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Cost Plus (NASDAQ:CPWM)

Q4 2010 Earnings Call

March 17, 2011 4:30 pm ET

Executives

Barry Feld - Chief Executive Officer, President and Director

Jane Baughman - Chief Financial Officer, Principal Accounting Officer, Executive Vice President and Corporate Secretary

Anne Mirante - Vice President of Finance and Treasurer

Analysts

Brad Leonard - BML Capital Management

TJ McConville

Operator

Great day, ladies and gentlemen, and welcome to the Fourth Quarter 2010 Cost Plus, Inc. Earnings Conference Call. My name is Thelma and I will be your coordinator for today's event. [Operator Instructions] I would now like to turn the presentation over to Mr. Barry Feld, CEO of Cost Plus World Market. Please proceed.

Barry Feld

Thank you, operator. Good afternoon and thank you for joining us to discuss our fourth quarter and fiscal 2010 results. With me for this conference call are Jane Baughman, Executive Vice President and Chief Financial Officer; Anne Mirante, Vice President of Finance; and Charlie Miltner, Corporate Controller. Following my opening remarks, Jane will discuss the fourth quarter financial results in detail, after which I'll make some concluding remarks and then we'll open up the call for questions. Before beginning today's discussion, Anne Mirante will read the company's Safe Harbor statement.

Anne Mirante

Certain forward-looking statements regarding the company's future performance and initiatives will be made during this conference call and will usually be preceded by words such as believes, anticipates, projects or expects. Any such forward-looking statements are subject to known and unknown risks and uncertainties that could cause the actual results to differ materially from those expressed or implied by these statements. Such forward-looking statements include, but are not limited to, our financial guidance for the first quarter and full year of fiscal 2011 and our expected capital expenditures for fiscal 2011. The risks and uncertainties include, but are not limited to: deterioration in economic conditions that affect consumer spending; changes in the competitive environment; currency fluctuations; timely introduction and customer acceptance of the merchandising offerings; foreign and domestic labor market fluctuations; interruptions in the flow of merchandise; changes in the cost of goods and services purchased including fuel, transportation and insurance; material unfavorable outcomes with respect to litigation, claims and assessments; unseasonable weather; the effects associated with terrorist attacks and changes in accounting rules and regulations. A more complete listing of risk factors is included in the company documents on file with the Securities and Exchange Commission.

Barry Feld

Thank you, Anne. Fiscal 2010 was a transformational year for Cost Plus World Market. Although weak economic conditions persisted throughout the year, we delivered significant year-over-year improvement in all four quarters and reached our target of net income 12 months ahead of projections. The strategic changes we made to our business model, which address the new value-based economy and capitalized on our core strengths, clearly resonated with both our existing customer base and customers who are shopping us for the first time.

In fiscal 2010, we delivered a 7.2% same-store sales increase, driven entirely by higher customer count and a flat average ticket. This top line, coupled with a 530 basis point improvement in gross profit rate, generated $40 million in EBITDA from continuing operations and resulted in net earnings from continuing operations of $0.21 per share for the year. Additionally, we significantly increased the size of our propriety database to 6.7 million customers, of which 4.3 million are members of our World Market Explorer loyalty program.

At this time last year, I outlined the strategic initiatives for 2010 and our two-year timeline to return to profitability. These strategic initiatives were designed to generate positive EBITDA for fiscal 2010 and return to net income in fiscal 2011. I think it is important to review the achievements made during fiscal 2010, which enabled us to complete the turnaround.

We restored gross margin by increasing initial markups and reducing markdowns, achieving a two-year projected rate during the first 12 months. Additionally, meaningful productivity gains in our supply chain operations contributed to the gross margin recovery. Our merchants worked diligently to evolve the uniqueness, sophistication and authenticity of our merchandise categories while maintaining the integrity of our everyday low-pricing strategy. Our marketing team expanded the use of alternate layered media to drive new customer acquisition and reduced reliance on newspaper tab inserts.

