Big 5 Sporting Goods Corporation
Q3 2008 Earnings Call Transcript

Published: 4 Nov 2008

[Operator:]

Good afternoon, ladies and gentlemen. Thank you for standing by. Welcome to the Big 5 Sporting Goods third quarter 2008 earnings results conference call. With us today is Steve Miller, Chairman, President, and CEO, and Barry Emerson, Senior Vice President and CFO. (Operator Instructions) I would now like to turn the call over to Mr. Steve Miller. Please go ahead, sr.

[Steven Miller:]

Thank you. Good afternoon, everyone, and welome to our fiscal 2008 third quarter conference call. Today we will review our financial results for the third quarter of 2008, provide general updates on our business, as well as provide guidance. At the end of our remarks, we will open the call for questions. I will now turn the call over to Barry to read our Safe Harbor Statement.

[Barry Emerson:]

Thanks, Steve. Except for statements of historical fact, any remarks that we may make about our future expectations, plans, and prospects constitute forward-looking statements made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements involve known and unknown risks and uncertainties that may cause our actual results in current and future periods to differ materially from forecasted results. These include the uncertainties as more fully described in our Annual Report on Form 10-K for fiscal 2007, our quarterly report on Form 10-Q for the second quarter of fiscal 2008, and other filings with the Securities and Exchange Commission. We undertake no obligation to revise or update any forward-looking statements that may be made from time to time by us or for us on our behalf.

[Steven Miller:]

Thank you, Barry. Given the unprecedented challenges of the consumer environment, we are pleased with the relative strength of our performance and ability to delivery earnings that exceeded our third quarter guidance. By continuing to focus on managing the controllable aspects of our business, such as inventory and expenses, we successfully lessened the impact of the macro environment on our third quarter results. Now for the numbers

[Barry Emerson:]

Thanks, Steve. Our gross profit margin for the third quarter was 33.3% or sales compared to 34.3% of sales for the third quarter of 2007. The 11 basis point increase in product selling margins and decrease in distribution center expenses were offset by higher store occupancy costs due mainly to new store openings. Our selling and administrative expense as a percentage of net sales was 29.6% in the third quarter of fiscal 2008 versus 27.7% in the third quarter of the prior year. The higher rate year-over-year was primarily due to the softer sales conditions and higher store-related expenses reflecting an increased store count. Now looking at our bottom line, net income for the third quarter was $4.5 million or $0.21 per diluted share, compared to net income in the third quarter of fiscal 2007 of $8.4 million, or $0.37 per diluted share. Briefly reviewing our nine month results, net sales declined 3.2% for the 2008 year-to-date period to $645 million from $666.2 million during the same nine month period in 2007. Same-store sales decreased 6.5% versus the same period last year. Looking at the bottom line for the first nine months, net income was $10.3 million or $0.48 per diluted share compared to net income of $21.9 million or $0.97 per diluted share in the same period last year. Turning to our balance sheet, at the end of the third quarter, total chain inventories were $247.7 million, which was approximately $10 million below last year’s levels. As Steve mentioned, we continue to focus on managing our inventory and on a per-store basis, quarter end inventories were down 9.7% from the same period last year. Looking at our capital spending, CapEx excluding non-cash acquisitions totaled $14.2 million for the first nine months of fiscal 2008, reflecting expenditures for new stores, store-related remodeling, distribution center and corporate headquarter costs, and IT purchases. We expect total capital expenditures for fiscal 2008, excluding non-cash acquisitions, of approximately $20 to $21 million. The investment will fund the opening of approximately 18 net new stores, store-related remodeling, corporate office and distribution center improvements, and computer hardware and software purchases. We generated cash flow from operations of $29.4 million in the nine months of fiscal 2008 compared to $14.6 million for the same period last year. The difference is mainly due to our efforts to reduce inventories to better align them with current sales levels. We have historically used our free cash flow for new store expansion, paying shareholder dividends, reducing debt, or repurchasing the company’s common stock, and we will continue to evaluate the best use of our cash on a quarter-by-quarter basis. To update activity under our share repurchase program, we have slowed our purchasing to preserve capital in light of the current economic environment. In the third quarter, we repurchased 85,757 shares of our stock for a total of $0.6 million. As of the end of the third quarter, we had $14.4 million available for stock repurchases under our $20 million share repurchase program authorized in the fiscal 2007 fourth quarter. Because of the current economic downturn, we’d like to spend a few minutes talking about our debt structure. We have $175 million financing agreement with the CIT Group, a syndicate of lenders with interest rates having a floor of 1% over Libor and a ceiling of 1.5% over Libor. If you are interested, the agreement and related amendments have been publicly filed as part of our SEC filings. The amended agreement includes covenance that among other things require us to maintain a fixed charge coverage ratio of not less than 1

[Operator:]

(Operator Instructions) Our first question is from the line David Magee with SunTrust Robinson Humphrey.

