Prospect Capital Corporation
Q1 2015 Earnings Call Transcript

Published: 9 Jun 2015

[Operator:]

Greetings, and welcome to the Pep Boys' First Quarter 2015 Earnings Conference Call. At this time all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions]. As a reminder this conference is being recorded. I would now like to turn the conference over to your host, Joseph Buscaglia, Vice President, Finance. Thank you, Mr. Buscaglia, you may now begin.

[Joseph R. Buscaglia:]

Good morning and thank you for participating in Pep Boys' first quarter fiscal 2015 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 flow. We will then turn the call over to the operator to moderate the question-and-answer session. The call will end by 9.30 Eastern Time. 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 www.investorcalendar.com. For anyone on the webcast who does not have the financial statements, you can access them on our website, www.pepboys.com. I will now turn the call over to John Sweetwood, our Interim Chief Executive Officer. John?

[John Sweetwood:]

Thank you, Joe and good morning everyone. First quarter results were favorable for Pep Boys. This morning I’ll provide some insights into the key drivers that generated those results and then update you on some tactical initiatives that have been in place for the future. Overall revenue was up, costs fell, inventories were reduced and store rationalizations continued. There were also some non-operating benefits which our CFO, David Stern will explain when he takes you through the numbers. During the quarter revenue was driven by comp sales again rising in service, commercial, fleet, tires and digital; and as predicted in last quarter's call, margins have begun to expand in tires, commercial and digital as volume grows. Commercial sales were driven by increased print and digital marketing, to expand the base of customers taking advantage of Pep Boys' unique ability to include tires as part of our product offering. We represent a simpler way for commercial buyers to shop as the parts and tires are available, ordered from, delivered and billed by one supplier. The fleet business has continued to grow at a double-digit rate, as our expanded sales force developed the business from segments, which we had previously not deeply penetrated. The new business is profitably selling bay occupancies and providing needed services to fleets of all sizes across our entire geography. Tires continue to be a success story for Pep Boys as both unit and dollar sales have been consistently growing. Consumers are responding well to the premium branded higher end products, now part of our assortment and the odds are better that we'll have the tires, they want, when they want them as we're moving more inventory from warehouses to the stores. The digital business is both growing sales and expanding margins. The range of products offered is continuing to grow and consumer input is guiding ongoing improvements to simplify navigation of our site to get DIY instructions, and better product information and to schedule service appointments. And each day more of our capabilities are mobile enabled. On the cost side, the revised labor management process implemented regionally last quarter has generated the planned savings. As it’s rolled out nationally we expect to continue to see payroll costs fall and our in-store discount improvement program initiated in the fourth quarter of last year is now generating a 150 basis point reduction. Inventory continues to shrink. Our new replenishment system is putting the right product in the right stores at the right time and what isn't turning fast enough is being rationalized. We've also been successful with clearance sections in the stores to free up funds that would otherwise be tied up in inventory. For the future, capitalizing on our recent success, we're creating new tire hubs within major markets, which will meaningfully increase the speed of delivery to stores. We're simplifying store operations by significantly reducing tasks to generate lower payroll costs and provide associates more time to spend with customers. We’re opening more service and tire centers during the year, continuously refining the model for better returns. And finally, two new Road Ahead markets grand re-open, Denver and Cincinnati, and a reduced investment model will be opening in Baltimore in July. So in summary, sales grew, expenses fell, margins recovered and inventory decreased and we're adding productive new stores. I'd like to personally thank the 18,000 plus associates of Pep Boys for making all of this happen. Thank you very much. I'll now turn the meeting over to our CFO, David Stern.

[David Stern:]

