Big 5 Sporting Goods Corporation
Q4 2008 Earnings Call Transcript

Published: 3 Mar 2009

[Operator:]

Good afternoon, ladies and gentlemen. Thank you for standing by. Welcome to the Big 5 Sporting Goods fourth quarter 2008 earnings results conference call. During today's presentation, all parties will be in a listenonly mode. Following the presentation, the conference will be opened for questions. (Operator Instructions) On the call today, we have Mr. Steve Miller, President and CEO, and Mr. Barry Emerson, CFO. At this time, I would like to turn the conference over to Mr. Steve Miller, please go ahead, sir.

[Steve Miller:]

Thank you. Good afternoon, everyone. Welcome to our fiscal 2008 fourth quarter conference call. Today, we will review our financial results for the fourth quarter and full year of 2008, provide general updates on our business as well as provide guidance for the current quarter. 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 forwardlooking statements made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forwardlooking 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 uncertainties more fully described in our annual report on Form 10K for fiscal 2007; our quarterly report on Form 10Q for the first, second, and third quarters of fiscal 2008; and other filings with the Securities and Exchange Commission. We undertake no obligation to revise or update any forwardlooking statements that may be made from time to time by us or on our behalf.

[Steve Miller:]

Thank you, Barry. Today, we reported fourth quarter and full year earnings at the upper end of the guidance range we provided in conjunction with our third quarter earnings release last November. We feel good about this accomplishment, given how difficult the holiday season turned out to be for virtually all retailers. We think our business was well served by our customer value proposition and our focus on managing the aspects of the business that we can control  product selection and promotions, inventories, and expenses. As we previously reported fourth quarter sales, I will now provide just a brief recap of the numbers. In the fourth quarter, sales were $219.6 million, down 5.4% from $232.1 million for the fourth quarter of fiscal 2007. Same store sales declined 8.6%. Consistent with recent quarters, the sales decrease was a traffic issue as our average transaction size for the quarter was virtually flat with the prior year. From a product standpoint, our three major merchandise categories of apparel, footwear, and hard goods performed within a relatively tight range of one another. Hard goods was just slightly stronger than footwear and apparel. Sales of winterrelated products were particularly softer in the quarter due both to the difficult economy and the lack of cold weather and snow in our markets until the last two weeks of the year when conditions turned very favorable for that product. Commenting on the overall holiday season, the environment was certainly one we would characterize as highly promotional. Not only did we see some of our competitors become very aggressive with their pricing, but we also faced a number of liquidation sales in our markets. For the most part, we were able to hold the line on our pricing, which enabled us to achieve margins for the quarter that we believe compared well to much of the retail world. Our product margins decreased approximately 50 basis points for the quarter. They were down just 25 basis points for the full year. These results in this highly promotional environment reflect our team's ability to provide a broad range of product offerings that deliver tremendous value to our customers, yet maintain healthy margins for our business. During the fourth quarter, we continued to successfully align our inventories to our sales levels. As of the end of fiscal 2008, our total chainwide inventories were down 7.8% from the prior year while operating 18 additional stores. On a per-store basis, inventories were down approximately 11%. On the expense side, our team has worked very hard to increase operating efficiencies and manage costs. During the fourth quarter, we lowered our SG&A expense by $2.6 million. We accomplished this by judiciously reducing our ad spend over the prior year, lowering administrative expenses. and reducing storerelated expenses despite ending the quarter with 18 more stores than the prior year. Additionally, over the course of fiscal 2008, through carefully managed attrition we reduced our companywide fulltime head count by approximately 9% and we continue to align our parttime store labor to sales levels. Store labor is our largest controllable expense, and our team did a terrific job of managing this area throughout the year. Commenting on store growth, we opened nine new stores during the fourth quarter. These stores were in Show Low Arizona; Tooele, Utah; Albuquerque, Carlsbad, and Rio Rancho, New Mexico; Sandpoint, Idaho; Parker, Colorado; and Fontana and Atwater, California. We ended fiscal 2008 with 18 new stores, net of relocations, and a total of 381 stores. In light of the current economic environment, we are taking a more measured approach to store growth in fiscal 2009. While we continue to be in the market for quality store locations and attractive lease opportunities, at this point in time I think it's safe to say we will be opening substantially fewer stores in 2009 than we did in 2008, most likely in the single digits. We are waiting to see some indication of a broader economic recovery before we resume our historical pace of store growth. One benefit of our model is that it allows us the flexibility to open stores quickly once we see the signs of an economic turnaround. Turning now to the current quarter, during the first two months of the first quarter of fiscal 2009, the overall retail environment clearly has remained challenging. Winter product sales, in particular, have been disappointing, which we attribute both to the economy and unfavorable weather comparisons in our markets, particularly in January. Quarter to date, our same store sales are tracking down in the high singledigit range, pretty similar to how we ran in the fourth quarter. While it's hard to get a firm read on our run rate at the moment, given the impact of weather, sales are steady and do not appear to be worsening. In fact, we think our value proposition is allowing us to limit some of the sales downside that many retailers are experiencing. One thing is for certain. We are in extraordinary times, and there's a lack of visibility as to how consumer demand will play out for the remainder of the year. Therefore, we will continue to focus on reducing our cost structure and managing our cash flow as business conditions warrant. This includes carefully managing our inventories, renegotiating store leases where possible, fine tuning our advertising spend, and managing labor costs and capital expenditures. We are also focused on providing longterm value to our shareholders. After giving careful consideration to the uses of our cash flow, our balance sheet, and the current macroeconomic uncertainties, our board of directors determined that it is prudent to reduce our dividend to $0.05 per quarter from $0.09 per quarter. This action will enable us to further reduce debt and is consistent with our objective to utilize our capital to maintain a strong and flexible balance sheet. Based on today's closing stock price, our dividend offered shareholders a yield of approximately 3.7%. Now I will turn the call over to Barry, who will provide more information about the quarter and full year as well as speak to our balance sheet, our capital expenditures, our cash flows, and provide guidance.

