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Executives

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

Barry Feld - Chief Executive Officer, President and Director

Anne Mirante - Vice President of Finance and Treasurer

Analysts

Joan Storms - Wedbush Securities Inc.

Anthony Chukumba - BB&T Capital Markets

TJ McConville

Cost Plus (CPWM) Q2 2011 Earnings Call August 25, 2011 4:30 PM ET

Operator

Good day, ladies and gentlemen, and welcome to the Second Quarter 2011 Cost Plus Inc. Earnings Conference Call. My name is Melanie, and I'll be your coordinator today. [Operator Instructions] As a reminder, today's call is being recorded. I would now like to turn the call over to Mr. Barry Feld, Chief Executive Officer. Please proceed, sir.

Barry Feld

Thank you, Melanie. Good afternoon, everyone, and thank you for joining us to discuss our second quarter and first half 2011 results. Today's conference call should be considered in conjunction with the press release we issued earlier today. With me for this conference call are Jane Baughman, Executive Vice President and Chief Financial Officer; and Anne Mirante, Vice President of Finance. Following my opening remarks, Jane will discuss the financial results in more detail, after which I will make some concluding remarks, and then we'll open the call to questions.

Before beginning today's discussion, Anne will read the company's Safe Harbor statement.

Anne Mirante

Certain comments made during this call may contain forward-looking statements within the meaning of Section 21E of the Securities and 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. The company's actual results or 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 the company's control. Please refer to the company's current press release and SEC filings, including our annual report 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.

Barry Feld

Thank you, Anne. We are pleased with our second quarter results, which exceeded our best-case bottom line guidance and consensus estimates. We continue to experience strong gains in customer count, driven by increases in traffic and conversion rate. This is our sixth consecutive quarter of positive comps and seventh consecutive quarter of increases in customer counts.

As discussed on our last call, our second quarter guidance reflected a truncated outdoor selling season this year due to the late Easter holiday. Although the company achieved a modest positive comp in its Outdoor Furniture business during the quarter, fewer weeks of full-price selling put pressure on margin and ticket. While our net loss from continuing operations increased $1 million from a year ago, the business performed as we expected and as we had previously communicated. Both the Home and Consumables divisions delivered a same-store sales increase for the second quarter.

For the 6 months of fiscal 2011, the company generated a 4.2% increase in same-store sales and reduced its net loss from continuing operations by 35% versus the first half of last year. Additionally, the company generated $5 million in EBITDA from continuing operations in the first half of fiscal 2011 and expects to generate $49 million to $52 million for the full year, which it will use for working capital purposes and to pay off the revolving credit facility in its entirety at year's end.

The revolving credit facility is the only bank debt that the company has on its balance sheet. The company's marketing program remains organized around the use of layered media, including online, electronic, print and partnerships to drive traffic with both our existing customer base and for new customer acquisition.

Our World Market Explorer loyalty program, which launched just 2 years ago, now has over 5 million members and is growing each day. We continue to develop our customer segmentation analytics, allowing us to market to customers' specific needs and drive frequency.

Last August, you will recall the company had a successful partnership with Sony Entertainment for the motion picture Eat Pray Love. This year, we have developed another exciting partnership with Paramount Pictures for the movie The Adventures of Tintin, directed by Steven Spielberg, which opens on December 23. Our marketing team continues to expand its toolbox to drive traffic and increase our national brand presence.

As you visit our stores during the second half of the year, you'll see that our Fall Harvest, Halloween and holiday assortment and visual merchandising have never looked better and are priced to deliver clear and recognizable value to our customers.

Our continual flow of fresh merchandise with exclusive designs will provide our customers with creative and affordable solutions for their gift-giving and home entertaining needs, which is particularly important in today's consumer climate.

I would now like to turn the call over to Jane, after which I will make some concluding remarks.

Jane Baughman

Thank you, Barry. As a reminder, the income statements 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 period. The company's balance sheet presentation remains unchanged.

Net sales for the second quarter of fiscal 2011 were $197.9 million, a 3.2% increase from the second quarter of fiscal 2010. Same-store sales increased 2.8%, driven by a 5.5% increase in customer count, partially offset by a 2.5% decrease in the average ticket. The Eastern region and Western region both delivered positive comps during the quarter. The California market delivered a same-store sales increase of 2.5% in the second quarter, in line with the chain.

The mix between Consumables and Home as a percentage of net sales was 65% and 35%, respectively, for the second quarter of 2011 versus 66% and 34%, respectively, for the second quarter of 2010.

Gross profit rate was 29.8% for the second quarter of fiscal 2011 versus 31.6% for the second quarter last year. The 180 basis point decrease in gross profit rate was primarily due to a reduction in merchandise margin slightly offset by lower occupancy expenses.