[David Magee:]

On historic growth for next year, if you decided to pull back, what will be the impact on the earnings next year?

[Steve Miller:]

David, we haven’t forecasted our 2009 earnings to a specific degree, but certainly as you scale back, depending on how dramatic you scale back your new store openings, that would have certainly some impact on our revenue for next year.

[David Magee:]

They are accretive, are they not, in the first year?

[Steven Miller:]

Yes, they typically are accretive in the first year.

[David Magee:]

The other question I have, on the footwear category, can you recall anything that particularly is working well right now? Nike or any other vendors that seem to be selling well?

[Barry Emerson:]

David, we generally do not comment on the individual vendor performance, just to be consistent with past practice.

[Operator:]

Our next question is from the line Rick Nelson with Stephens, Inc.

[Rick Nelson:]

Steve, you mentioned your lean inventory position and potentially allowing you to do more in the way of opportunistic purchases, which given the tough macro environment, I would think those would be more plentiful. What are you seeing in terms of opportunistic buys at this point?

[Steven Miller:]

Well, we think from an opportunistic standpoint are pretty dynamic right now, given the growing number of retailers, clothing stores filing from bankruptcy protection. Seems to be more cancellations out there that are creating buying opportunities for us. With that being said, I think the vendors are pretty tuned into the state of the economy and they’re certainly trying to tighten their belts as well, but all-in-all, we think it’s positive. I think it could be hopefully even getting more positive for us as additions play out.

[Rick Nelson:]

Did you recognize benefits in the third quarter…opportunistic buys?

[Steven Miller:]

I think that helps. Absolutely. I mean it’s really allowing us to create compelling values for our customers and yet maintain margins that are health for our business.

[Rick Nelson:]

What would the other drivers to the gross margin, the 11 basis points that you referred to, is that mix?

[Steven Miller:]

I guess there’s always an element of mix that’s there, Rick, but I mean it’s pretty consistent with what we’ve tried to achieve in the long run is try and optimize our pricing strategies and really manage the business to maximize gross profit dollars. You know, certainly a goal to try to maintain margins and optimize sales.

[Rick Nelson:]

The store opening pull-back for 2009, what is the driver there? Is it the rents are becoming more attractive and you’re waiting for those to decline and how many roughly are you thinking about for next year?

[Steven Miller:]

One, I think maybe there is some advantage to waiting in today’s environment, but just given the uncertainties of the extent and duration of the economic downturn, yeah, we think it’s prudent to be cautious and do a lot of evaluation in terms of new stores, you know, moving forward with new stores. We continue to evaluate these plans really on a daily basis and we’ll certainly have more to say after the holiday season when we’re a whole lot wiser about the direction of the overall economy.

[Rick Nelson:]

Do you see any issues with covenance and how difficult is it to change those with the banks?

[Barry Emerson:]

Rick, the covenance that we have typically are two-fold. A fixed charge coverage ratio and that kicks in if our availability is under $40 million as I described in the details of the communication earlier. The details of the covenant and all of our bank covenants are included in our credit facility agreement related amendments, which are then publicly available as exhibits to our SEC filings. Our credit facility requires us among other things to maintain a fixed charge coverage ratio of not less than 1

[Rick Nelson:]

And the pull-back that you’re talking about in terms of store openings, is that aimed at being compliant as well?

[Steven Miller:]

I think it creates greater flexibility for some of the uncertainties of the future.

[Rick Nelson:]

Where do you stand with the fixed charge coverage ratio now?

[Barry Emerson:]

As of the end of the September, Rick, our fixed charge coverage ratio was 1.11 and our availability was $44 million, and again, our fixed charge coverage ratio, the comparison is 1

[Operator:]

Our next question is from the line Brian Nagel with UBS.