[Barry Emerson:]

Thanks, Steve. Our gross profit margin for the fourth quarter was 32.5% of sales compared to 34.1% of sales for the fourth quarter of 2007. The decrease was due mainly to a decline of approximately 50 basis points in merchandise margins and deleveraging of store occupancy costs due to the lower sales levels. Our selling and administrative expense as a percentage of net sales was 29.3% in the fourth quarter of fiscal 20008 versus 28.8% in the fourth quarter of the prior year. The higher rate yearoveryear was due to the deleveraging of expenses as a result of lower sales volume. On an absolute basis, SG&A expense was actually down $2.6 million yearoveryear. As Steve mentioned, this improvement was due to a number of factors, including our ability to effectively reduce our labor expenses through managed attrition. Now, looking at our bottom line, net income for the fourth quarter was $3.6 million or $0.17 per diluted share compared to net income in the fourth quarter of fiscal 2007 of $6.2 million or $0.28 per diluted share. Briefly reviewing our full year results, net sales decreased 3.7% during fiscal 2008 to $864.7 million from $898.3 million in fiscal 2007. Same store sales decreased 7.0% in fiscal 2008 versus the prior year. Net income for fiscal 2008 was $13.9 million or $0.64 per diluted share compared to net income of $28.1 million or $1.25 per diluted share in fiscal 2007. As a reminder, earnings results for fiscal 2008 include the previouslyreported pretax charge of $1.5 million or $0.04 per diluted share recorded in the second quarter to correct an error in our straight-line rent expense, substantially all of which related to prior periods. Turning to our balance sheet, in this challenging business climate, we remain very focused on aligning our inventory with our sales levels. Total chain inventory was $233.0 million at the end of fiscal 2008, which was approximately $20 million below the prior year's level. Looking at our capital spending, CapEx, excluding noncash acquisitions, totaled $20.4 million for fiscal 2008 reflecting expenditures for 18 net new stores, storerelated remodeling, distribution center and corporate headquarters costs, and IT purchases. We currently expect total capital expenditures for fiscal 2009, excluding noncash acquisitions, in the range of $7 million to $9 million. In 2009, we will continue to invest in our infrastructure, but our overall CapEx investment will be below previous years as we expect to open substantially fewer stores in fiscal 2009 than we did in fiscal 2008. From a cash flow perspective, we generated cash flow from operations of $39.5 million for fiscal 2008 compared to $24.7 million for fiscal 2007. The improvement was mainly due to our ongoing efforts to reduce inventories partially offset by lower earnings for the year. We have historically used our operating cash flow for new store expansion, paying shareholder dividends, reducing debt, or repurchasing the company's common stock. To date, under our share repurchase program, in fiscal 2008 we repurchased 600,999 shares for a total of $5.3 million at the end of the year. At the end of the year, we had $14.2 million for stock repurchases under the $20 million share repurchase program authorized in fiscal 2007, fourth quarter. We evaluate the best use of our free cash flow on a quarter-by-quarter basis and, as Steve indicated, in light of the challenges and uncertainties in the current economic environment, our board decided to reduce our quarterly dividend to $0.05 per share of outstanding common stock for an annual rate of $0.20 per share. Our next dividend will be paid on March 20, 2009, to stockholders of record March 6, 2009. We also expect to reduce or discontinue our share repurchases in fiscal 2009. We believe that preserving our capital and maintaining the financial flexibility to pay down debt is the best way to maintain a healthy financial condition, which is increasingly important for companies today. We will continue to reevaluate our strategy throughout the year. In terms of our debt levels, at the end of fiscal 2008 we had $96.5 million in outstanding borrowings compared to $103.4 million at the end of fiscal 2007. As we discussed in detail on our last call, we have a $175 million financing agreement with the CIT Group and a syndicate of other lenders. Covenants under that facility require us, among other things, to maintain a rolling 12month fixed charge coverage ratio of not less than 1

