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Golfsmith International Holdings, Inc. (NASDAQ:GOLF)

Q3 2011 Earnings Conference Call

October 27, 2011 09:00 ET

Executives

Jean Fontana – ICR

Martin Hanaka – Chairman and Chief Executive Officer

Sue Gove – Chief Financial Officer and Chief Operating Officer

Analysts

Jennifer Davis – Lazard Capital Markets

Casey Alexander – Gilford Securities

Alex Silverman – Special Situations Fund

Operator

Please standby. We are about to begin. Good day everyone and welcome to the Golfsmith International Holdings, Inc. Third Quarter 2011 Earnings Conference Call. Today’s call is being recorded. For opening remarks and introductions, I would like to turn the call over to Jean Fontana of ICR. Please go ahead, ma’am.

Jean Fontana – ICR

Thank you. Good morning, everyone. Thank you for joining us today to discusses Golfsmith third quarter 2011 earnings results. As a reminder, our presentation includes, and responses to various questions may include, forward-looking statement about the company’s financial results and about future plans and objectives. Any such statements are subject to risks and uncertainties, which could cause the actual results and the 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 filed with the SEC. We issued a press release this morning. If you have not received 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 Financial Officer and Chief Operating Officer, Sue Gove.

With that I’ll turn the call over to Marty.

Martin Hanaka – Chairman and Chief Executive Officer

Thank you, Jean, and appreciate it. Also with us in Austin, Texas are Jim Eliasberg, our General Counsel, Anna Jobe, our Vice President-Controller, and Jeff Laforce, Senior Member of our accounting team.

I’m really pleased with the quarter, couldn’t be more pleased with the momentum that we’ve driven. As you shift through the numbers, a couple of headlines, you will see apples-to-apples in the quarter or an apple-to-apples in the year we are $0.11 versus $0.01 comparably and then year-to-date $0.43 against $0.11. So this is a great year-to-date performance as we’ve promise to get back to profitability and again really pleased with the results.

If we look at the top line, July was a solid month for us. We went in a trough in August frankly and that was right around the time of the drama around the debt ceiling limit, and the Obama downgrade. We have five or six weeks through the August where we missed our plan by 2% to 8%. We also rough flooding in early September as Irene came Berlin to the northeast. In fact, the northeast was down 25% for a couple of weeks which had a 5% impact on our total for those two weeks, but when you step back and look at it, we came back really strong in September with 6%, 6%, 10% and 4% comp, so overall 3.4% comp and we overcame that August softness. We comped 11 out of 13 weeks, so really pleased with the top line.

What’s also interesting is our traffic is essentially flat. Our conversion was flat, then we had increased AOV of 3% to 4% which gave us the kind of lift we had for the quarter. This is now four straight quarters of solid growth for Golfsmith and as we head into the balance of the year we think there’s all the reason to think it’ll be any less, keeping in mind that December is very heavy in the fourth quarter. It’s our second largest volume month of the year than October and November numbers 10 and 11. So we think this trend will continue particularly with the strong December.

Our EPS, as we said, is 10x on a comparable basis and 4x excluding these non-recurring items and our new stores are performing quite well. Our new stores that we've opened this year running 104% of their business plan and our last eight stores that we've opened under our new real estate model are running around 102% of plan. So we really feel we've got a lot of confidence in our ability to open new stores successfully.

Apparel was our strongest quarter as it has been all year long. Our web demand was up 17%, our proprietary business grew by over 12% and we are absolutely gaining our market share. We use Golf Datatech as the authority in the industry, the off-course space is what they measure, that’s the most important space where we compete in. if you look at units or dollars across the board, year-to-date through August, we’re up anywhere from 13% to 18%. Our growth measured against the industry. So we really fell the bottom line here is that we’re gaining share, we’re gaining momentum. We’ve improved our profits and we think that’s a bi-product of just strong management team that we’ve been able to put together here in the last two, three years. The fact that we have diversely in our geography, so we can overcome an event like we did with hurricane Irene this year, where the beneficiaries of the industry consolidation is taking place, the multichannel model and one of the things we did in our research is really understand our customers better in their cross shopping patterns and frankly a customer that shops two or more channels is worth at least four times where the single channel shopper is. So that understand on how we go to market and execute against that I think is helping us.

