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Pier 1 Imports, Inc. (NYSE:PIR)

F1Q09 Earnings Call

June 19, 2008 11:00 am ET

Executives

Nancy Benson – Assistant Treasurer, Director Investor Relations

Alex Smith – President, Chief Executive Officer

Cary Turner – Executive Vice President, Chief Financial Officer

Analysts

Analyst for Budd Bugatch - Raymond James

Michael Baker - Deutsche Bank

Neely Tamminga – Piper Jaffray

Brian Nagel – UBS

Analyst for Colin McGranahan - Sanford Bernstein

Operator

Good morning ladies and gentlemen. This is Pier 1 Imports’ quarterly conference call. (Operator Instructions) I would now like to introduce Mrs. Nancy Benson, Assistant Treasurer and Director of Investor Relations for Pier 1 Imports. Mrs. Benson, you may begin your conference.

Nancy Benson

Good morning everyone and thank you for joining us this morning. Today we will hear from our President and Chief Executive Officer, Alex Smith and Executive Vice President and Chief Financial Officer, Cary Turner.

The agenda for today’s call will be to hear opening remarks followed by a brief discussion of our first quarter results that we reported earlier today. We will provide you with an update on our business and we will provide limited guidance for fiscal 2009, followed by a question and answer period.

Before we begin I need to remind you that certain comments made during this call may contain forward-looking statements within the meaning of section 21E of the Securities Exchange Act of 1934 and can be identified by the use of words such as may, will, expect, anticipate, believe, and other similar words and phrases.

Our actual results and future financial condition may differ materially from those expressed in any such forward-looking statements as a result of many factors that may be outside of our control. Please refer to our SEC filings, including our annual report filed on form 10-K for a complete discussion of the major risks and uncertainties that may affect our business.

The forward-looking statements made today are as of the date of this call and we do not undertake any obligation to update our forward-looking statements. If you do not have a copy of this morning’s press release, you may obtain one on the Investor Relations page of our website located at Pier1.com. Now I would like to turn the call over to Alex.

Alex Smith

Thanks Nancy, good morning everyone. Well it has been an eventful two weeks since we launched our offer to buy Cost Plus on June 9. I will talk about this some more later, but right now we’d really like to focus on updating you about our continuing efforts to return our well loved company to profitability and beyond.

In the context of our turnaround, the first quarter was a good quarter. Meaning, it was significantly better than last year and indeed, better than the first quarter of fiscal 07 two years ago. We accomplished many of the things that we set out to do during the quarter. However, our financial goals and the analyst consensus for us were not in synch.

They are, however in line for the full year. So, to ensure that we remain in line going forward, I have asked Cary to provide more specific guidance for both the second quarter and for the year. So, not let’s get Cary to run through the numbers.

Cary Turner

Thank you Alex. Earlier today we reported a loss of $0.37 per share for the first quarter, compared to a loss of $0.64 per share for the year ago period. Total sales for the first fiscal quarter declined to $310 million from $356 million in the year ago quarter, primarily as a result of decrease store count as well as the elimination of ancillary businesses.

We continued to see an increase in conversion rate and the trend in units per transaction improved throughout the first quarter. Comparable store sales for the quarter declined 5.4% as we anniversaried the aggressive liquidation of Modern Craftsman that occurred in March and April of last year.

Given last year’s promotional activity, it was no surprising that traffic levels declined in March and April on a comparative basis. We saw improvements in traffic during the month of May and as a result comparable store sales in May increased 7.5%.

Also contributing to the decline in traffic as well as comparable store sales was our decision to move some of the marketing expense from the first quarter to the second half of the year. Our marketing efforts were concentrated in the month of May with the use of newspaper inserts, email advertisements and retail mailers surrounding the Mother’s Day and Memorial Day selling periods.

Overall marketing expense was $8 million less or 40% less than the same period last year. As we told you on our last call, our focus, especially during this difficult macroeconomic environment is on merchandise margins. Our discipline improved merchandise margins to 51.3% compared to 45.5% in the same period last year.

These improvements in merchandise margins can partially be attributed to the affect of the inventory liquidation in last year’s numbers, but the changes in our merchandising efforts and the decreased use of promotional mark downs has had a positive impact as well.

On a comparable store basis, merchandise margin dollars increased approximately 3% over last year. Store occupancy costs were $71 million compared to $75 million last year as a result of a lower store count and overall gross profit dollars increased to approximately $88 million compared to approximately $87 million last year.

We continued our efforts to reduce costs throughout the quarter. As outlined in today’s press release, SG&A expenses included special charges totaling $2.7 million for the quarter. Excluding these charges, savings in SG&A expenses totaled $19.7 million for the first quarter.