The Company continues to optimize the World Market Explorer loyalty program to drive shopping frequency and increase traffic levels. Strong inventory management discipline and tight SKU count resulted in a controlled buildup of inventory to support the planned increase in same-store sales. The store operations team continued to improve customer service levels to drive increases in conversion and units per transaction. The relative newness of both our distribution centers and our store fleet allowed us to limit capital spending to system maintenance and compliance projects.

The management team and community of Cost Plus World Market Associates have worked together to flawlessly execute these strategic initiatives in fiscal 2010. Both the strategic and operational changes made to the business model are sustainable and scalable. With the employee morale and productivity at an all-time high, the company is well positioned to drive sales and profit per square foot improvements in its core business during fiscal 2011.

I would now like to turn the call over to Jane.

Jane Baughman

Thank you, Barry. As a reminder, the income statement included in this afternoon's press release clearly breaks out the results from continuing and discontinued operations for both the current year and prior-year periods. The Company's balance sheet presentation remains unchanged. Net sales for the fourth quarter of fiscal 2010 were $341.6 million, a 7.1% increase from the fourth quarter of fiscal 2009. Same-store sales for the quarter increased 7.7% driven by a 6.6% increase in customer count and a 1.1% increase in the average ticket. Net sales for fiscal 2010 were $916.6 million, a 5.7% increase in fiscal 2009.

Same-store sales for fiscal 2010 increased 7.2%, driven by a 7.7% increase in customer count and a relatively flat average ticket. During the fourth quarter, we continued to experience strong performance across the eastern and western regions, which resulted in an 8.2% and a 7.1% comp increase, respectively.

The California market recovery continues to strengthen and delivered a same-store sales increase of 7.3% in the fourth quarter. The mix between home and consumables as a percentage of net sales, was 56% and 44% respectively for the fourth quarter of fiscal 2010 versus 54% and 46% respectively for the fourth quarter of fiscal 2009.

For the full year, the mix between Home and Consumables as a percentage of net sales was 60% and 40% respectively for fiscal 2010, versus 59% and 41% respectively for fiscal 2009. The modest shift in sales mix back towards the Home category was part of the company's ongoing strategy and will continue to benefit merchandise margins. Both the Home and Consumables division delivered mid-single-digit positive comps in fiscal 2010.

Gross profit rate for the fourth quarter increased 570 basis points to 33.1% versus 27.4% last year. The 570 basis point increase was primarily due to improvement in merchandise margin, combined with lower occupancy costs and the leveraging of those reduced costs on higher same-store sales. Gross profit rate for fiscal 2010 was 31.7% and is a 530 basis point improvement over last year and is steadily approaching historic levels.

Merchandise margin improved in the fourth quarter due to strong performance within non-furniture home, particularly in our seasonal, entertaining and gifting categories. Our core competency in gourmet and seasonal food items continues to be a favorite with our new and loyal customers, drawing them into both our Fall Harvest and holiday shops. Our Furniture business increased year-over-year in the fourth quarter, which is an improvement from the first three quarters.

Customer are responding to new aesthetics and new items within the Living Furniture business. The company continues to sell goods from all four corners of the store at full margin across most categories of the business, and with much less promotional than in the fourth quarter last year.

As a percentage of net sales, selling, general and administrative expenses, SG&A, decreased 80 basis points to 23.4% for the fourth quarter of fiscal 2010 from 24.2% for the fourth quarter last year. The decrease in SG&A expense as a percentage of net sales is largely due to increased leverage on higher same-store sales.

For fiscal 2010 as a percentage of net sales, SG&A decreased 160 basis points to 29.6% from 31.2% last year. Included in SG&A for fiscal 2010 is $5.5 million of expense related to the estimated annual bonus payout under the fiscal 2010 management incentive plan, which includes an incremental $1.9 million that was accrued in the fourth quarter for the portion earned during that quarter. There was no management incentive plan bonus payout or accrual for fiscal 2009.

Net income from continuing operations for the fourth quarter was $28.8 million or $1.24 per diluted share compared to $21 million or $0.95 per diluted share last year. Last year's fourth quarter results included an income tax benefit of $13.1 million or $0.59 per diluted share, primarily related to a receivables that was recorded for a tax refund, which was received in February 2010.