[Operator:]

Thank you, sir. We will now begin the questionandanswer session. (Operator Instructions) Our first question comes from the line of Sean McGowan with Needham & Company.

[Sean McGowan:]

Thank you. A couple of quick housekeepingtype questions and then a bigger one. Barry, what do you think would be a helpful for useful tax rate to use for 2009?

[Barry Emerson:]

I would use 38%.

[Sean McGowan:]

Regarding the timing of the store openings, are there commitments that you already had in place that might skew that opening schedule a little bit more at the beginning of the year than we might otherwise expect?

[Steve Miller:]

No.

[Sean McGowan:]

We should expect it to be backend loaded?

[Steve Miller:]

Reasonably backend loaded. No openings in the first quarter and then roll them out from there.

[Sean McGowan:]

Like a normal pattern, kind of?

[Steve Miller:]

Basically normal, but take note we said there will be substantially fewer openings.

[Sean McGowan:]

Third area, then, managing the costs as well as you did in the fourth quarter there, was there anything in the fourth quarter of 2007 or 2008 that was unusual that might have skewed that or is that a straight comparison there that just says you managed to cut the absolute dollars? Was there anything that was unusually high in Q4 2007 or materially lower that would be a onetime item kind of thing?

[Barry Emerson:]

Really not. There are costs going different directions, obviously, our occupancy costs are up and those kinds of things, but other than just trying to manage the cost structure really carefully, there isn't anything in particular. We've been continuing to benefit from favorable workers' comp experience. But that's just our internal management of those claims, and that would be the only thing that really jumps out at us.

[Sean McGowan:]

With that in mind, how should we look at 2009 then in terms of managing that same line? Should we be looking for flattish numbers there or modest, very slight increases or have you done what you can and there's going to be headwinds?

[Barry Emerson:]

We're certainly not providing full year guidance at this point. We are going to continue the best we can to manage those costs appropriately given the business climate at the time. We're not giving full year guidance at this stage. It really does depend on our sales levels going forward.

[Operator:]

Our next question comes from the line of Mike Baker with Deutsche Bank. Please go ahead.

[Mike Baker:]

Thanks. So my question is on balance sheet issues. The inventory, do we expect that to continue to fall at the same level? I guess it could for the next quarter or two, but then you start to cycle against it in the back half of the year. Should we expect it to flatten out or still be down in this sort of low double-digit range on a per-store basis? Then, I guess related to that, as inventories come down, what does that do to the borrowing base of your revolver? It's a $175 million agreement, but I guess the borrowing base is less than that because you have $96.5 million outstanding and only $52 million left. I am assuming that's because the assets that back it, i.e. the inventories, are down. If the inventories continue to come down, does the borrowing base come down?

[Steve Miller:]

Let me try the first part of the question and let Barry address the second half of your question. We were really pleased with where we brought inventories at the end of 2008. We don't anticipate that level of reduction in 2009 over 2008. We think we had our inventories recently aligned with sales. We're going to continue to watch them carefully and then keep them aligned with sales going forward. I think we're looking at some reductions of inventory yearoveryear but not to the degree that we experienced this past year.