[Brian Nagel:]

First off, with respect to the guidance in particularly the macro environment, clearly we’re in a very dynamic environment at this point, but how do you think about, you know, if you look at gas prices which have been coming down, housing still weak, credit becoming more difficult. How do you think about the macro environment and what factors may be most important to you guys?

[Steven Miller:]

Well I think all factors that affect the amount of discretionary income in our consumers’ pocket is important to us. I’m not sure exactly how to weigh it. What I feel is important to us is the fact that have a value offering that we think in today’s economy may resonate well for many, many years and right now maybe the consumer needs us arguably more than ever, because we have a tremendous reputation in our marketplace for delivering value and I don’t think anybody would dispute the fact that right now the general consumer out there is looking for value. So we’re very hopeful, but I think although it’s a challenging environment. We think we’re playing well through the challenging environment of particularly given our geography and we would look for that to continue going forward through this holiday season.

[Brian Nagel:]

Your circulars, have you been able to or have you decided to up the publication of those just to enhance the value image in the marketplace?

[Steven Miller:]

Well we’re aggressive 52 weeks a year really in terms of reaching out to our consumers. So we’re going to continue to obviously be aggressive in terms of our circulars and making sure everybody understands the values that are available at Big 5 Sporting Goods.

[Brian Nagel:]

I notice your tax rate in the quarter when down to 37.4%. Is that a one-time event or how should we be modeling tax?

[Barry Emerson:]

Brian, that’s a one-time event. Really that’s reflective of the impact of lower pre-tax income on our tax credit situations. So that’s really a true up for the nine months. So I’d use a rate of about 38.5% or so for the full year.

[Operator:]

Our next question comes from Mike Baker with Deutsche Bank.

[Mike Baker:]

Did you say what your CapEx expectation is this year and more importantly I wondered if you could talk about what it might be next year and if you don’t have a number, can you remind how much CapEx goes into store openings versus maintenance CapEx, if we make our own assumption of store openings next year we can come up with an estimate? Thanks.

[Steven Miller:]

Our capital expenditures for this year should be roughly $20 to $21 million and that’s to fund the opening of approximately 18 net new stores and store-related remodeling, corporate office, distribution center, computer hardware and software, and of course our CPI compliant. We typically spend on opening a new store approximately $500,000 per store. Just for modeling purposes, we’re looking to open 18 new stores this year. The CapEx, the maintenance CapEx runs roughly $3 to $4 million dollars a year, something like that.

[Mike Baker:]

Do you have any stores at this point for 2009 to which you’re obligated to open or could the number go to zero?

[Steven Miller:]

No, it won’t go to zero. I think we have at this tine three stores that we’ve committed to, one of which is a relocation of an existing store. We really retain great flexibility in terms of what the ultimate number will be for 2009.

[Mike Baker:]

If we just were to assume 18 to 3, then we can subtract out 15 store times half a million per store to get a CapEx estimate? Is that a fair way to look at it for next year?

[Steven Miller:]

We’re not saying that we’re going to only open three stores next year, but that’s how many we’ve committed to.

[Barry Emerson:]

And that’s just focused on the new stores, of course. I mean there’s other aspects of our capital expenditures including distribution, our IT investments, and things like that.

[Operator:]

Our next question comes from the line of Nick Genova of B. Riley & Company, Inc.

[Nick Genova:]

First, on the comp guidance, pretty much by Q4 I’m assuming that the roller shoe category won’t have a whole lot of impact and then you guys are also lapsing a pretty weak Q4 in 2007, so with those factors in mind, could this guidance you gave on the comp perspective, could that prove conservative? Are you guys looking at it from a pretty conservative perspective?

[Barry Emerson:]

We certainly hope so. The roller shoes, we’ll probably still comp down in roller shoes in Q4 this year against last year, although from a profitability standpoint, our margins in roller shoes a year ago were very soft. A year ago, really pushing through roller shoes and what we were selling were at very compromised margins. So from a bottom line standpoint, I think we’ll be way less impacted. Probably still a little impact in Q4, but hopefully less what it was in Q3. Certainly I mean we are going against our softness number that we’ve gone against at least since 1995 and we would obviously hope that there’s some rebound in the consumer activity. We think we positioned ourselves, as I just mentioned, to optimize sales in this environment and I think a few months ago we probably would have certainly been guiding higher, we were for Q4, but given sort of this what I’ll call the worse of the nation’s economic crisis. I think we and most all retailers have experienced over the last five or six weeks, there does remain a dreary uncertainty and so we certainly believe our guidance reflects that.

