Cost Plus CEO Discusses Q2 2010 Results - Earnings Call Transcript

| About: Cost Plus, (CPWM)
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Cost Plus, Inc. (NASDAQ:CPWM) Q2 2010 Earnings Call Transcript August 19, 2010 4:30 PM ET

Executives

Barry Feld – President and CEO

Anne Mirante – VP, Finance and Treasurer

Jane Baughman – EVP and CFO

Analysts

TJ McConville – Raymond James

Brad Leonard – BML Capital Management

Ed Antoian – Chartwell

Operator

Good day ladies and gentlemen and welcome to the second quarter 2010 Cost Plus earnings conference call. My name is Kendal and I will be your operator for today. At this time, all lines are in listen-only mode. Later, we will conduct a question-and-answer session. (Operator instructions)

I would now like to turn the conference over to Mr. Barry Feld, CEO and President. Please proceed.

Barry Feld

Thank you, operator. Good afternoon and thank you for joining us to discuss our second quarter and first half 2010 results. With me today 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 will open the call up for questions. Before beginning today's discussion, Anne 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 actual results to differ materially from those expressed or implied by these statements. Such forward-looking statements include, but are not limited to, our liquidity position, our financial guidance for the second quarter of fiscal 2010, achieving positive EBITDA for fiscal 2010 and net income for fiscal 2011.

The risks and uncertainties include, but are not limited to, continued deterioration in economic conditions that affect consumer spending, changes in the competitive environment, currency fluctuations, timely introduction and customer acceptance of 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. We are pleased with our second quarter results and the continuing momentum in the business. Seamless integration of our marketing and merchandising strategies, combined with improved store execution has led to our most successful quarter since fiscal 2005 without a meaningful change in consumer spending. We achieved a 6.5% same-store sales increase and a 540 basis point improvement in gross profit rate for the second quarter.

Our ability to drive increases in traffic, ticket and margin resulted in a 78% reduction in EBIT losses from continuing operations and a 66% reduction in net loss versus the second quarter of last year. We achieved $2.4 million in EBITDA for the second quarter. This is our third consecutive quarter of positive EBITDA, excluding store closure costs and we have now generated positive EBITDA on a trailing four-quarter basis. These results bode well for the achievement of positive EBITDA in fiscal 2010 and a return to profitability in fiscal 2011.

The year-to-date improvement in merchandise margin is the result of our merchants working diligently to lower the cost of good structure without sacrificing the quality or authenticity of our products. As expected, the reinstatement of everyday value pricing has significantly reduced the need for promotional and clearance markdowns.

We are selling through full-priced goods at a much faster pace. Since beginning the turn around, inventory turnover on a trailing 12-month basis has increased from 2.0 to 2.8 at the end of the second quarter and is steadily approaching a turnover target of 3.

A continual flow of fresh merchandise with exclusive designs provided our customers with creative solutions for both indoor and outdoor entertaining throughout the quarter. In addition, our Mother's Day and Father's Day gift assortments were well received generating both sales and margin gains over the prior year.

We continue to be a one-stop destination for outdoor entertaining and had another very successful outdoor season. Our core competency in outdoor furniture drives traffic and ticket during a time period when other retailers are liquidating summer merchandise to make room for back-to-school.

We continue to expand our marketing toolbox to drive traffic and increase our national presence. Our new marketing strategies support customer-relevant stories and provide a clear World Market point of view in a fresh and engaging manner. Our partnership with Sony Pictures Entertainment for the motion picture “Eat, Pray, Love,” is a recent example of this. Our stores showcased unique and authentic products from Italy, India and Indonesia where the film takes place and where we have been procuring products for decades.

As we look ahead for the second half of the year, our fall harvest, Halloween and holiday merchandise assortments have never looked better and are priced to deliver clear and recognizable value to our customers. The ongoing integration of our marketing, merchandising and visual presentation will continue to drive traffic, ticket and margin and keep our customers shopping all four corners of the store.

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 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 second quarter of fiscal 2010 were $192.4 million, a 4.9% increase from the second quarter of fiscal 2009. Same-store sales increased 6.5%, primarily driven by a 5.8% increase in customer count. Additionally, the average ticket increased 0.7% as a result of higher units per transaction and a higher average unit retail. The eastern region and western region both performed well during the quarter. The California market continues to strengthen and delivered a same-store sales increase of 5.4% in the second quarter.

The mix between home and consumables as a percentage of net sales was 66% and 34% respectively for the second quarter of 2010 versus 65% and 35% respectively for the second quarter of 2009. Although consumables grew at a slightly stronger rate than home, the mix within consumables was more heavily weighted towards higher margin food.

