certainly what the math fact [ph] said to us. There are some other costs that Sue can go over.

Sue Gove

But, the other key piece that we called out Derek, was the deleverage effect that the new stores had in terms of the quarter. And again, several of these stores opened mid quarter, but had more of a full complement of expenses and again, the promotions on new store opening. So we don't expect those stores – new stores to deleverage on an ongoing basis, but in the quarter they opened this particular time they did. And that was about 40 basis points.

Derek Leckow – Barrington Research

About 40 basis points. Okay.

Sue Gove

40 basis points.

Derek Leckow – Barrington Research

And then, if you were to take a look at some of the strategic initiatives, the systems investment, you mentioned new stores already, but just wondering what the true underlying SG&A trend was, if you take away some of the strategic investment?

Sue Gove

If the true underlying SG&A trend would have been positive. And again, if you take out what Marty called out the advertising, the impact of that was 40 basis points, the impact of the new stores was 40 basis points, that get us right at flat. And on flat sales that say there was no deleverage, there were some expense investments but we still have the experience of some of the expense savings that we have been accomplishing as well. So those two – the deleverage and the investment, the savings all offset.

Derek Leckow – Barrington Research

Okay. Was there any remodeling activity in the quarter?

Martin Hanaka

Yeah. We had several stores that we remodeled and were completed in the quarter, Norwalk, Connecticut at the beginning of the quarter, Downers Grove, we spend some money in our Austin showroom, we actually refixtured it as part of a three year plan to update that store, yes, so four or five it is too early to tell, we see some mixed results, but we are encouraged. We spent a little bit of money in Manhattan and we’re going to spend more there as we get out of season. So, yeah, we’re committed to taking some of those older stores and updating them. And as we reposition and recalibrate, we’re going to decide how much more we should put into the older stores going forward.

Derek Leckow – Barrington Research

You know, the 0.4% decrease in comps is actually pretty good compared to other retailers I am looking at. And I just wondered if you could – is it attributable to some of that remodeling, is that – are those remodeled stores comping higher or what’s…

Martin Hanaka

Yeah. Some are – we like to get through the next couple of months with a really peak season, when we are together in October we will give you real clear feedback on that and how we intend to change our spending, if we need to. But overall, I think our team has done a great job. The big half of our business, the clubs, we’re very fearful we couldn't make our numbers in drivers and we are having a terrific iron year. Our custom fitting business is very strong and we are very encouraged by that. Our apparel business is the best business we have in the house now and that soft lines total is about 17% of our mix, it’s creeping up. We think that overall that can get to 25% of our mix with the leadership and investments we can make here. So that’s a really bright part of our business too, so a number of factors. Stop making us always down, it always puts us in a hole, because that business is declining continually. We are about hitting bottom now, but that was once the cornerstone of the company and we've had to absorb outsized losses there over the last several years, as OEM prices have dropped and the gap between a custom made club which you can buy from one of the best global brands has really narrowed. So we've started lap over we – every single quarter, but again, that’s slowing down and it looks like we'll put that behind us soon.

Derek Leckow – Barrington Research

Put that behind you. You mentioned the last five weeks were up close to double digit, but not quite. And has that…

Martin Hanaka

No, they are extra solid they are not double digit. They are mostly close, but we are in the best pattern we have had in two years Derek. And we…

Derek Leckow – Barrington Research

Is the comp positive also during the – the comp is obviously positive during the last five week is that right?

Martin Hanaka

Yes, it is. One of the things we did is we moved our clearance up a couple of weeks from last year. And we are competitive in the marketplace. If you went back two years, we started our clearance in August, which is late, think about apparel starting your clearance in August when you should be fall. This year we will be fresh in the fall. And our clearance was accelerated. And today we’re starting our summer clearance on hard goods. So I think we are now competitive in timing and that has helped our business too.

Derek Leckow – Barrington Research

Okay. Thanks. Good luck.

Martin Hanaka

Thank you.

Operator

And we take our next question from Todd Slater with Lazard Capital Markets.