And then fact that we’ve had real focus on a few initiatives that are really delivering for us, building the web, aggressively growing it; expanding the new stores which are working by the way we opened in Sarasota here in a few weeks in Florida and we already have seven leases signed of the ten we’ve targeted for next year. Five were actually signed, two I would say were in the T-Box on 18 and ready to sign. So really seven out of ten done and our prospects are clear that we’re going to hit our target of ten new stores that will work very well for us plus two relos.

We are also beside expanding stores and growing the web aggressively really moving our mix in a apparel and private label as I’ve said. And then our whole focus on building a selling and service culture seems to be paying off as we’ve really improved our conversion year-to-date, and our AOV and so all that effort on custom fitting and getting closure to the customer seem to be paying the dividends.

Well, before I close, I’m going to turn over to Sue who is going to expand on my comments and then we’ll go in the Q&A. Sue?

Sue Gove – Chief Financial Officer and Chief Operating Officer

Okay. Thank you, Marty. Good morning everyone. For the third quarter again net revenues increase 8.3% to $101 million compared to $93.3 million in the third quarter of 2010. The sales growth was driven by 3.4% comparable sales increase and 11.2% growth in our direct to consumer business. As Marty mentioned our sales are negatively impacted by the hurricanes but rebounded nicely in September.

In addition, sales benefited from the opening of three net new stores. We opened four new stores and closed one store since the third quarter of last year. Comparable store sales were driven by increased AOV and higher conversion rate with a slight decrease in traffic for the quarter. We believe this strong comp store sales growth is a reflection of our improved merchandize assortment and selling culture that we have been gaining traction on over the last several quarters. Also rounds played for the eight months ended August 2011 decreased 3.3% as compared to the same period in 2010. As Marty mentioned we are growing our market share despite challenging industry trends.

Gross margin for the third quarter increased 20 basis points to 34.5% as compared to 34.3% for the same period last year. The gross margin improvement consisted of a 150 basis point improvement in merchandize margin primarily due to a mix shift towards our higher margin goods such as shoes and apparel consistent with our strategy. This was partially offset by increased shipping and freight cost related to free shipping offers as well as higher freight cost resulting from higher carrier fuel cost and increased inventory. In addition we had higher shrink cost during the quarter primarily due to a timing difference of actual, physical inventories compared to the timing last year.

SG&A expense, expenses increased 4.6% to $32.9 million in the third quarter compared to $31.5 million in the same period last year. The dollar increase was related to the four new stores and higher performance bonuses. SG&A expense also included $600,000 in legal and other professional service costs incurred outside of the ordinary course of business.

Excluding the unusual charge SG&A decreased to 32% of sales in the current quarter compared to 33.7% of sales in the same period last year, resulting from leveraging our fixed cost and improved labor productivity management and our stores. Operating income increased $2.9 million to 1.8 million for the third quarter to fiscal 2011 compared to operating loss of 1.1 million for the third quarter last year.

As a remainder we have recorded a $1.6 million lease termination charge during the third quarter of last year. Excluding the unusual item of 600,000 mentioned earlier, operating income was 2.4 million for the third fiscal quarter 2011 compared to 500,000 of operating income excluding the lease termination charge in the same period last year. Income tax expense in the third quarter totaled $87,000 compared to an income tax benefit of 229,000 in the same quarter last year.

Net income for the third quarter totaled 1.3 million or $0.08 per diluted share as compared to a net loss of $1.1 million or $0.7 per diluted share last year. Excluding the store closing cost and other unusual charges, the company’s net income for the third quarter fiscal 2011 was $1.9 million or $0.11 per share as compared to 200,000 or $0.01 per share for the third quart of fiscal 2010.