Decrease in merchandise margin for the second quarter was due to higher promotional markdowns in Outdoor Furniture which were needed to clear the seasonal merchandise within the quarter in advance of setting the fall schematic in August.

This year, our Outdoor business was negatively impacted by a late Easter holiday combined with cool, wet weather in many coastal states until mid-June. Next year, the Easter holiday comes 2 weeks earlier, which will allow the company to maximize and completely sell-through its Easter merchandise and set the center of the floor with Outdoor merchandise during the first quarter.

Selling, general and administrative expenses as a percentage of net sales for the second quarter of fiscal 2011 were 32.7% compared to 33.6% for the second quarter last year. A decrease in SG&A expenses as a percentage of net sales for the second quarter and year-to-date was the result of increased leverage on higher sales.

Net interest expense was $3.2 million for the second quarter of fiscal 2011 compared to $2.7 million for the second quarter of fiscal 2010. Included in net interest expense is interest related to the distribution center capital lease obligations of $2.2 million and $2.1 million for the second quarters of fiscal 2011 and 2010, respectively.

It is important to note that the distribution center lease obligations are capitalized leases and not bank debt. The company does not own these buildings.

Net loss for the second quarter of fiscal 2011 was $8 million or $0.36 per diluted share versus a net loss of $7 million or $0.32 per diluted share for the second quarter of fiscal 2010. Year-to-date, the net loss was $11.4 million or $0.52 per diluted share versus $17.3 million or $0.78 per diluted share for the same period last year.

For the second quarter of fiscal 2011, the company had breakeven EBITDA from continuing operations compared to EBITDA of $2.4 million for the second quarter last year. Year-to-date, the company had EBITDA from continuing operations of $5 million compared to $1.5 million last year.

The company reduced its borrowings from a year ago by $22.8 million and ended the quarter with $45.2 million in borrowings and $7.7 million in letters of credit outstanding under its asset-based credit facility compared to $68 million in borrowings and $9.9 million in letters of credit at the end of the second quarter last year. The percentage utilization under the credit facility at the end of the quarter of fiscal 2011 was 39% versus 59% at the end of the second quarter last year. The company expects to pay off its asset-based credit facility through a revolving credit line in its entirety at the end of the fiscal year. This will be the first time the company has been debt-free since the end of fiscal 2006.

Going forward, the company will use the revolving credit line to fund working capital in inventory purchases in advance of the holiday season and will return to its historical cadence of paying off the credit lines completely at the end of each fiscal year.

Capital expenditures for the first half of 2011 were $2.8 million versus $1.5 million for the same period last year. The company closed one store and opened no stores during the second quarter.

Capital expenditures for the full year of fiscal 2011 are expected to be $10 million compared with $4 million in capital expenditures last year.

In this afternoon's press release, we have provided our outlook for the third quarter and full year of fiscal 2011. The company expects a same-store sales increase of 2% to 4% in the third quarter. Guidance for the third quarter gross profit rate reflects a continuation of increased promotional activity related to higher price point in Dining and Living Furniture. Last year, the sales penetration of the Furniture business was 4 to 10 percentage points higher in the first 3 quarters of the year compared with the fourth quarter when sales volume correspondingly shifts into lower-price point Consumables, holiday decor and gift.

The company is expecting a net loss from continuing operations in the third quarter in the range of $8 million to $9 million and a loss per share from continuing operations in the range of $0.36 to $0.40.

The company's full year guidance reflects a 4% to 5% increase in same-store sales and a 10 to 20 basis point improvement in gross profit rate versus fiscal 2010. The company will continue its practice of strong fiscal management and is projecting net income from continuing operations in the range of $13 million to $15 million for the full year and fully diluted earnings per share from continuing operations in the range of $0.54 to $0.63. Today's bottom line guidance remains unchanged from our prior guidance.

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

Barry Feld

Thank you, Jane. I feel that it's important to communicate our short-term and long-term financial objectives and timeline, and we'll continue this practice so that our valued long-term shareholders and potential new investors have a clear view into management's expectations for the business, particularly in light of the uncertain economic times.

As we're all aware, the recent events surrounding the national debt debate combined with the global debt crisis and stock market volatility are weighing on the consumers' psyche. We believe we have entered a more difficult consumer phase which may be with us for the foreseeable future.

World Market is well positioned to navigate these challenges, given our proven ability to weather difficult economic periods and our continued intense focus on value initiatives, along with our core competency in seasonal and gift-giving merchandise. We continue to remain cautiously optimistic about our fall and holiday seasons and have reaffirmed our bottom line full year 2011 guidance.

Additionally, the company continues to move ahead with investment in its 4 growth initiatives: sales per square foot productivity improvements, expansion of the Internet business, a conservative new store opening program and other initiatives related to wholesale and retail concepts.

