Pep Boys Manny Moe & Jack's (PBY) CEO John Sweetwood on Q3 2014 Results - Earnings Call Transcript

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Pep Boys Manny Moe & Jack (NYSE:PBY) Q3 2014 Earnings Conference Call December 9, 2014 8:30 AM ET

Executives

John Sweetwood – Interim CEO

David Stern - EVP & CFO

Sanjay Sood – VP, CAO and IR

Analysts

David Kelly - BB&T Capital Markets

James Albertine – Stifel Nicolaus

Brian Sponheimer - Gabelli & Company

Operator

Greetings and welcome to the Pep Boys Manny Moe & Jack Third Quarter 2014 Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded.

It’s now my pleasure to introduce your host, Sanjay Sood, Vice President, Chief Accounting Officer, and Investor Relations for Pep Boys Manny Moe & Jack. Thank you, Mr. Sood. You may begin.

Sanjay Sood

Good morning and thank you for participating in the Pep Boys third quarter fiscal 2014 earnings conference call. On the call with me today are John Sweetwood, Interim Chief Executive Officer; and David Stern, Executive Vice President and Chief Financial Officer. The format of the call is similar to our previous calls. First, John will provide opening comments regarding our results and our strategic priorities, and then David will review the financial performance, balance sheet and cash flows. We will then turn the call over to the operator to moderate the question-and-answer session. The call will end by 9:30 a.m.

Before we begin, I'd like to remind everyone that this conference call is governed by the language at the bottom of our press release concerning forward-looking statements, as well as SEC Regulation FD. In compliance with these regulations, we are webcasting the conference call on investorcalendar.com. For anyone on the webcast who does not have the financial statements, you can access them on our website, pepboys.com.

I will now turn the call over to John Sweetwood, Interim Chief Executive Officer. John?

John Sweetwood

Thank you, Sanjay. Good morning everyone. As the interim CEO at Pep Boys, I’m well aware that one of the first questions you’d like answered is what progress is being made toward hiring a permanent CEO? All I can do at this point is assure you that the search is well underway and we’re moving diligently to have a new Chief Executive on board as soon as possible.

Third quarter performance reflects continued progress on our stated strategy of moving the business towards service, while stabilizing retail. Comp service revenue increased by $9.9 million or 3.7% versus last year, led by increases in tires, maintenance and repairs. To further move revenues towards service, we continue to add Service and Tire Centers to the portfolio. As that model is refined, returns from the most recently opened stores are exceeding the cost of capital. Retail comp sales were $4 million or 1.8%.

The Road Ahead program continues to perform well and is generating significant learning in terms of associate training, customer behavior and store design and investment. Our challenge in the total business now is to scale costs to better match revenue generation. We continue to take cost out of the business while focusing investment in those areas which are generating the best and most immediate returns. Currently those areas which are growing most robustly, commercial, fleet, tires and digital are depressing total margins.

We believe Pep Boys is on the right strategy. However we must execute better against it with greater productivity from our operations. To achieve that, we are determined to deliver ever increasing customer satisfaction in both the service and retail lines of business and we are simplifying our operations to better focus on the key driver of our business, our customers. Finally I’d like to thank our 19,000 associates across the country for their efforts as we transform the company.

Thank you very much and I'll now turn the call over to our CFO, David Stern.

David Stern.

Thanks John. Good morning everyone. This morning I will review our results on both a GAAP and a line of business basis. The last page of our press lease includes financial information in the line of business format.

Sales for the third quarter of 2014 were $517.6 million, an increase of $10.5 million or 2.1% from the third quarter of 2013. The increase was driven by sales in non-comparable locations during the quarter of $4.7 million and an increase in comparable store sales of 1.2% or $5.8 million. Comparable store service revenue increased by 6.1%, while comparable store merchandise sales declined by 0.2%.