As of October 1st this year, total inventories were up modestly at $85.3 million as compared to ending inventory at $80.7 million in the third quarter last year. On an average, comparable store basis, inventories decreased 2.4% compared with third quarter of 2010. We expect to continue to benefit from the inventory management focus that led to improvement in aging of inventory and reduced inventory per store. As of October 1, we have $35.4 million of outstanding borrowings under our credit facility and borrowing availability of $29.1 million. This compares to last year of $42.6 million of outstanding borrowings under the credit facility and borrowing availability of $18.4 million for last year.

We continue to execute on various operational initiatives that drove another quarter of strong financial performance. Our key initiatives remain to build on our intentional web business, shift the merchandise mix to more apparel and footwear, grow our important proprietary brands, expand our proven new store model, optimize our (four-walled) results by store segment and realize operational excellence in every function.

We are pleased with the performance of our new stores in Boca Raton, Florida and St. Louis, Missouri, and Washington D.C.’s Tysons Corner area and look forward to opening our Sarasota Florida store scheduled for November. New stores typically reach profitability in their first full fiscal year of operation. Our plan is for up to 10 new stores in fiscal 2012. We strive for operational excellence driving significant increases in conversion rates and AOV. We remained focus on continuously improving our website. We’ve experienced significant growth in apparels on the website as well through expanded assortments, creative enhancements and special promotional buys.

We also continue to leverage social media and cinema notifications of special events. Finally, we continue to enhance the personal shopping experience on our website with personalized merchandize and how-to-guide. As Marty stated we’ve built a solid foundation for growth over the last three years and we are poised to enter 2012 in a stronger position than ever.

I’ll now turn the call back over to Marty.

Martin Hanaka – Chairman and Chief Executive Officer

Great. Thank you, Sue. Our prospects we believe are really exciting. We’re looking forward to a strong Q4. We’re not planning the sales to be the same as our year-to-date trend slightly less but with solid margin and net expense control, which is pretty common place around here we think we can deliver a good fourth quarter.

As Sue, said we can open up to 10 new stores with all internally generated funds. We’re looking for continued high teens web growth, we’re looking for mid single digits catalogue reduction next year which is natural and we’re hoping a little bit as we’ve manage our circulation and page countdown. We’ll also believe our soft lines business is going to roll into next year. We have gone from 15% of our mix to 19% of our mix, we’ve targeted 25 and with investments more floor space and so forth more inventory and taking 10nish out of the number of stores we’re really enabling that business to continue to grow.

And we’re going to monetize our brand assets. We often ask with all those licensing we’ve been doing means and its probably with the couple of pennies a share at the end of day next year go forward incrementally and that does not count to Korea deal which we expect to get done by the end of December. And that we’re very active in the social space. We have over 145,000 Facebook fans. So if you can take the whole of course channel and added it up, they wouldn’t even meet our number. So we think we’re the first move over there and now the question is how we get closer to those customers and monetize it. So, kudos to our entire team.

And now I’d to open up the floor to questions. Operator?

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) We’ll go first to Jennifer Davis with Lazard Capital Markets.

Jennifer Davis – Lazard Capital Markets

Hey, guys. Congratulations on another great quarter.

Martin Hanaka

Thank you.

Sue Gove

Thank you.

Jennifer Davis – Lazard Capital Markets

I’ve got a couple of questions. First of all, I guess Marty can you talk a little bit bigger picture about the competitive environment what you are seeing in terms of store closings now and kind of what you see going forward for at least next year or so?