Net income from continuing operations for fiscal 2010 was $4.7 million or $0.21 per diluted share compared to a loss from continuing operations of $46.2 million or $2.09 per diluted share for fiscal 2009. Net income, including discontinued operations for the fourth quarter of fiscal 2010 was $28.5 million or $1.23 per diluted share compared to $21.1 million or $0.95 per diluted share last year.

Net income, including discontinued operations for fiscal 2010, was $2.9 million or $0.13 per diluted share compared to a net loss of $63.3 million or $2.87 per diluted share last year. For the fourth quarter of fiscal 2010, the company had earnings before interest taxes, depreciation and amortization or EBITDA from continuing operations of $37.6 million compared to an EBITDA of $17.1 million last year.

For fiscal 2010, the company had EBITDA from continuing operations of $39.5 million compared to an EBITDA loss of $19.2 million last year. The company continues to maintain a full valuation allowance against this deferred tax asset, which was $78.6 million at the end of the fourth quarter, of which $45.4 million is comprised of net operating loss carry forward. The company has completed its Section 382 Study and does not expect there will be any significant limitation on its ability to apply its federal net operation loss carry forwards against future taxable income.

Net interest expense for the fourth quarter of fiscal 2010 was $2.9 million versus $2.8 million last year. Net interest expense for the full year was $11.1 million versus $11.2 million last year. Included in net interest expense is interest related to the distribution center lease obligation of $8.3 million and $8.2 million for the full year of fiscal 2010 and 2009, respectively.

At the end of the fourth quarter, our inventory balance was $181.9 million compared to $177.2 million last year. Per store inventory levels increased 4.6% from a year ago to support the planned increase in same-store sales. The company ended the fourth quarter with $25.4 million in borrowings and $10.8 million in letters of credit outstanding under its revolving credit facility compared to $48.5 million borrowings and $12.9 million in letters of credit last year.

For the year, capital investments for 2010 projects were $4.3 million versus $2.9 million for 2009 projects. Capital spending for fiscal 2011 projects is forecast to be approximately $10 million for the full year. In this afternoon's press release, we have provided our outlook for the first quarter and full year of fiscal 2011.

Our guidance takes into account the current level of volatility in commodity prices, fuel prices and geographic instability. I would like to provide some additional clarity around certain line items in our guidance. The company will record tax expense for states where the company files separately and for states that have suspended the use of NOLs including California and Illinois. As discussed earlier, the company will be able to utilize its federal net operating loss carry forward.

The loss from discontinued operations includes the adjustment of estimated lease exit costs, net of estimated sublease income for the remaining seven stores closed in prior years for which lease buyouts are being negotiated. Lastly, our diluted shares outstanding guidance includes the impact of the stock options that were previously excluded due to their anti-dilutive effect.

I will now turn the call back over to Barry, for his concluding remarks.

Barry Feld

Thank you, Jane. Seamless integration between merchandising and marketing increased the speed by which were able to drive traffic and restore gross margin. This has resulted in the company's ability to achieve net income for the first time since fiscal 2005 and formally conclude the successful completion of our four-year turnaround.

As Jane pointed out, our financial projections for fiscal 2011 reflect cautious optimism and incorporate the current level of commodity pressures, rising fuel cost and instability in a number of geographic areas.

Ongoing refinements to our strategic merchandising and marketing initiatives, combined with the continuation of the momentum experienced in fiscal 2010, will result in another strong financial performance in fiscal 2011.

As you may recall, I suspended our new store opening program at the beginning of the turnaround until such time that the company had reestablished a profitable business model. While our fiscal 2011 guidance does not currently contemplate any new store openings, we are working to open a modest number of stores in the back half of this year.

The strategic and operational changes made to the business model generate the necessary cash flow to pay off the credit line in its entirety at the end of fiscal 2011 and will provide the necessary working capital needed to resume a formal new store opening program in fiscal 2012.

With our average store sales volume of $3.4 million in fiscal 2010, there is ample opportunity to increase the sales per square foot productivity within our existing stores and continue leveraging our fixed costs. This will ultimately enable the company to return to historic profit margins.

Furthermore, we believe we can support the next 100-plus new store openings without the need for additional distribution capacity. We are confident that both our financial plans and ongoing strategic initiatives for fiscal 2011 are both realistic and achievable.