Gross profit, which includes service payroll, warehousing, and occupancy costs, for the third quarter of 2014 was $118.3 million, a decrease of $4.5 million or 3.6% from the third quarter of 2013. Gross profit margin was 22.9% of sales, a decrease of 130 basis points. Excluding the impairment charges of $1.4 million and $2 million in the third quarters of 2014 and 2013 respectively, gross profit margin was 23.1%, a decrease of 150 basis points from the prior year. This decrease was primarily due to lower product margins of 130 basis points, driven by a shift in the balance of business towards hires, commercial and ecommerce, along with increased commercial activity.

The selling, general and administrative expense rate was flat for the third quarter of 2014 at 22.7% of revenue. SG&A expenses for the third quarter of 2014 were $117.7 million, an increase of $2.5 million, or 2.2% from the third quarter of 2013. The increase was primarily driven by higher severance cost of $800,000, higher media spend of $700,000 and higher store expense of $1 million due to store growth.

Operating profit for the third quarter was $600,000, a decrease of $7.1 million from the prior year. The current year includes an impairment charge of $1.4 million and a severance charge of $1.4 million compared to an impairment charge of $2 million and a severance charge of $600,000 in the prior year. Adjusted for these items, operating profit for the third quarter of 2014 was $3.4 million compared to $10.2 million for the comparable period last year.

Interest expense for the third quarter was $3.5 million, a decrease of $100,000 from last year.

The income tax benefit for the third quarter of 2014 was $700,000 for an effective rate of 29% compared to an income tax expense of $3.5 million for 78% for the prior year.

The net loss for the third quarter of 2014 was $2 million or $0.03 per share compared to net income of $1 million or $0.02 per share for the third quarter of 2013. The net loss for the first nine months of 2014 was $600,000 or $0.01 per share compared to net earnings of $10.2 million or $0.19 cents per share for the nine months of fiscal 2013. 2014 results include on a pretax basis a $5.2 million asset impairment charge, a $4 million charge for litigation and a $2.4 million charge for severance. In addition, the 2014 results included $900,000 tax expense related to valuation elapses. The 2013 results included on a pretax basis, a $4.9 million asset impairment charge and a $600,000 severance charge.

I will now turn to our results by line of business as opposed to GAAP basis for our service center and retail operations for the third quarter of 2014. The service center business, which includes service labor revenue and installed merchandise, generated revenue of $289.4 million in third quarter of 2014, an increase of 5.6% or $15.4 million compared to the third quarter of 2013. This increase was primarily due to sales of $5.5 million from non-comparable locations and higher comparable store sales of 3.7% or $9.9 million. The increase in comparable store sales is due to a 4.3% increase in tire sales driven by a 3.1% increase in units and increase in the average unit retail of 1.2%. Excluding tires, services center comparable store revenue grew by 3.3% primarily due to brakes, oil changes and alignments.

Service center gross profit was $57.7 million, an increase of $3.7 million or 6.8% from the third quarter of 2013. Excluding the impairment charges of $1.1 million and $1.2 million in the third quarters of 2014 and 2013 respectively, service center gross profit as a percentage of service center revenue was 20.3%, an increase of 20 basis points from the same period in the prior year, primarily due to increased leverage employee cost as a result of increased sales, partially offset by lower product gross margins.

The retail business generated sales of $228.2 million in the third quarter of 2014, a decrease of 2.1% or $4.9 million from the third quarter of 2013. This decrease was due to a decline of $900,000 in sales from non-comparable locations and lower comparable store sales of 1.8% or $4 million. Retail comparable store sales declined primary in chemicals and filters tune up and oil categories. The retail business generated gross profit of $60.7million for the third quarter of 2014, a decrease of $8.1 million or 11.8% for the third quarter of 2013.

Excluding the asset impairment charges of $300,000 and $900,000 in the third quarters of 2014 and 2013 respectively, the retail gross margin rate was 26.7%, a decline of 320 basis points from the same period in the prior year. The decrease in retail gross margins was primarily due to lower product margins and deleveraging of occupancy costs against lower sales.