During the first quarter the primary contributors to the decrease in ongoing costs were savings of $8.2 million in marketing expense, $4.6 million in store payroll and $6.9 million in other general and administrative costs when compared to the first quarter of last year.

The special charges during the quarter primarily related to severance and out placements costs incurred in connection with the elimination of 70 full time positions in the company’s distribution centers as well as additional headcount reductions in the home office.

The reduction in force in our distribution centers was the direct result of our ongoing efforts to improve efficiencies within the supply chain. These changes will provide us greater flexibility to adjust our labor force to meet the changing needs of our business throughout the year. This will also help us as we strive to more effectively manage our margins by making DC labor more variable in nature.

Our efforts to reduce inventory in the DCs have paid off and inventory at the end of the first quarter was $385 million or $44.00 per square foot compared to $412 million or $47.00 per square foot at the end of the year.

We now expect a $50 million reduction to $360 million of inventory by year end. During the quarter, capital expenditures were $1.9 million of which $1.1 million was invested in our existing stores. Capital expenditures for the year are expected to be $15-$20 million, primarily being used to update existing stores.

We currently estimate that our tax NOL is over $200 million. During the quarter we closed one Pier 1 Imports store. We ended the quarter with 1,116 Pier 1 Imports stores with 1,033 stores in the US and 83 stores in Canada. Store closings for the year are expected to be 20-25 stores.

On June 9 we completed the sales of our headquarters facility to an affiliate of Chesapeake Energy Corporation. In connection with the closing of this transaction, we entered into a seven year lease agreement to lease approximately 250,000 square feet. The least contains provisions that allow for early termination after five years.

On a full year basis, the affect of the transaction will be a $2 million increase in SG&A, a decrease in depreciation of $4 million and a decrease in net interest expense of approximately $3 million. Net proceeds from the transaction were $100 million, providing total cash to begin the second quarter of approximately $180 million.

As Alex mentioned, in an effort to give you a sense of where we believe we are headed for the rest of fiscal 2009, we will provide limited guidance concerning the remainder of the year.

Based on early results in June, we expect to report slightly negative to modestly positive comparable store sales for the second quarter with merchandise margins at or above first quarter levels. We expect to incur special charges of approximately $3.5 million, including onetime costs relating to the closing of excess DC space. In addition, the second quarter EBITDA before special charges is expected to be slightly negative to slightly positive.

For the full year, we anticipate flat or slightly positive comparable store sales, with merchandise margins of at least 53%. Additionally, we expect to report a modest net income before special charges for the full year. Of course, this guidance is predicated on our ability to deliver expected results during the critical holiday selling periods of November through January.

Now I’d like to turn it back over to Alex.

Alex Smith

Thanks Cary. It goes without saying that things have gotten a lot tougher since we last spoke. You all know the script: gas prices, housing market, negative consumer, etc, etc, not good. As to how this impacts Pier 1 Imports, we have been very consistent in our view that even if the climate is negative, we should be able to make progress in our turnaround, albeit at a slightly lower rate than we would make in a positive environment.

Our first quarter results demonstrate this. Although May sales were strong, sales for the quarter were below our expectations due entirely to traffic levels. The other important part of our sales equation, like conversion rates and units per transaction, continue to show the levels of improvement that we enjoyed in the fourth quarter.

Customers like what we are doing. The traffic decrease, I have to tell you was partially self inflicted. We made the decision to move marketing dollars into the second half of the year to coincide with our key selling period. I mentioned this on our last call.

Consequently, our marketing spend in the first quarter was down 40% from last year, which certainly didn’t do anything to help sales as everybody knows, when you don’t anniversary marketing spend, it’s inevitably painful in terms of sales comparisons. But remember, the first quarter is the least important quarter of the year and we certainly feel good knowing that our marketing spend will be greater in the second half of the year.

As you know, and increase in merchandise margin is three times as powerful as improving net income as an increasing comp store sales. And so, we focused our attention on merchandise margin dollars as we promised we would. Endeavoring to maximize the profits on every SKU that we purchase has really paid off for us and as Cary mentioned, we were able to grow comp store merchandise margin dollars by 3% during the quarter.

Concentrating our efforts in this way makes so much sense for us in this environment and it allows us to get maximum income from our customer flow. To keep us on track, we must continue to work on the appeal of our merchandise assortments and the quality of our in store experience so that conversion rates, units per transaction and average ticket continue to move upwards.

We are certainly hitting the target more often, now we need to get closer to the bulls eye. Let me just give you a few more highlights from the first quarter. The new impulse item departments and the expanded assortments in our other lower ticket departments performed very well, positing significant increases in the quarter in both sales and merchandise margin dollars.