Thanks, John. Good morning everyone. This morning, I will review our results in both the GAAP and line of business basis. The last page of our press release includes financial information in the line of business format. Sales for the first quarter of 2015 were $542.3 million, an increase of $3.4 million or 0.6% from the first quarter of 2014. The increase was driven by an increase in comparable store sales of 0.8% or $4.2 million, partially offset by lower sales at non-comparable locations during the quarter of $800,000. Comparable store service revenue increased by 1.3% and comparable store merchandise sales increased by 0.6%. Gross profit, which includes service payroll warehousing and occupancy costs for the first quarter of 2015 was $133.8 million, an increase of $600,000 or 0.5% from the first quarter of 2014. Gross profit margin remained flat to the prior year at 24.7% of sales. Excluding the impairment charges of $800,000 and $1.2 million in the first quarters of 2015 and 2014 respectively gross profit margin decreased by 10 basis points to 24.8% in 2015. Selling, general, administrative expense rate increased 130 basis points to 22.3% of revenue in the first quarter of 2015. SG&A expenses for the first quarter of 2015 were $120.8 million, a decrease of $6.2 million or 4.9% from the first quarter of 2014. The decrease was primarily due to reduced marketing expense of $5.5 million and lower litigation expense of $4 million. Also during the quarter we sold our rights in leasehold ventures for $10 million. Operating profit for the first quarter was $23.1 million, an increase of $17.1 million from the prior year. The current year includes the $10 million gain on sale of leasehold ventures partially offset by the $800,000 impairment charge. The prior year results included the asset impairment charge of $1.2 million and litigation accrual of $4 million. Income tax expense for the first quarter of 2015 was $8.3 million or an effective rate of 41.2% compared to income tax expense of $1.1 million or 39.5% for the comparable period last year. Net earnings for the first quarter of 2015 were $11.9 million or $0.22 per share compared to net earnings of $1.6 million or $0.03 per share in the first quarter of 2014. These results included the previously referenced gain, impairments and litigation expense. 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 first quarter of 2015. Service center business, which includes labor revenue and installed merchandise, generated revenue of $300.9 million in the first quarter of 2015, an increase of 2.4% or $7 million compared to the first quarter of 2014. This increase was primarily due to higher comparable store sales of 1.9% or $5.5 million and increased sales of $1.5 million from non-comparable locations. Comparable store service revenue increased in both tires by 4% and all other maintenance and repairs, excluding tires, by 0.8%. Service center gross profit was $66.9 million, an increase of $3.1 million or 4.9% from the first quarter of 2014. Excluding impairment charges of $800,000 and $1 million in the first quarters of 2015 and 2014 respectively, service center gross profit as a percentage of service center revenue was 22.5%, an increase of 50 basis points from the comparable period last year. This was primarily due to increased leverage of employee and occupancy costs as a result of increased sales. The retail business generated sales of $241.4 million in the first quarter of 2015, a decrease of 1.5% or $3.5 million from the first quarter of 2014. This decrease was due to lower comparable store sales of 0.5% or $1.2 million and a decline of $2.3 million in sales from non-comparable locations. The retail business generated gross profit of $66.9 million in the first quarter of 2015, a decrease of $2.5 million or 3.6% from the first quarter of 2014. The retail gross margin rate was 27.7%, a decrease of 70 basis points from the comparable period last year, excluding the asset impairment charge of $200,000 in 2014. The decrease in retail gross margin was primarily due to lower product margins, partially offset by lower occupancy and employee cost. I’ll now turn to the balance sheet and cash flow. Cash at the end of the first quarter was $42.2 million, an increase of $4.2 million and $4.4 million from the prior year end and the comparable quarter of last year respectively. Debt net of cash at the end of the first quarter of 2015 was $153.3 million, a decrease of $21.7 million and $13.4 million from the prior year end and comparable quarter of last year respectively. Inventory at the end of the quarter was $651.5 million, a decrease of $5.5 million and $12.1 million from the prior year end and comparable quarter last year respectively. Capital expenditures were $12.3 million and $14.6 million in the first quarters of 2015 and 2014 respectively. Capital expenditures for the first quarter of 2015 in addition to our scheduled store investments, distribution center improvements and information technology enhancements, included investments in new stores along with the ongoing conversion into our Road Ahead format. I will now turn to a review of our key strategic initiatives. The first is to lead and grow our service business through enhanced customer experience, continued expansion of our tire and fleet businesses and new service and tire centers built in the Road Ahead format. Our second key initiative is to transform our store experience with the physical remodel and associate training program of the Road Ahead. The Road Ahead initiatives have been completed in the Tampa, San Francisco, Boston, Charlotte, Denver and Cincinnati markets. Construction in Baltimore, which will be our first full market test of our reduced investment Road Ahead remodel will be completed in the second quarter. As of the end of the first quarter, 97 stores or 12% of our 803 locations were in the Road Ahead format. The third key initiative is to significantly grow our digital business in both service and retail. During the quarter, digital sales, which includes service appointments and retail sales, continued to grow at a strong rate, up 49% for the quarter and represented 6% of total sales. The fourth key initiative is to accelerate the strength we’ve seen in the commercial business through emphasizing our unique ability to include tires as part of this offering, refining our commercial specific website and introducing a commercial specific loyalty program. As we’ve previously announced we are in receipt of a notice of nomination from a shareholder that it intends to nominate director candidates for election to the Pep Boys Board of Directors at our 2015 Annual Meeting of Shareholders. For more information on this matter we refer you to the definitive proxy that was filed with the SEC on June 3, 2015. We will not be commenting further on this matter during today’s earnings call and we request in the question-and-answer period to remain focused on our results. With that, I’ll now turn the call over to the operator to begin the question-and-answer session.