Martin Hanaka

Yes. Actually I’m seeing the competitive environment is very rational at this point in time. The closings have slowed somewhat, but they are still out there. One of our most problematic markets for example was Kansas City and the person there was irrational in their go to market strategy. So we became equally irrational and he just get out of the business. He sold it to someone who I guess for a song. So that market has become much more rational and it should be a real plus for us as we head into 12. But overall, the closings here, the big structural change is behind us. We think it will continue because still half the doors in our space are small operators.

Jennifer Davis – Lazard Capital Markets

All right. Got it. Okay. And then can you talk a little bit about the exclusive products from Nike and Adidas that I think you began selling in the fall?

Martin Hanaka

Yes. Our merchant team has really worked on being exclusive launch partner on new products hope we have a hedge start. They’ve got end of life sale products they have come from some of these OEM brands and we are doing exclusive promotions with these and really I think it’s a recognition that of all the – of all the brands out there in retail, I think we are having the most success at this time. So, the vendors want Pos and they want a partner with someone that is growing and doing it the right way. We are not a price leader promotionally. We don’t get beaten on price, but we’d rather do think that are exclusive in nature and the brands are signing up.

Jennifer Davis – Lazard Capital Markets

Got it. And then can you talk a little bit about the drivers of the increase in average order value, apparel sales are strong, but I assume that those are generally lower ticket items. So, are you seeing an increase in units per transaction or you are seeing higher tickets or both?

Martin Hanaka

Yes, we are seeing – it’s a great point you made Jennifer, because there are some categories that are up, this has been a good driver year. This is a year where our custom fittings, which drive a higher AOV have improved and will continue to improve. And at the same time our apparel growth are excellent. AUR is less in apparel, so overall that’s probably 4% to 5% less in apparel and up in the big equipment categories and it blends out 3% or 4% more. The other one is our conversion year-to-date is better. People are better trained we’ve made a lot of investments in training in webinars, in product and really teamed up with the brands. The zonal customers have done a terrific job, certainly tailor-made it really delivered much better field services that have enabled our people to do better job. And we are all about given personal service, we walk you to play better, that is our mantra and so everything we do is about giving you to play better, because if you do you will like us more and you will recommend us and building that selling and service culture and some of us done a couple of times. It takes a couple three years and over those last couple three years we made the investments and now we’re really starting to get the payback.

Jennifer Davis – Lazard Capital Markets

All right. And then regarding the operating margin and I think you were a little over 6% back in 2001. It looks like you’ve been 4%, 5% historically. What level do you think you can get to? Do you think you can get back to that 6%? I mean is there anything I would say that – I would think that environment is better for you, but did you see any structural changes or any reasons why you can’t eventually get back there?

Martin Hanaka

Now, we think that this industry consolidation will continue and so we believe it’ll continue to rationalize and at the same time we’re going move or mix in the direction we’re currently going. Our trough for next year is really not materially different than it was this year. We can open our new stores, which is really going to allow us to get leverage out of our headquarters expenses and so it’s not crazy that we could get back there. There was one big factor that existed that is at our club making business with margins 50, 60 points shrunk and so we are consciously being trying to offset that again with the apparel and footwear growth, which is working now and can only improve and also moving our private label mix. Our penetration hasn’t moved in private label, but it’s up over 12% year-to-date now and we think that we can continue to do that and hopefully offset that negative of club making over time.

Jennifer Davis – Lazard Capital Markets

Got it.

Martin Hanaka

And also the stores that we’re targeting, there are markets that are hypercompetitive and ones that are dossal. So we are really looking at where we invest and which markets are under-penetrated and carefully selecting those stores that again would help us avoid another Kansas City problem.

Jennifer Davis – Lazard Capital Markets

All right. And then last question, sorry for second time. What percent of your customers shop both online and in stores and what kind of difference are you seeing from the kind of the online purchases versus the in-store purchases, and then how many countries are you currently shipping to and I think that’s it?