[Barry Emerson:]

On your credit agreement question, certainly the lower your inventory goes the lower your borrowing base goes. Don't forget, as you reduce your inventories you are also reducing your debt. Frankly, on the borrowing base, they only give you  leave it at that. You really got to look at both equations.

[Mike Baker Deutsche Bank:]

So, in other words, the base will come down, but you will be able to generate some cash because your inventories are down so your level of borrowing might not be as high?

[Barry Emerson:]

That's right. That's exactly right.

[Operator:]

Our next question comes from the line of David Magee with Sun Trust Robinson Humphrey, please go ahead.

[Chris Rapple:]

Hi, this is Chris Rapple today on the call for David. You mentioned that there were a number of liquidation sales going on in your space during fourth quarter. I was just wondering where that stands now and if you feel like for now, anyway, that's materially wrapped up or if you think that's going to continue.

[Steve Miller:]

I think the liquidation sales that we experienced in the fourth quarter are mostly wrapped up. Principally Shoe Pavilion stores, Mervyn stores, to the best I know, I think those are done.

[Chris Rapple:]

No big new ones then on the horizon?

[Steve Miller:]

I don't think there are any big new ones that I can speak of at the moment.

[Chris Rapple:]

Then, secondly, I was wondering, we've heard from some others that they've seen relatively good trends in hunting and firearms; and I was wondering if that was your experience as well.

[Steve Miller:]

I think it's pretty well documented firearm sales are up nationwide and we do sell firearms, long guns; we're not in the handgun business. It's certainly been a positive category for us as it has been for most everyone else.

[Chris Rapple:]

You mentioned that hard goods were just a little bit higher than the other categories. Is there anything within that, any other products that were standouts?

[Steve Miller:]

We had a number of categories that performed strongly within the hard goods categories that performed better than others. For competitive reasons, we don't get overly specific about some of our subcategories.

[Operator:]

Our next question comes from the line of Eric Hollowaty with Stephens Inc. Please go ahead.

[Eric Hollowaty:]

Hi, this is Eric on Rick Nelson's behalf. He's traveling. Earlier in the year, you talked about the impact of heelys on your gross margin compression. I was wondering whether you could quantify how much that was in the fourth quarter and what the outlook is for the early part of 2009? As I recall, in the earlier part of 2008, you thought that this would be anniversaring in the third or fourth quarter of 2008. Could you address that, please?

[Steve Miller:]

Heelys was much less on an issue for us in the fourth quarter. It was negative for our sales but less of a hit than it was in the early part of the year. Our margins probably received some benefit from the heelys or roller shoe category in the fourth quarter because we were anniversaring real soft margins of that product fourth quarter of 2007. It's an absolute nonissue for us going forward. Just another item.

[Operator:]

Our next question comes from the line of Bill Dezellman with Titan Capital Management. Please go ahead.

[Bill Dezellman:]

Thank you. Relative to your comment in your opening remarks that sales now appear to be steady and don't appear to be worsening. I guess really three questions around that. Number one, could you expand upon that? Number two, could you reconcile that comment with comps being down in the high single digits? That doesn't quite feel like steadying. I am not understanding your comments very clearly. Then I will come to the third point later.

[Steve Miller:]

I guess steady was a reference to the fact that we comped down 8.6% in the fourth quarter. We're saying we're comping in similar fashion thus far and guiding to a high singledigit comp in the first quarter of this year. So steady meant steady at that level. Certainly not a level we're happy with, so don't interpret steady as being a level that we're pleased with. I think in this difficult environment based on much of what I have heard and read about how others are performing, we feel we're more than holding our own, particularly in our marketplace. I guess my point was we don't see visa our levels of sales performance deteriorating, staying reasonably consistent and certainly we hope that conditions turn more favorable.

[Bill Dezellman:]

Then the third piece of the question that we had is if we understand correctly just looking at the different economies that you participate in, it appears as though you had some of your stores in markets that hit the negative comps very early on in the nationwide economic downturn. I am thinking places in Arizona and Nevada and some of the harder hit California markets. Then, later on, you were negatively impacted by markets in Washington and Oregon, Utah, and probably other markets in California that weren't as hard hit. I guess the question is trying to understand have you seen a mitigation of the rate of decline that you could say fit just across the board on some of those earlier markets that went into a tailspin, or pretty much all the markets still struggling?