Jennifer Davis – Lazard Capital Markets

Hi. It’s actually Jennifer Davis for Tood Slater. Congratulation on a good quarter in this rough environment.

Martin Hanaka

Thank you.

Jennifer Davis – Lazard Capital Markets

I was just wondering, if you could expand a little bit on July sales trend, you said you moved clearance up a couple of weeks, so can you quantify how much that has helped July?

Martin Hanaka

I have to tell that it has helped us. In fact, some of our stores are thin on apparel right now with result of that and our fall receipts are definitely needed and desired on that part of our business. We actually had conversation this week and we are going to build some transition inventories next year, because we know we’ve lost some business in July by being a little bit short of inventory. We have less clearance than ever. We had a board meeting yesterday. And our inventory over 360 days is a lowest any of us can ever remember. So our inventories are really healthy. These move the clearance really was smart. We are waiting for fall to land and our business could be better if we had deeper inventories right now.

Jennifer Davis – Lazard Capital Markets

Well, maybe, we’ll see the lowest markdown on ratio in the company history next quarter too.

Martin Hanaka

We, we’ve would hope so. We’ve got some nice receipts coming and when you got into our stores around, first, second week of August we are going to look better than ever. And again, we continue to think we are taking market share.

Jennifer Davis – Lazard Capital Markets

And that leads to my next question. So you’re about 4%, 4.5% better than the industry?

Martin Hanaka

If you look at dollars, the dollars and units for those categories in the aggregate that’s where we have landed.

Jennifer Davis – Lazard Capital Markets

And what do you attribute that to mostly?

Martin Hanaka

I think our Play Better Guarantee. The fact that we will custom fit someone to the exact waff, lie, shaft they need for their arm length, their posture, their swing speed. We’ve gone out and said, if we custom fit you and you don’t play better, we will give you full credit and I think that’s differentiated us. We are not just someone who’s trying to sell $149 drivers of old product. We are selling new stuff and we want to get you into the right new stuff. And I think it’s a point of differentiation because of the strength of sour people, our organization, the training that’s been done that we do it as well as anyone. And we just launched our 15 yard longer guarantee. We guarantee that off the tee you will get 50 yards more if we can custom fit you on a driver. And people, again, I think are responding to that. We believe that’s the case.

Jennifer Davis – Lazard Capital Markets

All right. Great. Good luck.

Martin Hanaka

Thank you.

Operator

And we’ll take our next question from Casey Alexander with Gilford Securities.

Casey Alexander – Gilford Securities

Hi. Good morning.

Martin Hanaka

Good morning.

Casey Alexander – Gilford Securities

Good morning. Not sure how customer would come back and prove that they didn’t get 15 yards farther off to tee, or you would prove that he did but it is an interesting promotion.

Martin Hanaka

No. It’s no questions asked and I have to tell you that if we fit you, you are going to just feel it. You are going to hit the sweet spot. It’s going to make a sound and it’s going to have a feeling to it that second to none. And you were probably never hitting off that tee in that location but you will know. And plus we know, if we get our hands on you, we can get you the right club and you will hit it further, guaranteed. They are supporting us on the backend.

Casey Alexander – Gilford Securities

You guys sound more energize and more offensive than you have in long time which is good to hear. But do you have any insights into what’s up in California? I mean, what do you think was driving such significant underperformance in that once specific market?

Martin Hanaka

We actually had our regionals together last week. And we go through every P&L. We talk about every manager. We look at all the trends. And you’ve got an unemployment rate there that is over 12%, 12.2% I think in Orange County. You’ve got markets where there it is 14% unemployment. So jobs is number one. There is no question about it.

You’ve got this whole foreclosure thing going and bankruptcy thing going on. So consumer confidence is probably one of the weakest areas of the company and we also have consumer confidence drop. That’s why we are looking at our June sales, our July sales, excuse me, this is an anomaly given the bad economic news that’s out there.