I'll now turn to the balance sheet and cash flow. Cash at the end of the third quarter of 2014 was $36.4 million, an increase of $3 million from the prior year end and a decrease of $19.4 million from the comparable quarter of last year.

Inventory at the end of the third quarter was $667.4 million, a decrease of $4.9 million from the prior year end and an increase of $2.5 million from the third quarter of last year. The increase in inventory of 0.4% from the comparable period of last year was due to increased investments in tires, speed shops and new service and tire centers, mostly offset by the closure of super centers.

Accounts payable, including the trade payable program at the end of the third quarter was $362.2 million, a decrease of $23.7 million from the prior year end and a decrease of $26.4 million from the comparable period of the prior year. The accounts payable inventory ratio was 54.3% compared to 57.4% at year end and 58.4% for the comparable period last year.

Capital expenditures for third quarter of 2014 were $55 million, and primarily consisted of the addition of 11 service and tire centers, one Supercenter relocation, the conversion of 21 stores to the Road Ahead format, remodels in progress and required expenditures for information technology enhancements, including our ecommerce initiative as well as our regular facility improvements. Capital expenditures for the third quarter of 2013 were $38.3 million. For 2014, we anticipate capital expenditures of approximately $70 million. For the year, we plan to open 19 service and tire centers, relocate two Supercenters and convert 30 stores to the Road Ahead format. To date in the fourth quarter, comparable store sales have increased by 2.4%.

I'll now shift to review of our three key strategic initiatives. The first is to lead with and grow our service business. Our service and tire centers, particularly those built in the Road Ahead format, have outperformed the pro forma so we will continue to use that format as we increase density going forward.

Our second key initiative is to transform our store experience with a physical remodel, and associate training program we refer to as the Road Ahead. The Road Ahead initiatives have been completed in the Tampa, San Francisco, Boston, and Charlotte markets and continue to produce positive results. The remodels in the Cincinnati and Denver markets will be completed in the fourth quarter, and grand reopened in the first quarter of 2015. Baltimore, which will be grand reopened in the second quarter of 2015, will be our first full market test of a reduced investments Road Ahead model. As of the end of the third quarter, 30 Supercenters and 50 Service & Tire Centers were in the Road Ahead format.

The third key initiative is to significantly grow our Digital business in both service and retail. During the third quarter digital sales, which include service appointments and retail sales for pick up in store and ship to home, continue to grow at a strong rate, up 48% for the quarter, and represented 5% of total sales.

I’ll now turn the call over to the operator to begin the question-and-answer session.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] Our first question today is coming from Bret Jordan from BB&T Capital Markets. Please resume with your question.

David Kelly - BB&T Capital Markets

Good morning. This is actually David Kelly on for Bret this morning. Just a couple of questions and just want to follow up on some of the Tire comments. I may have missed it, but could you provide the Tire comp for the quarter and then maybe some additional color on what you’re seeing on a unit and price basis?

John Sweetwood

Sure David. Comps for Tires were up 4.3% and increase in both units and average unit retail. Units were up 3.1%, and average unit retail was up 1.2%. And what we’re seeing is this continued shift towards branded. We’ve been seeing it over the past several quarters. It’s consistent with what we’ve talked about in the past, our migration with the Road Ahead going to a little bit more upscale, And so what we saw was really not that big of a change but just a continuation of the trend that we’ve been seeing.

David Kelly – BB&T Capital Markets

All right. Great. I appreciate the color. And then just maybe some regional demand trends, were there any outperformers, underperformers in the quarter by region or was it similar across the board? What were you seeing in the third quarter?

John Sweetwood

Sure. We didn’t see tremendous swings, but those that performed particularly well were our Florida and Georgia markets. Of course Road Ahead was first introduced in Florida so we’re starting to see the spread of that even to some of our non-physically remodeled locations. We saw strength in San Francisco, which is of course one of our remodeled [indiscernible] as well. Our Western Service & Tire Centers performed particularly well as did the Mid-Atlantic region. We experienced weaker performer in our Central and North Central markets.