[Steve Miller:]

Obviously, we have some areas that at any given point in time are performing better than others. We're not going to get overly specific for competitive purposes. We never have. But I think the general statement I will make is it's pretty challenging in all markets. I don't think some of the markets, whether it's California, Arizona, and Nevada. They're all facing issues today as I think virtually every state in the country is. Maybe some of these markets even have tougher issues.

[Operator:]

Our next question comes from the line of Anthony Lebiedzinski of Sidoti & Company. Please go ahead.

[Anthony Lebiedzinski:]

Good afternoon. Just to clarify as far as the debt covenants, they only kick in if your availability goes below $40 million, is that correct?

[Barry Emerson:]

That's right. On a fixed charge coverage ratio, that's really the only financial covenant that we have. It does not come into play unless our availability slips below $40 million, that's right.

[Anthony Lebiedzinski:]

Have you guys signed any store leases so far for this year?

[Steve Miller:]

We have one certain lease for a store that we'll be opening in the second quarter of the year.

[Anthony Lebiedzinski:]

As far as your CapEx, you gave some guidance there. What's the absolute minimum CapEx that you guys would need to spend in order to keep up the stores and keep up with any IT system upgrades or anything for the corporate office or distribution center? What's the absolute minimum of CapEx?

[Barry Emerson:]

We've given a range of $7 million to $9 million. We could bring that down somewhat. We do want to continue to support the infrastructures of our stores clearly. And we want to be able to take advantage of opportunities on the new store front if they make sense for us. We could bring that down further if we needed to.

[Anthony Lebiedzinski:]

Also, you had some comments that you will further reduce your cost structure. What exactly are you doing to reduce the cost structure? Also, assuming that you only open a handful of stores, can you give us a range as far as where SG&A expense dollars could be for 2009?

[Barry Emerson:]

I'm not going to go to the full year in terms of a guidance at all. What I can do, just because it is contingent upon business conditions. Many of the significant costs that we have are directly related to our level of sales volume. We can't go there until we understand what the future looks like. You know that we have always run a lean business. Some of the larger items that we've commented on before, store labor, advertising, distribution center, administrative. These are all areas that we certainly look at and can continue to look at in 2009 if we need to. Some of the other areas, our interest expense, we expect that to be down significantly this year just because of the lower rates as well as the cash flow and the paydown of debt. We will continue to look at our advertising. We're doing some things on the freight side to be able to source some product that hopefully will save us some freight costs. You have heard us talk about rent renegotiations. We're working hard on that. We're having a fair amount of success there. It's not a material number, but certainly it's going to help us in the 2009. It will help us going forward. Then, various other areas. We're really looking at all areas of the company.

[Anthony Lebiedzinski:]

How many store leases do you have that are up for maturity that year that you could possibly renegotiate those?

[Steve Miller:]

I am not sure I have a precise number. We have a number of leases coming up for renewal or expiration, and we're actively looking at these as opportunities to renegotiate better terms and, as Barry said, we've achieved some savings in this area already. We have a number of ongoing discussions with our landlords and we expect these savings to be helpful in 2009. As Barry said, not overly material to our results. We're excited also that these are going to help our expenses going forward over a number of years.

[Operator:]

Our next question is a followup question from the line of Sean McGowan at Needham & Company. Please go ahead.

[Sean McGowan:]

Thank you. Given the reduction in the planned store openings, what impact will that have on what you show for depreciation and amortization in 2009?

[Barry Emerson:]

I wouldn't expect much of a reduction. We added really a net 18 stores in 2008. We did have some expenditures for our IT department, the DC, and things like that. These costs are going to hit us next year, in 2009, and they'll be offset by retirements and so on. But I wouldn't expect a significant reduction. In fact, I would not model a significant reduction at all.

[Sean McGowan:]

They're amortized straight line, right?

[Barry Emerson:]

Yes.

[Operator:]

At this time, there are no further questions in the queue. I would like to turn it back to Mr. Miller for any closing remarks.

[Steve Miller:]

We appreciate your interest and your joining us today. We look forward to speaking to you on our next call. Have a good day.

[Operator:]

Ladies and gentlemen, that does conclude our conference for today. Thank you very much for your participation. You may now disconnect.