Martin Hanaka

Oh gosh. I’ll take the last one first because it’s kind of – we will ship anywhere right now. But the vast majority of what we do ship outside the U.S. is Canada and U.K. It really is – we have just gone through an Oracle conversion and over the last year had delayed new software which would allow us to penetrate international countries better. Suffices to say we don’t really have a number in our future plans for that, but as we finished up this work I think we will be in a position to accelerate our marketing in other countries and grow that part of the business profitably.

I don’t – we don’t give an exact number on the cross channel because it is proprietary, suffices to say it is growing and if we were one channel customer at Golfsmith you pay – you spend X, excuse me, if we were two channel that could be catalog 1,800 number or a web customer you will spend 4X. If you are shopping this across all the channels you are probably at least 10X lifetime value to us. And that’s one of the analysis we’ve just completed recently. So we are trying to cultivate that in every way possible. Golfsmith was a first mover on this long before I became affiliated with the company. We have kiosk in our stores, we have software. We want you to buy the way you want, we want you to pick it up in store, we’ll ship it to your office. We’ll do whatever because we want you to be closed to us and shop the way that’s convenient for you and nobody else.

Jennifer Davis – Lazard Capital Markets

Thanks, and then – yeah, definitely.

Martin Hanaka

Okay.

Jennifer Davis – Lazard Capital Markets

And then lastly what kind of – are you seeing different trends of what you’re selling online versus in-store, I mean I know you have an expanded…

Martin Hanaka

Yes, yes. It is

Jennifer Davis – Lazard Capital Markets

Selected accounts stuff online but..?

Martin Hanaka

Yes. It is very different in depending on the period, but it is very different. Our AOV is much higher on the web, number one, and our – one of our biggest growth categories on the web right now is apparel and we’ve just begun to introduce non-endemic product on the web where you can buy Rockport shoes for example, you’re going to see lifestyle, casual wear on the web. So someone have to phrase, we want to be the Zappos of the Golf web space. Well, that’s a stretch right now. But, I think the point is that there’s some natural affiliated extensions of our categories, Gulf categories that are non-endemic that we can sell and we think that may lead to other growth, again that’s not built into our numbers at this point. It's in the trial phase.

Jennifer Davis – Lazard Capital Markets

Great. Thanks and best of luck.

Martin Hanaka

Thank you.

Operator

Your next question comes from Casey Alexander with Gilford Securities.

Casey Alexander – Gilford Securities

Hi. Good morning.

Martin Hanaka

Good morning, Casey.

Sue Gove

Good morning.

Casey Alexander – Gilford Securities

You actually got a number of my questions, but I still have a couple. One is, there’s been a real dynamic on the PGA Tour towards belly of long putters. Have you seen that spillover into your stores? Was there inventory to take advantage of it? Are you hearing from the companies that there’s programs directed towards that and that should be a pretty good margin sale, how do you see that playing out in 2012?

Martin Hanaka

I think right now, it's a very good question, and the answer is, I guess is yes, yes, yes, yes, yes. At one time in this industry I think this happened before and it was a fad. Our people believe now it's a trend and so we have adapted accordingly. We did run out our product, because it started one of the shelves, especially when lefty picked one up. But it's a trend, it will be lot of growth there. We’re catching up to it and we’re placing orders for several of the brands and we’re building proprietary as fast as we can get it from overseas.

Casey Alexander – Gilford Securities

Well, it seems to me that, that really the bigger companies would be the ones that would be in a position to take advantage of that trend, don’t you think?

Martin Hanaka

Yes. Well, certainly I mean that 90% of our business and clubs is OEM brand, so there’ll be some people moving. It’s not going to deliver the year for us, but it is a trend that we want to be first to market and you’ll see us trying to capitalize as much as possible.

Casey Alexander – Gilford Securities

Right. Secondly, at the end of the second quarter which was something that none of us knew at the time when you guys were reporting, Callaway announced a big cost savings program with a large incremental amount of those costs going into marketing spend. Have you heard from them, are they – especially given your ability to take share from the rest of the marketplace, are they talking with you about expanding in some more aggressive marketing program to take advantage of your success in 2012.