Gross profit rate for the quarter increased 540 basis points to 31.6% versus 26.2% last year. The 540 basis point increase was the result of a 400 basis point improvement in merchandise margins combined with lower occupancy expenses compared with the same quarter last year and the leveraging of those reduced costs on higher same-store sales. Gross profit rate for the first two quarters of fiscal 2010 are steadily approaching historic levels.

Merchandise margin continues to improve due to strong performance in the non-furniture home category, significantly lower markdown and higher IMU across most categories of the business compared with the same period last year.

We conducted our annual chain-wide physical inventory during the second quarter and shrinkage expense remains below 2% of sales. We also continued to ensure the highest quality of inventory with the percentage of old age merchandise lower than a year ago.

Selling, general and administrative, or SG&A, expenses for the second quarter of fiscal 2010 were flat compared to the second quarter of last year. As a percentage of net sales, SG&A expenses decreased 160 basis points to 33.6% for the second quarter compared to 35.2% last year. The decrease in SG&A expenses as a percentage of sales is largely due to increased leverage on higher same-store sales.

For the second quarter of fiscal 2010, the loss from continuing operations before interest and taxes, or EBIT loss, declined to $3.8 million versus an EBIT loss of $16.8 million last year. The net loss for the second quarter of fiscal 2010 decreased 66.4% to $7 million or $0.32 per fully diluted share compared to a net loss of $20.8 million or $0.94 per diluted share last year. The company had non-GAAP EBITDA for the second quarter of $2.4 million.

The company continues to maintain a full valuation allowance against its deferred tax asset, which was $78 million at the end of the second quarter. Additionally, the company has a $58 million net operating loss carry-forward which will be applied against future taxable income.

Net interest expense was $2.7 million for the second quarter of fiscal 2010 compared to $2.9 million for the second quarter of fiscal 2009. Included in net interest expense is interest related to the distribution center lease obligation and capital leases of $2.3 million for both the second quarter of fiscal 2010 and 2009.

At the end of the second quarter, our inventory balance was $189.2 million compared to $185.8 million last year. Per store inventory levels increased 4.2% from a year ago to support a planned increase in same-store sales. The company ended the second quarter with $68 million in borrowings and $9.9 million in letters of credit outstanding under its revolving credit facility compared to $65.3 million in borrowings and $9.5 million in letters of credit last year.

At the end of the second quarter, utilization of our credit line was 59%, which was lower than last. Our forecasted peak borrowing requirements will be well within our $200 million credit capacity and in line with last year's peak borrowing at $108 million.

Year-to-date capital investments for 2010 projects were $1.5 million versus $1.1 million for 2009 projects last year. There were no stores opened or closed during the quarter. The company expects full-year 2010 capital spending to be approximately $4 million.

In this afternoon’s press release we have provided our outlook for the third quarter of fiscal 2010. Our guidance reflects a continuation of the positive trends we experienced during the first half of 2010 in traffic, average ticket and in merchandise margins.

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

Barry Feld

Thanks, Jane. Since beginning the turn around, I have clearly communicated our strategies and timeline. In order to regain our retail pricing credibility we accepted a short-term impact on the average ticket and margin as a necessary trade-off to ensure the longevity of the brand.

Today, our merchants have retooled assortments to lower the cost of goods and to maximize the non-furniture business. Marketing has expanded its use of multi-layered media and established the best-in-class royalty program to drive customer acquisition and shopping frequency.

The cost structure of the business has been rationalized and we have exited underperforming media markets. The culmination of these efforts has enabled World Market to emerge as a healthier organization with our brand promise intact. Our first half 2010 results continue to validate this approach and we have accomplished this without any dilution to our loyal shareholders.

The entire leadership team remains committed to delivering positive EBITDA for fiscal 2010 and returning the business to sustainable profitability in fiscal 2011. I'm confident we are on track to achieve both of these goals, which will ultimately restore shareholder value.

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

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from the line of Budd Bugatch with Raymond James.

TJ McConville – Raymond James

Good afternoon, Barry. Good afternoon, Jane. It’s actually TJ McConville filling in for Budd.

Barry Feld

Hi, TJ.

Jane Baughman

Hi.

TJ McConville – Raymond James

Congratulations again on the positive EBITDA. A couple questions for you. First, maybe not to get too far ahead of ourselves but the prospect of profitability next year is certainly obviously intriguing to us all. Barry or Jane, what has to happen between now and then to get you there mostly from a top line and probably gross margin perspective, how close to that peak of 36%, 37% gross margin do you need to get? What kind of comp break do we need, if you could just walk me through some of that?