Operator

Thank you. Our next question today is coming from James Albertine with Stifel. Please proceed with your question.

James Albertine – Stifel Nicolaus

Good morning and thanks for taking the questions. If I could ask a quick follow up on the Tire side, just given the announcement in November around the Tire tariff, wanted to see if there was any number one I guess promotional activity that you were seeing in advance or pricing pressure, positive pressing pressure around the tariff or since the tariff announcement.

John Sweetwood

Sure Jamie. As everyone is aware, it was implemented on December 1st and it was actually retroactive back 90 days. Of course we were working with our suppliers throughout this time. It wasn’t a surprise when it was announced to anybody. That’s why I knew it was coming and I’ve made arrangements for production outside of China. Everything I’ve talked about so far is more on a macro-basis or micro Pep Boys specific. Our balance of business is less skewed towards non-branded Chinese imports than the industry. And so we perceive less of an impact on us than most others in the industry.

James Albertine – Stifel Nicolaus

So just going back to the prior tariff a couple of years ago, the branded took some pricing as well during that period. You haven’t seen anything to that extent so far, it sounds like?

John Sweetwood

No, we haven’t.

James Albertine – Stifel Nicolaus

Great. And then just some clarification as well. You mentioned two key items to your strategy, one obviously looking for a CEO and second for sort of simplification broadly speaking around the portfolio. Could you elaborate a little bit on both those? First, what are you simplifying exactly and how are you looking at that more critically? And then given your prior CEO had pretty fairly recognized – a pretty strong background in service and retail, is there something you’re looking for that’s different in the new CEO? Is it maybe someone from outside the industry or with a restructuring or more of an M&A kind of background?

John Sweetwood

We’re looking for someone who is strong in service, hopefully has some retail. We view this as a pretty plump job actually for someone that’s stepped into a business that has a tremendous amount of potential, has a one share of a $200 billion market and participate with no dominance in the service area. It’s a very, very fragmented market. There’s no barriers to the success in the industry really in our area of focus. So we’re looking for the person who can energize us around that. Specifically, what exactly is the background we are – at this point in the search we’re still at the top of the funnel. So we’re looking at everyone.

James Albertine – Stifel Nicolaus

The simplification of the business strategy, what exactly -- is it merchandizing? Is it service offerings? What are you trying to simplify from here?

John Sweetwood

Simplifying the way our stores are run. We’ve got a lot of complexity in it now, a lot of procedures that we’re trying to eliminate to give our operations folks more time with the customer and less time with things that are not specifically driving the sale.

James Albertine – Stifel Nicolaus

Very helpful and then if I can sneak one more. Just real estate value of those updates there so how you’re thinking about your own real estate. Thanks.

A-David Stern.

Sure Jamie, I’ll take that. Not an update. Our own real estate has a fair market value just north of $720 million. We’re ongoing -- as an assessment of that, we look at the returns of stores based on and compare it to the cost of capital and the fair market value. So coming over the next few quarters, you’ll probably see some asset sales, but it’s just an ongoing process of what we’ve done previously as well.

Operator

[Operator instructions] Our next question today is coming from Brian Sponheimer from Gabelli & Company. Please proceed with your question.

Brian Sponheimer - Gabelli & Company

Just one – talk about the cadence in the quarter and whether you saw any benefits towards the end of the quarter from lower fuel prices?

A-David Stern.

We did. Of course it’s hard to attribute what we think was the specific attribute, but yes you’re right. As fuel prices decreased through the quarter, we did see improvements month over month and as I mentioned into the fourth quarter, today we’re now at 2.4%. And so we’ve seen a continuation of that trend post the end of Q3.

Brian Sponheimer - Gabelli & Company

Terrific. And just as far as your own purchasing of Tires potentially ahead of some price increases by suppliers as these tariffs roll on, and I’m talking on the branded side, are you guys doing any stockpiling of Tires, or non-Chinese Tires ahead of this?