Martin Hanaka

Our team has met with Callaway and I think you’re going to see them doing more. I guess they report today at 5 o’clock so we’ll learn more. But you know that where the natural value in the industry and the launches come in Q1, so if R&D going to spend more that’s when you’ll start to see a show up in the marketplace.

Casey Alexander – Gilford Securities

All right. Okay. Great, thank you.

Martin Hanaka

Yes, sir.

Operator

Your next question comes from Alex Silverman with Special Situations Fund.

Alex Silverman – Special Situations Fund

Good morning.

Martin Hanaka

Good morning Alex.

Alex Silverman – Special Situations Fund

Can you give us a sense I may have missed it, but can you give us a sense of the breakdown between traffic and price in that comp?

Martin Hanaka

Yes. We said for the quarter that our traffic was essentially flat for the quarter. Our convergence was essentially flat and our AOV was up 3%, 4%, 5% depending on the period.

Alex Silverman – Special Situations Fund

Okay. And is this to some extent you folks raising prices in order to match the higher cost to goods?

Martin Hanaka

No, no, no. That hasn’t happened at all. No. it’s really a question of mix, it’s really the mix of categories.

Alex Silverman – Special Situations Fund

Okay.

Martin Hanaka

It’s continued close penetration.

Sue Gove

Close penetration being very strong this year. We will talk a little bit about it, Alex, the fact is our fastest growth category year-to-date is apparel and our average order, average item is gone down about 4%, 5%. The comps has been strong in our (indiscernible) too, so that the mix of the three of those is just the total.

Alex Silverman – Special Situations Fund

How should we think about it going forward?

Martin Hanaka

I think you see us correct the apparel, so that becomes a net positive for us. And it really is going to depend on how our people can continue to sell more custom. Custom goes out the door and have higher average price and a little bit better margin with a lot happier customers. So that’s our philosophy. We want you to play better, we want to you sell you what fits, and that will help us raise our AOV over time in our sales.

Alex Silverman – Special Situations Fund

Okay. Can you give a sense how October started off in terms of traffic?

Martin Hanaka

Yes. We said earlier that we feel good about Q4 in total, but it always hinges on December, not October. We have come out of a conversion on our Oracle system and that put us one hand behind our backs for a little bit of time, but we caught up now. So the real test is December and our people are very bullish on December. We’ve got a number of exclusive promotions, we’ve got a couple of important repositions, we are not spending any money in October or November on marketing. It’s not till we get towards the 1st of December that we start to spend money again. And that’s investment we feel very good about. And December is more than October, November combined.

Alex Silverman – Special Situations Fund

Okay. And then last question, can you touch on what the 600,000 in one time legal is for?

Martin Hanaka

Oh sure, sure, sure. That was outside the normal course of business as we’ve said you know at the behest of the Board, we have conducted a comprehensive deep dive into the industry structure. We have a research component and we did work that I think is really put us in a best position for future value creation.

Alex Silverman – Special Situations Fund

Understood. Thank you.

Martin Hanaka

Thank you.

Operator

And we have no further questions on the queue.

Martin Hanaka – Chairman and Chief Executive Officer

Great, Kudos to our entire team. Guys, we are so proud of your great job, we are really excited about the growth prospects, and we think we have a very sensible and manageable investment plan. We’ve a come a long way in the last several years to build the business that gets golfers the best selection of innovative product and then builds around exciting marketing campaigns to drive traffic, world-class customer service and a fun shopping environment. Our business model is proven as competition has shrunk. So we have a nice foundation for growth, which is now producing vastly improved results. We are confident in our long term growth prospects, that they are better than ever. We’re gaining share and as industry fundamentals improve, we think, we can hopefully take advantage of it. Thank you for your time and interest today. We’ll see you soon. Take care.

Operator

And that does conclude today’s conference. We thank you for your participation.

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