Jane Baughman

Sure. What we’ve talked about in the past is that our stores used to do about $4.1 million on an absolute basis (Technical Difficulty).

Barry Feld

(Technical Difficulty) in Florida, they have had to some degree a disproportion amount of economic challenge associated with them. So we are currently operating in some, what I would characterize as, difficult macroeconomic market and the business model has been retooled to take that into account.

TJ McConville – Raymond James

Okay. That answers my question. So guys, thank you very much for taking them and good luck on the rest of the year and next year.

Barry Feld

Great. Thanks, TJ.

Operator

(Operator instructions) Your next question comes from the line of Brad Leonard with BML Capital Management. Please proceed.

Brad Leonard – BML Capital Management

Hi, thanks for taking my call.

Barry Feld

Sure. Hi, Brad.

Brad Leonard – BML Capital Management

Yes. Nice job on the quarter there. Just a couple of quick ones. Why would we expect gross margins to be lower in Q3 than Q2 and Q1?

Jane Baughman

Brad, it is Jane. There is some natural seasonality to our business with regard to (inaudible) of the assortment. So in the third quarter we being to move heavily into outdoor dining and living furniture which has a lower margin within the home category than even outdoor which we sell predominately in the second quarter, and in the first quarter we are heavily Easter and seasonal focused. So there is just a natural seasonality to the business if you go back and look historically.

Then in the fourth – as we move into the fourth quarter the margins actually drop even further as consumable really takes a meaningful gain over the home side of the business.

Barry Feld

What I would add though, Brad, is to keep your equilibrium, I think what you have to do is look at the margin performance as we continue to restore the margins back to their historic levels, I think it’s important to benchmark that margin improvement against similar quarters in prior years, and you will see that the relative improvement is still quite impactful.

Brad Leonard – BML Capital Management

Sure. I agree. If I look back five, six years it looks like Q1 through Q3 is pretty – back when you guys were humming pretty good, it was pretty stable. Not a whole lot of difference there and so we are talking 29 versus what would it be here for Q3 even if the guidance number – I mean it’s going to be a little bit bigger difference than I would have thought, but not terrible.

But then at the same time, I thought Q2 would have been a little bit lower with July being kind of a clearance month for your sector. Can you comment on why they came in better?

Jane Baughman

Yes, and we talked a little bit, one of the advantages that we have as a company based on our assortment is our ability to play through the summer with the outdoor entertaining business as the country heats up as you move across the nation, we have the ability to extend that. And based on our commentary about the health of our inventory, we had very little clearance compared to what we had any of the last several years as we’ve been reestablishing pricing and moving through older goods.

Brad Leonard – BML Capital Management

Okay. One last one. The historical relationship on merchandise margins in Q4. I know you guys don’t break those out, but how much lower would merchandise margins typical be in Q4 than Q1, Q2 and Q3?

Jane Baughman

I don’t have that right on my finger tips. Give me a second here.

Barry Feld

Brad, we'll get you a precise number here.

Brad Leonard – BML Capital Management

Okay. I'm just thinking you should pick up about just on occupancy maybe 400 basis points in Q4 due to the volume increase?

Jane Baughman

That's a little rich. I'd say merchandise margins are going to drop around 200 basis points to 250 basis points from the other quarters.

Brad Leonard – BML Capital Management

Okay. But you think that occupancy won’t be – it’s not that bigger differential?

Jane Baughman

No. It’s probably closer to about, I’d call, 300 basis points from the other quarters.

Brad Leonard – BML Capital Management

Okay. That’s all I have. Thanks and good luck in the third quarter.

Barry Feld

Great. Thanks, Brad.

Jane Baughman

Thanks, Brad.

Operator

Your next question comes from the line of Ed Antoian with Chartwell. Please proceed.

Ed Antoian – Chartwell

Hi, everybody. I'm reacquainting myself with the name. Can you guys give me a little help on the different mix? You gave us a little cut on the mixes of the business for percent of revenue. Maybe just do it on an annual basis for me and maybe what the relative gross profit margins are by those categories.

Jane Baughman

Well, I can talk to you a bit about the annual mix of the business, but we don’t actually break out gross profit by category. So on a full-year basis, it’s roughly 65/35 on an annualized basis. It dropped a bit in the fourth quarter.

Ed Antoian – Chartwell

What about in home, what about non-furniture versus furniture?