With that, I would like to turn the call over to the operator for the Q&A portion of the call.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Budd Bugatch with Raymond James & Associates.

TJ McConville

It's actually TJ McConville filling in for Budd. I had a couple of quick housekeeping questions. Jane, I missed the NOL carryforward number. Was it $45 million?

Jane Baughman

Yes. $45.6 million.

TJ McConville

And for the quarter, what was the operating cash flow? Do you have that number?

Jane Baughman

I don't have the actual statement in front of me.

TJ McConville

Okay. I'll just wait for the filings to come out. Looking at the guidance, wondering a couple of things on the top line. It was nice to see the average ticket increase this quarter. What is embedded in both the first quarter and maybe the full-year guidance from your perspective, from a traffic ticket mix standpoint? It's plus four to plus five, what's the mix there?

Barry Feld

We're actually expecting the majority of the top line increase to once again come from average, from customer traffic improvements, and we are anticipating modest improvements, again, in the average ticket. As you're aware, TJ, we have repositioned the business so that average tickets in the mid-$30 range has the requisite impact as it relates to sales and profit generation and our primary focus is really to continue to drive our traffic initiatives.

TJ McConville

Okay, that's helpful. And any potential bump in the ticket from an APU or average unit perspective would be sort of gravy on top of that?

Barry Feld

That's correct.

TJ McConville

Okay. And looking at some of the housing markets that were hardest hit, Jane, you gave us the comps for California. Are those expected to continue to drive our performance relative to your overall comp? Are they going to be positive drivers is the question, in your opinion?

Jane Baughman

I think the California market will continue to perform as it has been performing. I don't think there'll be another step function up, but we're not expecting kind of a reversal of the traffic counts that we're experiencing in California.

TJ McConville

Okay. And my last one, if I might, Barry, you started to hint that some of the store opening plans, which is great to hear for the back half of this year. Any inkling to give us a sense for beyond maybe 2011? I know we've talked about the potential for 125 stores in existing markets and maybe 500 more total. Any sense for the pace of that store openings beyond this current year?

Barry Feld

Not at this juncture, TJ. I'll be prepared to comment on that as we move further along in the fiscal year. But the numbers you just cited, I think are worth again pointing out that we've identified approximately 100, 125 opportunities in existing markets and that will be our initial focus. The pace of that and how it materializes in the cadence of the number of stores in those markets, I'll be better prepared to talk with a little more granularity as we move further along in the fiscal year.

Operator

Our next question comes from Brad Leonard with BMO Capital Management.

Brad Leonard - BML Capital Management

Barry, you mentioned something about productivity of the box and getting back to historical rates of profitability. So based on the guidance, it looks like maybe you're roughly at 3% EBIT operating profit this year plus or minus around that level. So historically, when you guys were really doing well somewhere between 6% and 7%, so what do you have to do to get back to that 6% to 7% range?

Barry Feld

Well, I think the real key is if you look at the fixed cost structure of the business, the platform is really quite stable at this juncture, and it's really going to result in the continuation of improved sales per square foot productivity as we move off the $3.4 million average store volume and start to move back. If you go back to the numbers you were citing, the stores were generating on average a little bit over $4 million a year or roughly $275 sales per square foot. We finished last year at about $218 sales per square foot and a lot of these new categories that we've introduced over the last 36 months, these product categories such as Jewelry and Accessories and the improved performance around areas like tabletop textiles, we anticipate further productivity gains in those areas of the store. So over the next several years as that performance improves, we anticipate tightly controlling the fixed cost structure of the business and then being able, now that we've restored our gross profit margins, being able to take a portion of those incremental dollars down to the operating and ultimately, the net income line. I would anticipate EBITDA margins ultimately back in the 6% to 8% range and net income margins, Jane, I would say probably in the 2% to 3%?

Jane Baughman

No, it'll be north of that. It'll be 3% to 5%.

Barry Feld

And net after-tax net income?

Jane Baughman

Yes, at around $4 million or so.

Barry Feld

Okay. So 3% to 4%, Brad.