[Nick Genova:]

On product margins, it was encouraging to see that you guys continued to at least maintain or actually grew those by 11 basis points. With your lower inventory position, can you talk a little about whether or not you’ll be able to maintain those product margins and how the lower inventory position benefits or helps that?

[Steven Miller:]

Well, the lower inventory position, our inventories are clean right now, so I think we may be looking at potentially fewer markdowns. Certainly the lower inventory position allows us great flexibility to take advantage of opportunistic buys as they become available and typically opportunistic buys is a way we can create great value for our customers, yet enhance margins. The roller shoes, we sold a fair amount of roller shoes still last year at very soft margins and that should benefit the margin comparisons this year. That being said, I mean it’s a challenging environment and we want to make sure we’re priced right to try and optimize sales and gross profit dollars. Our guidance actually reflects a small reduction in product selling margins this year.

[Nick Genova:]

Is there anything you’re doing looking ahead to Q4 and seeing the trends obviously weaker than we would have anticipated a few months ago. Is there any shift in advertising strategy or promotional strategy that you guys are pursuing?

[Steven Miller:]

As a matter of practice, whether the environment is healthy or challenged, we adjust our promotional and we spend a lot of time every week looking at upcoming ads and thinking about pricing strategy. So we’re always making adjustments and we think we hopefully can make the right calls as this holiday season plays out.

[Operator:]

Our next question is from the line of Reed Anderson with D.A. Davidson & Co.

[Reed Anderson:]

Steve, is it still a situation that if you look at your store base geography that southern California continues to be one of the worst areas and northern is maybe not quite as bad. Could you give us a little flavor on kind of what you’re seeing across your geography?

[Steven Miller:]

During the third quarter, I’d say sales were generally soft across all market areas, but logically we did have some areas which performed better than others, but for competitor reasons and again consistent with past practice, we’re just not going to get very specific on geographical performance. I think it’s well documented that some of the areas, states, California, Nevada, Arizona, are frequently spoken of as being maybe three out of the four worst toughest environments in the country, but we’re just not going to get very detailed about the specific regional performance.

[Reed Anderson:]

How about SG&A, you guys have done a good job controlling that. I’m just curious, have you gone so far as to make staffing cuts or have you pulled back anywhere? Have you tweaked store staffing? Could you give us a sense of what you might have done there to keep that in check.

[Steven Miller:]

We’re always watchful of expenses and certainly increasingly watchful now given the current conditions. We manage our store labor at a week-to-week basis. We have implemented. I think we’ve gained benefit, a new Cronus time keeping system that provides better visibility in management of week-to-week payroll usage and fast reaction time to changing sales trends. So we certainly manage our store payrolls carefully and we’re watching that as we go forward.

[Reed Anderson:]

What about the DC or corporate? Have you cut back there a little bit or not?

[Steven Miller:]

Well again, in the DC, our expense, we operated our DC with less expense this year in the third quarter than we did last year despite operating 19 additional stores and paying particularly in the third quarter dramatically higher fuel costs in the previous year and really the way we did that was by managing our labor and improving efficiencies of productivity.

[Reed Anderson:]

Barry, just a quick kind of housekeeping one. It looks like your balance sheet, it looks like your payables are actually going down as a percent if you look at relative to inventory. I’m just wondering if that’s a fluke or if I’ve got the wrong number or by plan. I’m just thinking about managing work in capital and I think you’d want to flex that the other way if possible.

[Barry Emerson:]

I would expect our leverage ratio for payables to be roughly equal what it was at the end of last year. We’re not doing anything different relative to managing the terms. If anything, we’re working with our vendors in this environment to try and improve terms and so I think that’s what we would expect.

[Operator:]

Our next question is from the line of Jeff Mintz with Wedbush Morgan Securities.

[Jeff Mintz:]

In terms of the sales percentage that comes from your newspaper inserts, I know historically that’s been fairly consistent. Have you seen any change in that kind of percentage of sales as the consumer has gotten a little bit weaker here in the last month or so?

[Steven Miller:]

No, I think it’s generally speaking in the same ball park. I think the ratio of our promotional sales, overall sales, has not changed dramatically.