The big negatives for the quarter were obviously big ticket furniture items, where a lot of the Modern Craftsman inventory was held last year. On the other hand and this is important, when we look at May, margin dollars in furniture were strong in nearly every category.

In May we also began to see improvements in the tabletop departments which you know have been disappointing to us. Our increased SKU counts with smaller buys is starting to positively impact our inventory levels. And I’m pleased to tell you that our DC inventory levels are now below last year.

We believe that as we continue to improve our buying and planning execution, our ability to run our business with lower inventories will allow for further cost efficiencies within our distribution network and supply chain and as Cary said, free up another $50 million of working capital by year end.

Now just a few words about the rest of the year. You may remember that we talked about seasonal products as an opportunity and since then we have introduced or reintroduced merchandise for all the main holiday events, including for the first time, a fourth of July celebration assortment. It’s selling well and I hope you’ll go in and buy.

On Sunday we start the Pier 1 sale which runs until the end of July and is supported by retail mailers and Sunday newspaper inserts. We have some great bargains. In August we will launch our value-versity event which is centered around Pier 1 favorites and a much expanded back to college assortment.

Then in September we begin the fall inter-holiday trading period, with strong marketing support for home furnishings, entertaining and gifts. We can’t predict how the customer will be feeling during this period, but we are very confident in our new merchandise for the second half of the year and believe it will keep the momentum going.

Lastly, like all retailers who manufacture overseas, we are facing significant price inflation in a number of markets. Some of this will flow through to increased selling price in the stores because we will not compromise on our initial buyers margin.

Fortunately for Pier 1 Imports, so much of our merchandise is proprietary and special and decorative, so its perceived value has a greater deal of price elasticity in it. This allows us to make price increases without impacting the everyday fair value approach to our business. That said, we will continue to be aggressive in improving supply chain efficiencies so we can mitigate some of these first cost increases.

Now that I’ve updated you on our business, I would like to talk briefly about our proposal to acquired Cost Plus. As I’m sure most of you know, on June 9 we announced a proposal to acquire all the outstanding shares of Cost Plus common stock in a strategic stock for stock transaction.

Under the terms of the proposal, we would issue 0.6 shares of our common stock for each share of Cost Plus stock. We believe that the combination of Pier 1 and Cost Plus is extremely compelling and will create significant value for the stakeholders of both companies and will create a stronger and more competitive company that is positioned for future growth.

For those of you who have been following the story, you know that earlier this week, Cost Plus rejected our proposal. We have reiterated the compelling nature of the combination. We believe that our proposal is full and fair and we remain committed to working directly with the Cost Plus shareholders to make this transaction a reality.

Having said that, we are here today to discuss Pier 1 Imports’ first quarter results and I would really appreciate it if you’d limit your questions to our earnings. We’re now happy to answer your questions.

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from Budd Bugatch – Raymond James.

Analyst for Budd Bugatch - Raymond James

This is actually TJ [McCondle] filling in for Budd, he’s on the road traveling. A couple questions here, first the strong comp performance in May, one of the things that we were wondering was if you would be able to breakout what last year’s comps looked like on maybe a monthly basis so we could get a good comparison there. And then see if you had any comments on what June has looked like so far.

Alex Smith

What we look at of course if the, we look at trends. So we’re looking at the trends for the year compared to last year and the year before.

Cary Turner

When we take a look at and what we do is we look at a two year cumulative comp and when we take a look at what happened in March, April and May, we’re seeing that the trend is definitely improving. As we’ve said, we saw traffic moving up in May and so therefore we felt pretty good about the May comp, especially given the margins that we got.

Alex Smith

As far as June, we’re only, this is a five week month, we’ve got two weeks to go. For the month so far, we’re sort of flattish. But we expect a very strong couple of weeks as we go into the Pier 1 sale.

Analyst for Budd Bugatch - Raymond James

And then on the merchandise margin, the 53%, just to clarify, that’s your full year number, not just from here on out?

Cary Turner

That’s correct.

Analyst for Budd Bugatch - Raymond James

How do you think we get there, is it, it’s obviously you commented on the increasing cost pressures, so it’s more weighted towards less of the store being on sale, but any quantification there of what the mix is between better buying and less of the store on sale?

Alex Smith

I think those two, better buying and less of the store on sale are kind of linked, really. The way we will get the increased margin is very simple. We’re spending very much less on promotional markdowns as we’ve talked about in many of the calls. And we expect to see our markdown percentage fall in the second half as the benefit of the smaller buys really starts to have an impact.