Jane Baughman

Well, again, furniture dropped in terms of penetration in the fourth quarter as consumable takes on a bigger role.

Ed Antoian – Chartwell

No, no, I understand that. But within home, how much of it is furniture, how much is non-furniture?

Jane Baughman

I apologize. Furniture is roughly 20% of sales.

Ed Antoian – Chartwell

All right. And non-furniture around 45%?

Jane Baughman

Right. And then the balance is home and consumables, and beverages 18% to 20% of sales depending on the time of the year.

Ed Antoian – Chartwell

But for the full year?

Jane Baughman

For the full year.

Ed Antoian – Chartwell

I’m coming up with more than 100%. So 20% is furniture?

Jane Baughman

Right. 20% is furniture.

Ed Antoian – Chartwell

18% to 20% is beverages.

Jane Baughman

Right. Then you’ve got another 15% to 20% in food.

Ed Antoian – Chartwell

Okay, only 15% to 20%.

Jane Baughman

In round numbers you can60/40, 40 is food and beverage, 60 is home.

Ed Antoian – Chartwell

Yes, okay. Then just maybe – I know you won’t give me exact numbers but by these four categories, the spread is in merchandise margins the spread is only a 1,000 basis points?

Jane Baughman

It’s meaningful. I would just leave it at that. Food is the lower margin segment of the business. Within the consumable side, beverage is even lower than food and then you have the home side of the business.

Barry Feld

So it would be, I mean, from an intuitive standpoint, while we don't break out individual margins the easiest way to think about it is it’s somewhat obvious and you would already be aware but obviously the consumable side has – it's a high velocity, lower margin business to it. Furniture has improved margins over consumables but lower margins in general than non-furniture home.

Ed Antoian – Chartwell

Right.

Barry Feld

That’s really the way it would break out.

Ed Antoian – Chartwell

Right. But it is a big number as far as the spread, a 1,000 basis points isn’t a silly number at all. That’s probably bigger.

Jane Baughman

No. I'd say you're a little bit heavy there.

Ed Antoian – Chartwell

Okay. All right. Just one last thing. When you look at markdown activity, is the non-furniture home your most volatile gross profit margin segment even though it’s your highest?

Jane Baughman

No. There is a fashion element to that. But the company has price discipline and ways to make sure that we’re addressing and moving through collections and seasonal goods.

Ed Antoian – Chartwell

Well, when I think about the 1,000 basis points of decline in gross profit margins from your peak to now, what’s the biggest – what category was the biggest culprit?

Jane Baughman

Well, quite honestly it was more in the furniture side of the business because it’s high ticket and it’s a highly promotional category versus your non-furniture home. It’s much less volatile because we are able to have a lot of exclusive designs and aesthetics that you can’t get in other places. So we are able to – there is less price volatility there versus a large dining room table or a leather sofa. That's really where we felt the pressure in the last couple of years is in the furniture piece of the business.

Ed Antoian – Chartwell

Okay. And lastly for me on the balance sheet, can you give me a little color on the $68 million of debt? What do I need to know about that as far as terms or covenants?

Jane Baughman

Sure. The company has a $200 million asset based credit facility that expires in June of 2012. Those are our seasonal borrowings underneath that revolver. The other debt that you see on the balance sheet is the DC capital lease obligation, which is really was a sale leaseback but it appears on our financial statement for some GAAP accounting reasons as really a refinancing, but it is not traditional debt.

The only debt the company has is the revolver. As I talked about in my comments, we moved through the line in advance of the peak holiday season as we procured goods in advance of the fourth quarter selling. So our peak inventory borrowing typically occurred in mid-November, and last year that number peaked at a $108 million on the $200 million facility. And we expect to be in and around the same place this year.

Ed Antoian – Chartwell

Okay. All right. And the terms on that as far as what kind of rate you are paying?

Jane Baughman

We pay LIBOR 150.

Ed Antoian – Chartwell

Okay. All right. That’s good. Thanks.

Jane Baughman

Okay.

Barry Feld

Thank you, very much.

Operator

And you have no further questions. This concludes the question-and-answer session. I would now like to turn the call back over to Mr. Feld with closing remarks.

Barry Feld

Thank you, operator. We look forward to reporting the results of our third quarter in November. Again, we want to thank our shareholders for the long-term support they provided and we are excited as the business continues to perform as we had hoped and the momentum continues to build. Thank you all very much.

Operator

Ladies and gentlemen, that concludes today’s conference. Thank you for your participation. You may now disconnect. Have a great day.

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