A-David Stern.

No. We haven’t seen a need to do that. Again this tariff was well known that was coming down the pike. Our merchandizing team has been working with our suppliers directly. We will be less impacted than our – than we were in the past because our balance of business has shifted away from the non-branded Chinese imports relative to what it was during the last tariff. And we’ve got --

Brian Sponheimer - Gabelli & Company

I was just wondering whether you’re potentiality seeing some of your branded partners taking the opportunity to increase their own prices as you see some of the low end tires [appetite] the tariffs.

A-David Stern.

No. We’ve been specifically watching that Brian and no, we have not seen that and we are very comfortable with our tire inventory.

Brian Sponheimer - Gabelli & Company

Okay. John, this question is for you. You spoke to the potential of this business and obviously it's been a struggle for a few years now. Elaborate on that just for a minute or two. What do you see as where this business should be in three to five years? And then I guess along with that, as you are looking of a new CEO and you’ve already had a well-defined plan with the Road Ahead, is it incumbent upon the new CEO to adhere to that Road Ahead plan?

John Sweetwood

The potential I see in the business is that we are moving toward service which is the growing end of the business and the biggest end of the business and a business where we think we can get the margins we want. As I said before, we really don’t see any barriers to success there. It’s simply just upon ourselves to please the consumer as much as we possibly can. What was the second part?

Brian Sponheimer - Gabelli & Company

If you are looking for a CEO and you’ve already had -- the strategy has been laid out in the Road Ahead, is it a prerequisite for the CEO to agree with that plan and continue down that path?

John Sweetwood

It's not a prerequisite for the CEO to agree with that. We welcome new and fresh thinking. That said, we are seeing some pretty good signs out of our strategy. So that would be the CEO’s option. We would not want to burden them with an existing situation.

Operator.

Thanks. Our next question is a follow up from James Albertine from Stifel. Please proceed with your question.

James Albertine – Stifel Nicolaus

Thanks. Just one more quick follow up as I'm thinking through on the gross margin side. It sounds like -- first of all congratulations. Digital growing that quickly I think is certainly a credit to probably Road Ahead, but also some broader initiatives that have been in place for some time. But it sounds like tires are going to continue to be strong perhaps, or the service side at least continues to be strong and maybe that’s a pressure from an aggregate margin perspective. Wanted to understand how you’re thinking about the cadence looking ahead to the next quarter but maybe into the first half of next fiscal year. And then as a related comment, just a clarification, the promotional activity you called out, is that retail specific, service specific? Is that specific to you guys or is that a market promotional activity that you were seeing during the quarter. Thanks.

A-David Stern.

Sure, I'll take the second part of your question first. Promotional activity, it was more broad based and we specifically were more promotional than we were in the third quarter of the prior year. Jamie, the first part of your question was related to gross margins and what we foresee going forward. Is that correct?

James Albertine – Stifel Nicolaus

Correct. Given some of the digital growth, e-com growth, the tire growth, it seems like there’s going to be some pressure at least for the foreseeable. Wanted to get your view on that.

A-David Stern.

Yes. Seeing a balance of business shift to tires, ecommerce, fleet and digital does pressure gross margin. Now of course this is something that we’ve been working with our merchandizing team on as well as our operations team to take that into account. The total ticket for tires was up versus last year. And so we can say as the tire balance of business becomes a greater potion, in a vacuum that would hurt margins, but of course we’re doing things to drive that, to drive higher attachment to the tires as well as to mitigate that.

End of Q&A Session

Operator.

Thank you. We’ve reached the end of our question-and-answer session. I'd like to turn the floor back over to management for any further or closing comments.

John Sweetwood

All right. We want to thank you for your time, interest and questions and as usual we will be available for follow up discussion and have a good day.

Operator

Thank you. That does concludes today’s teleconference. You may disconnect your lines at this time and have a wonderful day. We thank you for your participation today.

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