The third thing, I think is that California has rounds played that are down substantially. And we really think though we should remain offensive. This is a big market. It’s a year round market and the market share is there for the taking. So we are really committed to California and Southern California in particular, where we are building our network. We just think it’s temporary. We don’t think this is permanent. It is 20% of our chain.

Casey Alexander – Gilford Securities

Okay. I guess – This is just asking for an opinion rather than a fact, unless you know this issue. Are sales of the golf industry for the year down?

Martin Hanaka

It depends on which category you're talking about, obviously and I have through May Golf Datatech. By the way, you say industry, I’m talking off course. I can't talk about sporting goods and I…

Casey Alexander – Gilford Securities

Right.

Martin Hanaka

… I can't talk about web. But, frankly if you went year-to-date May Golf Datatech, which is a third-party, we believe that if you look at every category, added them up, they are down over 3% in dollars and down in units as well.

The big losers through May was Woods. They were down 8% year-to-date through May and we know in June they dropped 9%. That is the big loser. And that is, as we say in the business, as go Woods so does your business, because it is so big and it’s a purchase that people make every couple of years. So, yeah, it’s down. The recovery hasn't happened in the industry the way we had all hoped.

Casey Alexander – Gilford Securities

Is that Woods' figure you think more price compression than units?

Martin Hanaka

No. It’s promotional. Last year if you bought a driver from any one of the big brands, TaylorMade, Callaway, Nike, you would get a free hybrid, free fairway. That was a big value and that held us together and the vendors fully supported it in the backend, so we all made full margins on it. That was not repeated.

From their viewpoint it wasn't affordable. So everybody did something a little different, but none of them had the impact and we fortunately were able to overcome it in the quarter, but we still came up short of plan.

Casey Alexander – Gilford Securities

Yeah. Okay. So it’s not promotional this year, it’s against last year's promotional?

Martin Hanaka

Exactly.

Casey Alexander – Gilford Securities

Yeah. Okay. Great. All right. Perfect. Thanks very much.

Martin Hanaka

Thank you.

Operator

(Operator Instructions). We’ll go next to Steve Kernkraut with Berman Capital.

Steve Kernkraut – Berman Capital

Hi, Marty and Sue. I just had a quick question. I just got your red covered flyer with the 60% off sale. I just wanted to get a sense in terms of the marketing programs that you have going forward for the third quarter. Is this program that you have the sale going on now, is that comparable in depth and breadth to what you had last year? And what kind of vendor support are you getting, I mean, how much incremental marketing should we anticipate here in this third, fourth quarter?

Martin Hanaka

Yeah. Well, this is our summer sale and clearance event. We have run it historically in August every year. A big part of it previously was apparel and we would all wait and enroll discount at the same time our clearance at least at Golfsmith.

We moved and taken apparel, moved it up a couple weeks earlier last year and even earlier this year. So while apparel is part of this promotion, we’re really running thin on goods. This is more about hard goods. And we are getting the same support we always have. And we actually moved this event up a full week for hard goods from last year prior. And by doing so we added one other effort in the month of August chain-wide, other than that, our calendar spending is essentially the same as LY.

Steve Kernkraut – Berman Capital

Okay. And you’re factoring in that the moving up of the promotion and when you talk about how business has been so good in July, I mean, is it, I mean, I just want to make sure that we’re not looking at it so that business is good in July because we moved up the events and then August is going to be weaker because it is not – it’s less comparable to last year.

Martin Hanaka

That is a very good question. Essentially if you looked at this quarter in its entirety, we added one event. This is it starting today. I guess it was supposed to be delivered beginning yesterday and by doing so it brackets July and August. And then the one event we always had in August stays the same. So the only the incremental spending it is in your hands right now.

Steve Kernkraut – Berman Capital

Okay, well, good luck.

Operator

At this time, we have no further questions from the phone lines. So I would like to turn the call back over to management for any additional or closing remarks.

Martin Hanaka

Now thank you very much for your time and interest in Golfsmith. We hope our next call has much better news than in the past and that this trend continues. Thank you very, very much. Good day.

Operator

This does conclude today's conference. Thank you for your participation.

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