Analyst for Budd Bugatch - Raymond James

And is there any sort of sequential cadence we should follow there? What quarter would you think we would have the highest merchandise margin?

Cary Turner

Well as always, probably the highest margin will be in the third quarter.

Analyst for Budd Bugatch - Raymond James

On inventory here, taking that $50 million out, any comments on where that’s going to come from mainly? I know you said it’s in the DC but what type of product are you going to be removing there or less safety stock of I’m sorry.

Alex Smith

It’s pretty much across the board. I mean obviously we’ve restocked significantly on our big ticket furniture. I mean that’s apparent to everybody. But our buying disciplines are in every department. And so that safety stock as you call it, even though it didn’t look like safety stock, we have to mark it down. That is really in every department.

Operator

Your next question comes from Michael Baker – Deutsche Bank.

Michael Baker - Deutsche Bank

Just relative to Wall Street expectations, first quarter was certainly worse, but the full year you’re more in line with consensus? So is that sort of an endorsement of the $0.16 consensus number?

Cary Turner

It’s definitely closer than the first quarter consensus.

Michael Baker - Deutsche Bank

What is meant by modest net income? If you do a 53% merchandise margin and I assume we’re still looking at $160 million or so in cost savings over a two year basis, I guess it depends on what modest means but I get what I would consider a little bit more than modest operating or net income.

Cary Turner

Again, what I really don’t want people to do is get ahead of us because it’s all contingent on sales.

Michael Baker - Deutsche Bank

One other question I had is so June flattish, so you said the two year trend as you look at it, it was getting better March, April, May. June at about a flat number, does that still hold?

Cary Turner

Yes.

Operator

Your next question comes from Neely Tamminga – Piper Jaffray.

Neely Tamminga – Piper Jaffray

On conversion rates, so conversion rates are positive, that’s certainly good, average ticket, can you compare it with where the average ticket is? I might have missed that in your presentation and I just have a couple follow up questions on that.

Alex Smith

On the conversion rate, we started to see those improvements in the fourth quarter of last year. What we’re really pleased about is those percentage improvements have really been rock solid. They haven’t moved. We’re seeing day in day out, week in week out significant improvements to the level of, to our conversion rate.

In terms of our units per transaction, again it’s really, really stable. We’re seeing improvements in our units per transaction. It started in the fourth quarter and those have continued. The average ticket moves a little more. So for example when we were in March and April when we were anniversarying the Modern Craftsman clearance, the average ticket last year was very, very high.

So our average ticket versus last year fell in March and April. But really again, what we look at is the trends. So if you had asked me what is the trend in your average ticket and how is it progressing? The good thing from our perspective is that it’s not moving very much. So the average ticket stays pretty much the same week in week out.

So what we’ve created here in the last six months is a business where our weekly sales volumes are much more predictable than they were, where our transactions are much more predictable than they were and our conversion rates are much more predictable. The whole business is becoming significantly more stable and predictable as we go through this turnaround.

Neely Tamminga – Piper Jaffray

Specifically I was intrigued in your comments on tabletop. Is tabletop improving you think because you’ve improved seasonal within tabletop or are those two separate merchandise mix categories?

Alex Smith

They’re very separate. I mean the tabletop is dinnerware, stemware, serve-ware, barware, those are the main departments in tabletop. And the reason it got better is because our merchants have got that product closer to the bulls eye and the customers are liking it more and buying it more.

Neely Tamminga – Piper Jaffray

As we look into Q3, Q4, maybe even into Q2, if you look at the bigger buckets of the merchandise mix overall, other than the retail 101, blocking and tackling that you guys are doing, just being better, making more intelligent buys, are there specific bigger buckets of opportunity within the merchandise mix, either from a top line and or a margin perspective that we should be looking at for improvement in Q2, Q3, Q4.

Alex Smith

Well I don’t think there is any category of merchandise that we don’t think has got room for improvement. I mean clearly when we do our merchandise budgets we don’t put flat growth numbers on each department. We know we take a view as to how we feel about the quality of our assortment and how the customers are responding.

But we are expecting to see, I can tell you this, we are expecting to see sales improvement across the board in the rest of the year and that’s important because if you go back to the previous call and we talked to you about our furniture percentage staying at about 40% of our sales and how important that was in terms of the average ticket. Again, that hasn’t moved. So we’re staying at that 40% furniture.

Within furniture, absolutely there’s some flex between dining and bedroom and occasional and all those things. But the net-net number is 40% and then 60% on the impulse and the lower ticket items.

Operator

Your next question comes from Brian Nagel – UBS.