Brad Leonard - BML Capital Management

Okay. And what would you think a timeframe of that, something like that would be? I mean, I know you don't have a crystal ball but...

Barry Feld

Yes, I hate to give you such a -- cast such a wide range but I put guard rails around call it sort of a 36-month, a three-year plan as we move from year-to-year. We think in terms of solid comp performance in sort of the mid-single digit range on a go-forward basis. And we try to remain, to some degree, conservative in our assessments given so many macroeconomic and there's just a lot of unstable things out in the marketplace. Despite that, our level of confidence is over the next 36 months that we can predictably and conservatively move back toward those objectives. But that's really about the best I could give you at this juncture.

Brad Leonard - BML Capital Management

Sure. So you said 6% to 8% EBITDA margins. I think historically, you guys had been even as high as, more like 8%, even approaching 10%. So you think that the structure of the business will just be maybe 100 basis points lower than the peak?

Barry Feld

I'm sorry I really, Brad, I misspoke. Because I was referring to the EBIT margins and I said EBITDA. But I'm talking about operating income margins.

Brad Leonard - BML Capital Management

Okay, operating income. Okay, so that's...

Barry Feld

Yes, I misspoke and quoted EBITDA margins.

Brad Leonard - BML Capital Management

So an 8%, I don't think you guys -- I'm just looking at old data here, I don't remember the last time you ran an 8%. Well, I guess 7.3% in '01 or 2000.

Barry Feld

In the early 2000s.

Brad Leonard - BML Capital Management

Yes, early 2000s, okay. So you think that's still achievable today?

Barry Feld

I sure do. Particularly in the way we've retooled the fixed cost structure of the business. And remember, the distribution centers, which were to some degree a liability at the beginning of the downturn are now going to be very valuable assets because a significant amount of the established fixed costs that are here will be able to support higher sales volume.

Brad Leonard - BML Capital Management

Okay, okay. That's excellent. And then I'm just looking at interest expense for next year. Is that on your guidance, do I see it looks like it's going up $3 million?

Jane Baughman

Yes. So there's a couple of things impacting that number. I'm sure you recall we negotiated our credit facility in January of this year at a higher borrowing rate. So there are two components to the credit facility, there's a term loan for $10 million and then $190 million revolving piece. The increase on the borrowing rate on the revolving piece is about 150 basis points higher than what we paid this year. And then on the term loan, it's 350 basis points higher. Additionally, we have increases in the unused fee, LC fees and then we're also amortizing the cost of renegotiating that facility over the term of the loan. So that's what's contributing to the increase in the interest line.

Barry Feld

Brad, something else I pointed out in my commentary that I think is worth noting is, in fiscal 2011, we will also return to completely paying down the credit facility at year's end. That is our plan as we put out there into the market.

Brad Leonard - BML Capital Management

Okay, so you think probably on a run rate per quarter, you're going to be down $20 million to $30 million on the revolver?

Barry Feld

That's correct.

Jane Baughman

That's right.

Brad Leonard - BML Capital Management

Okay, okay. And then lastly, and I know you're probably not going to answer this, but I have to ask. So you're doing this test with Bed Bath & Beyond, three stores, no one is really commenting on it. I mean, from an investor standpoint of view, it looks like this could be a pretty good deal, whether you're going to roll that out, I don't know what it's going to be but it seems like it could be a meaningful event. Would like to comment on that at all, Barry?

Barry Feld

Brad, I mean you're right. I don't want to be gamey and I hate to be evasive, but it's a merchandising test with Bed Bath & Beyond. We're looking at a variety of initiatives out there in addition to just resuming our store opening program. But as it relates to Bed Bath & Beyond, it's a merchandising test and I really can't comment at this juncture. As we move through the year, I'm hopeful I could provide more granularity on it for you.

Operator

[Operator Instructions] We have no additional questions at this time.

Barry Feld

Okay, thank you, operator. I would like to thank everyone for joining us today to review our fiscal 2010 results and I look forward to reporting our first quarter fiscal 2011 results in May. Thanks for joining us again everyone.

Operator

Thank you for your participation in today's conference. This concludes today's presentation. You may now disconnect and have a good day.

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