Looking forward, as the company continues to execute its longer-term growth strategy, it will realize significant operating leverage on the business, which we'll ultimately expect to result in 6% operating margins and 3% after-tax net margins.

Along the way, there will be good quarters and tough quarters, but that will not prevent the company from reaching its target of $270 sales per selling square foot and judiciously growing the chain up to 500 high-quality retail locations over the longer term and developing $100-plus million fully integrated Internet business. Management remains solely focused on the elements of the business it can control, which will return the company to historic operating metrics and continue building shareholder value.

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 the line of Budd Bugatch with Raymond James.

TJ McConville

This is TJ filling in for -- Barry, Jane, the inventory looked really well controlled. And Barry, you made some comments about having to push through some clearance in the quarter to get through the seasonal or to make room for the seasonal. How do you guys feel about the current shape of the inventories, maybe how old is it, how do you feel about its current status?

Barry Feld

I'll let Jane address that. We feel, overall, very good about the inventory. And as you know, TJ, we are very disciplined about, at the end of every season, clearing all of our seasonal goods through. And I'll let Jane get into some more granularity as it relates to that.

Jane Baughman

Sure. I just want to be clear in terms of when we talked about moving through the Outdoor Furniture during the second quarter, we didn't really have -- clearance per se, we just have to -- we priced it differently than we did a year ago in order to be clean at the end of the quarter, so there really wasn't a residual inventory issue. Our inventories are very clean, old age still well below 5% and down from a year ago.

TJ McConville

Okay, that's very helpful. And on the decline in ticket in the quarter, can we dig a little bit deeper into that? Was it some -- it sounds like there might have been a small mix shift. Was it still the unit per transaction number that was going down, or was it something else? Or are consumers trading down a bit still?

Jane Baughman

It's more average unit retail.

TJ McConville

More average unit retail?

Jane Baughman

Yes.

TJ McConville

Okay. And then on the other side of that, the traffic number was very good, but Barry started to allude to a little bit of the caution that you're seeing. Any color on how that number trended throughout the quarter? Did we start to see a slowdown, or have we started to see that number trail off a bit with all these negative headlines out there?

Barry Feld

I'll tell you, TJ, where we actually have seen the impact is our customer counts have remained strong. Where we generally -- and if you think about it, you've been following us for a while. Historically, what we see is we see the pressure on the average transaction per customer. Because our Consumable business really works in our favor as it relates to ongoing customer count, the pressure we really feel when we start to see softening is at the higher ticket, with particular emphasis on the Furniture side of the business.

TJ McConville

Okay. And then lastly, for me guys, great to hear the news on the ABL. Where do you think that number peaks? I know we peak into the third quarter here, Jane. Where should we be thinking about that number peaking at the end of the next quarter?

Jane Baughman

In the revolver? Usually, the revolver actually peaks in the middle of November. Last year, we peaked at about $109 million. This year, we're running roughly at $20 million delta lower in borrowings year-over-year, so that's a reasonable expectation for the third quarter or for the peak.

Operator

[Operator Instructions] Our next question comes from the line of Anthony Chukumba with BB&T Capital Markets.

Anthony Chukumba - BB&T Capital Markets

I just had a couple of questions. I mean, you were pretty much at the midpoint in terms of your comp guidance, but you did slow from Q1, including on a 2-year basis. You guys had called out that the truncated late Easter led to a truncated selling season for Outdoor Furniture. I mean, is there any way to kind of quantify what the impact of that was? I mean, in terms of like basis points on your comp, I mean, is there a way to kind of think about it that way?

Jane Baughman

Yeah, roughly, the change in the Outdoor business really cost us about a point in comp on the second quarter year-over-year.

Anthony Chukumba - BB&T Capital Markets

Okay, that's helpful. The other thing that you sort of alluded or you mentioned in your earnings release was the more promotional retail environment. And I guess looking at your guidance, I guess I'm assuming that you're expecting that to continue in the third quarter given that you are expecting your gross margin to be down year-over-year. I mean, is that a fair assessment?

Barry Feld

Yes, I think, Anthony, what we're seeing out in the marketplace as it relates to higher-ticket items, particularly weighted towards Furniture. We also sell it in the store in our Outdoor season. We anticipate in Q3, where we have emphasis on both Living and Dining Furniture, even with our value price point orientation, we believe we'll get pressure that that higher -- really at the higher-ticket segment of that business. When we look out in the marketplace, the other home retailers that we compete against, we have definitely seen over the last several months heightened promotional activity continuing to take place, and so we anticipate that that market will remain promotional. Now the good news for us is as we work our way through the third quarter, we start to very quickly and dramatically shift into lower-price, high-quality gifting, and Consumable, nice margin, seasonal decor product categories, which we believe every year we'll have our more normalized promotional cadence. But in Q3, particularly for that portion of the business that relates to the higher-ticket Furniture items, we positioned ourselves that if we need to be more promotional and participate in that activity that we will.