Brian Nagel – UBS

As you look at Q1, how did the quarter shake out relative to your internal projections? Maybe you could give us some color there on the top line as well as the bottom line number.

Alex Smith

The sales were somewhat shy of where we thought. We knew we had to cycle the Modern Craftsman numbers, so we had planned March and April very conservatively. But as it turns out, we hadn’t planned them conservatively enough. When we got to May we were much happier with those numbers.

That was getting very near to what we expected. In terms of the margin percentage, the margin percentage was higher than we had planned. And that was why our gross margin dollars came in really very strong we thought.

Brian Nagel – UBS

The $0.37 loss, can you comment if you had an internal projection for that?

Alex Smith

Well, we don’t comment on internal projections. But what I can say is we’re pretty comfortable with that number.

Cary Turner

The biggest thing and we haven’t talked about it but the reduction of inventory levels, we are very pleased with and we’re going to continue to see that and as I’ve said an overall reduction over the year of the $410 at the beginning of the year of inventory going down to just $360 million, we feel very good about.

Brian Nagel – UBS

From a longer term strategic perspective, you’ve been around the business now for more than a year, we know what operating margins and such looked like at Pier 1 back in its heyday, as you think about the longer term profitability of the model, how much further and not to [inaudible] guys but how much further up from here on a longer term basis?

Alex Smith

You mean are we going to get back to those double digit return on sales? Well the answer is today, I don’t know. I mean we certainly think that is achievable. I couldn’t tell you whether it’s going to be the year after next, the year after that. But as we grow our merchandise margins and we see now why we can’t get those back to historical highs. We’ll get somewhere near it.

Ultimately it’s going to depend on how much we can get on the top line. And the amount we’re going to get on the top line is going to be somewhat influenced by what’s happening outside.

I have no doubt whatsoever that if the environment today was neutral to slightly positive that we would be really rocking because we see that in our conversion rates, we see the way the customer responds to what we’re putting in stores. And I have the advantage over you guys, I know what’s coming down the pike from what I see down in the sample room.

Cary Turner

I would also say that one thing we feel very strongly about is the business model is the same as it always has been. We have the opportunity to drive that merchandise margin and if we do that and we drive the top line, then the bottom line margins will [hump].

Operator

Your final question comes from Colin McGranahan – Sanford Bernstein.

Analyst for Colin McGranahan - Sanford Bernstein

This is [Sara Senitori] for Colin, he couldn’t be on the call today. About merchandise margin, I think this time last year you talked about normalized adjusted for the liquidation your merchandise margins would have been north of 52%. So I just wanted to think about on a normalized basis what the promotional environment looked like this quarter versus less so last quarter. But still, we were a little surprised even if it sounds like you weren’t on the merchandise margins where they were this quarter.

And I also wanted to see if I could get more of your thoughts on the ad spend. Because again, top line versus our expectation came in a bit light and I’m wondering do you need to increase you ad spend overall or what the payback is on that and on the decision to alter the cadence of the year.

Alex Smith

On the advertising first. When we advertise, either through our mailers or through the pages, whatever medium we use, we clearly get a response and we track that very carefully. And that response is a percentage on our base traffic. So if you think about this, if during the first quarter of the year you have, take a base of 100. Say you have a 100 people coming into your stores to pick a number.

If you increase that by a percent as a result of your marketing, you get a few percent, a few over 100. When you get into the third and fourth quarter, the base traffic level has increased substantially, so let’s call it 150. If you advertise then and increase by the same percentage you’re obviously getting a much bigger return on your investment.

So and that’s why retailers all do it, it makes sense to spend your marketing dollars at the time when you’re most likely to influence customer’s behavior and drive them into your stores. So that’s fine.

Cary Turner

And I guess we still see the marketing spend to be the 4-5% of sales and that’s no change.

Analyst for Colin McGranahan - Sanford Bernstein

Right and that’s keeping in mind right that the return on the dollar is better in the latter half of the year, that total dollar spend through the year is the right amount?

Cary Turner

That’s right. And then with the 52% normalized margin that we talked about, to get that, what we really are looking at is and as you’ve heard on the guidance, the first quarter margin is usually a little higher.

But in terms of, we use some more clearance markdown dollars to get rid of some more clearance inventory so that the margin in the second quarter when we usually clear some out, it’ll be the same or slightly higher than the second quarter and so as we look at next year’s margin it’ll probably be north of the 52%. So but overall, as we’ve said, we are seeing continued improvement in the merchandise margin and we feel very comfortable right now talking about the 53% margin for the year.

Alex Smith

Okay, thank you very much everybody. Thanks for joining us today and we’ll talk to you on the next call.

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