[Jeff Mintz:]

In light of the weakness out there, have you looked at or considered closing more stores. I mean is kind of consumer weakness raising the potential that there are stores that might have worked in a better environment and aren’t working in the current environment?

[Steven Miller:]

We’re certainly always evaluating our store base, looking at our lowest performing stores. At this point in time, we don’t have any plans currently to close any stores. We’ll continue to watch and evaluate it on an ongoing basis.

[Jeff Mintz:]

Then the DC cost, it’s amazing that you were able to reduce 3% given the environment. Can you give us some sense of what the potential is given the lower gas costs and similarly the lower shipping cost. I mean could that be down mid to high single digits in Q4 given better shipping rate?

[Barry Emerson:]

In terms on order of magnitude, Jeff, I mean we do expect our DC cost in the fourth quarter to be down from what they were in the fourth quarter of last year. Now they’ll be up a little bit obviously from the third quarter of this year, just because of higher volume. But the overall costs of the DC, it’s costing us roughly about 4.5% to 5% of sales and if you go back to the old DC, it was closer to 3.5% to 4%, but we are getting pretty dog-gone close to leveraging those costs at the DC nowadays, even with the sales levels where they are today. So again, as volume continues to kind of decline and be weak, we’re going to continue to manage those costs real carefully.

[Jeff Mintz:]

Barry, does that suggest when we do get some kind of a turnaround and you start to get better comp numbers that you will be able to significantly leverage those costs?

[Barry Emerson:]

Absolutely. I mean we’ve said that all along. I mean when sales conditions turn around, not only we’ll be able to leverage the DC semi fixed cost, but certainly in all of the corporate labor which we have had added some base costs into our financial reporting and our stocks and our MIS team. We have the cost related to stock compensation that have been burdened on our corporate costs for the last couple years, but when sales conditions turn around, we think we’re going to be able to leverage those for quite awhile.

[Operator:]

Your next question comes from the line of Anthony Lebiedzinski with Sidoti & Company

[Anthony Lebiedzinski:]

If you achieve your sales plans, where do you expect your yearend inventories to be?

[Steven Miller:]

If our sales plans are achieved, the we expect our inventory to continue to trend downward. We expect our inventories to be in very good shape at the end of the year, down well below the prior year has been the trend all year.

[Anthony Lebiedzinski:]

Any sort of an idea as to what free cash flow is going to be for this year?

[Barry Emerson:]

I think as we’ve talked, for 2008, we certainly expect to return to more normal levels of free cash flow that we experienced prior to 2007. We generated cash flow from operations of $29.4 million for the first three quarters of this year compared to $14.6 million for the same period in fiscal 2007 and of course this is being driven by the reduction in our overall inventory purchases. We would expect free cash flow in the range of $20 million dollars or so for 2008 and we’re going to continue to evaluate the best use of cash, which of course includes shareholder dividends and reducing debt and repurchasing our company’s common stock.

[Operator:]

Our next question is from the line of Aaron Goldstein – JP Morgan.

[Aaron Goldstein:]

Hi, it’s Aaron Goldstein from JP Morgan. I just wondering if you could talk about your average transaction or average basket. I see that wasn’t a big decline for the quarter. Have big ticket items held up relatively well sequentially or have you just seen customers building baskets?

[Steven Miller:]

It seems like our average transactions remained reasonably consistent. I would say it’s all kind of the average basket is we made reasonably consistent, unfortunately just a slightly few baskets. So I guess the big ticket sales are off, but consistent with our overall business.

[Aaron Goldstein:]

Just to clarify, when you said trends kind of continued from Q3 into Q4, have they consistently deteriorate or did they just kind of leveled off from where they declined in the back half of Q3 or Q2.

[Barry Emerson:]

I would say they sort of leveled off, just kind of dropped a bit in the end of Q3 and that softness has continued, but has not really accelerated into Q4.

[Operator:]

Mr. Miller, there are no further questions at this time. Please continue with any closing remarks you may have.

[Steven Miller:]

Thank you, operator. We’d like to thank everyone for your interest and being on today’s call and we look forward to speaking with you again soon. Thank you.

[Operator:]

Thank you. Ladies and gentlemen, this does conclude the Big 5 Sporting Goods third quarter 2008 earnings results conference call. We thank you for your participation. You may now disconnect.