Anthony Chukumba - BB&T Capital Markets

Okay. And yes, I mean, you sort answered the other part of my questions, but just to confirm, so you're expecting that when we get to Q4 and you shift away from that higher-price point merchandise more to the giftables and the consumables, you're not going to have as much of that -- those sort of promotional headwinds. Is that a fair assessment?

Barry Feld

It's a very accurate assessment.

Anthony Chukumba - BB&T Capital Markets

Okay. And then one final question, and then I'll let someone else ask questions. Any update in terms of -- I know you guys are planning on actually opening a store or 2 this fall, and I just wanted to see if there was any update on that?

Jane Baughman

We have 1 new store opening, which is a relocation of an existing store, planned in the third quarter, and that's in the California market. And then there are no other new stores currently planned to open this fiscal year.

Operator

Our next question comes from the line of Joan Storms with Wedbush Securities.

Joan Storms - Wedbush Securities Inc.

Most of my questions have been answered, but I guess I'm still trying to get a feel for the consumer out there. I mean, we heard from Williams-Sonoma that business is still choppy, sort of a week in-week out basis. Customers are definitely attracted to value. So I guess I'm wondering what your marketing and or promotional cadence may be to cater to that customer that sort of could be on the sidelines and really looking for that value.

Barry Feld

Well, Joan, I'll address this two ways. First and foremost, as you know over the last several years, particularly with such a predominant store positioned in the California marketplace, we have worked diligently on having an everyday low-price value offering in the vast majority of the segments of the product categories within our stores. What we have seen is not so much a slowdown in customers coming in or frequency of visit, it's really, as I've already expressed, we have actually seen, a more conservative buying approach to the higher-ticket product categories. And we started to see that at the higher end of our Outdoor towards the latter part of the season. We expect to experience some of that in the Living and Dining, but outside of high price points, and even though those categories are value price points, we see far less pressure on consumer behavior as it relates to the day-in and day-out product categories, whether it's the food or the wine side of the business or tabletop textiles or ceramics or personal care products. But when you start moving to the higher-ticket items, that's where we're seeing pressure. But we are a value-based retailer. We've got -- as I mentioned in my comments, our loyalty program is now up to 5 million members. We've got about a 7 million customer database. So we've approximately doubled that database from this time last year, and that is really giving us terrific opportunity to market to a much larger segment of our loyal customer base and offsets a lot of the pressure on ticket by improving frequency and customer count. And while our ticket did drop as you saw on our press release, we've actually been able to maintain a pretty solid customer count performance year-over-year.

Joan Storms - Wedbush Securities Inc.

Okay. And traffic is always important. And then so is your ad spend sort of similar year-over-year for Q3 and Q4? Are there any issues there that we should know about?

Barry Feld

Our annualized ad spend will, again, be approximately $50 million. However, we have weighted higher dollars to the fourth quarter of this year, which is obviously our strongest quarter. And it's our most predictable given our dominance in seasonal business. And so we, looking at the consumer behavior of the year, have wanted to put more dollars weighted towards the holiday season, the fourth quarter. So our annual dollars will remain approximately the same, but they are weighted differently with a higher weighting of ad expense in Q4 of this year.

Joan Storms - Wedbush Securities Inc.

Okay. And then on the -- is Q2 your highest sort of Outdoor Furniture ticket risk compared to the rest of the year? I know you said Q4 is much more sort of gifts and decor items and lots of food, consumables, et cetera. What is Q3 on a comparison basis look like?

Jane Baughman

Well, in terms of the Furniture business in both Indoor as well as Outdoor Furniture, the highest penetration is in the second quarter. And as I said in my comments, the percentage point difference between furniture in the first 3 quarters of the year to the fourth quarter is 4 to 10 percentage points. And so as we move into the fourth quarter, which is built on lower price point consumables and decor, we anticipate that there will be less pressure on ticket than there was in the second quarter.

Operator

Ladies and gentlemen, that does conclude the time that we have available for questions. I'd like to turn the call back over to Barry for closing remarks. Please proceed.

Barry Feld

Okay. Operator, does that conclude the time we have, or does that just conclude the questions that we have?

Operator

That concludes the questions that we have.

Barry Feld

Okay. I just wanted to be certain of that. Okay, thank you very much. I'd like to thank everybody for participating on the call, and we will look forward to updating and sharing our results as we move through to the third quarter of fiscal 2011. Thank you very much.

Operator

Ladies and gentlemen, thank you for your participation in today's conference. That does conclude the presentation. You may disconnect. Have a wonderful day.

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