[Operator:]

Thank you. We will now be conducting a question-and-answer session. [Operator Instructions]. Our first question is coming from the line of Bret Jordan, BB&T Capital Markets. Please proceed with your question.

[Bret Jordan:]

Hey good morning guys.

[John Sweetwood:]

Good morning.

[Bret Jordan:]

Question on the tires, the plus 4 comp how much of that was unit versus dollars?

[David Stern:]

It was a pretty even split between the two, Bret; units were up 1.5% with AUR average price up 2.5% to get to the 4% all-in comp. And we have been pleased with our tire performance. It’s the third quarter of positive comps and we are up quarter to date in Q2 as well. That’s the function of the increased capacity that we’ve got in stores and in market and improved assortment both in-stores and end market. And we are seeing this continued shift that we’ve seen previously toward branded tires and that’s consistent with our Road Ahead initiative. We recently added Pirelli to the line-up and we see this growing development of tire culture within the stores and it’s also a function of our improved online capabilities. So we are pleased with the direction tires have been taking.

[Bret Jordan:]

I guess since you mentioned what you are seeing quarter-to-date in tires, could you give us little bit more color on what you are seeing quarter to date across the board?

[David Stern:]

Across the board we are seeing as a little bit weaker quarter-to-date than what we report -- than the 0.8% comp increase for Q1 and I am talking about not tires, for across the business.

[Bret Jordan:]

Okay. And then in Road Ahead I guess since you have got a number of stores could you talk about various markets volatility. I guess the performance in Tampa was very strong out of the box I mean some of the markets have been stronger and/or weaker than your average mall, could you give us some feeling for the dispersion in those 97 stores?

[David Stern:]

Sure and across the 97 stores, with any 97 stores that you look at we do see variability and of course we track it by market, by store, by week and so the operations team is intensely focused on that. We’ve got stores that are doing a little -- I am sorry taking this backup to the market level some markets are performing a little better than the others but all of them are generating acceptable returns. Now one of the interesting things that we want to learn with the Baltimore lower investment model is while these other markets are generating acceptable, they may not be our optimal returns. And so it'll be a test of a lower investment model to see how much of that sales increase we can generate through the enhanced associate assessment and training and a reduced physical investment.

[Bret Jordan:]

What is the dollar value of the lower reduced investments?

[David Stern:]

It varies by store, but it would be round about 350.

[Bret Jordan:]

Okay. Thanks. I've got a few more questions. So I'll get back in queue just so I don’t hog it all on the first one.

[John Sweetwood:]

Got it.

[Operator:]

Our next question is coming from the line of James Albertine, Stifel. Please proceed with your question.

[James Albertine:]

Thanks and good morning everyone. I want to focus more on the retail side if I may. Can you remind us first your split of sales of DIY versus DIFM? And then separately can you articulate, now you focused a lot obviously on Road Ahead and this reduced cost roll out involves risk. Can you help us understand what you're doing on the distribution side? So maybe providing some details as to the shipments you are current supporting each store with, is it per week, you're kind of focused on now is it per pay enhancements, kind of where do you stand there and really what I'm trying to get at here is DIY feels very static in terms of a growing part of the retail side, DIFM a lot more dynamic, how do you get that DIFM side up over time from here?

[David Stern:]

Sure, I'll take these in the order that you asked and you've got a few in there. First was the breakdown of our sales, 55% of our sales are in the service line of business. 34% are DIY and the remaining 11% is commercial. Now comparing us to some of the others our commercial number’s a little bit skewed because, of course, it's 11% of our total business in comparison to trying more accurately look at it as a percentage of our retail business in which case it’s about 25%. Regarding replenishment to the stores and frequency, it varies by the volume of the store and proximity through the distribution center. And so we have some stores that are once a week and we've got a number of stores that are multiple times per week as well. And they're now in the process of testing daily replenishment to a number of stores as well and those, of course those that are closer to the distribution center. Regarding invigorating DIY, yes that has been -- primarily our performance hasn't been strong and there are a few initiatives in place to do that. One is our recently implemented inventory replenishment enhancements that we put in place at the beginning of the year. Two is the rollout of speed shops and again when we look at speed shop we don't look at it as how is that particular portion of the box doing, you really look at it, what is the following effect on DIY. So we've got an inventory assortment enhancement process in place. It hasn't yet rolled out, but that is going to refine our process down to by store, by SKU level of what the appropriate assortment should be and a portion of that would be of course continued down the road with SKU rationalization as well as enhancements within the stores.

[James Albertine:]

Very helpful. Thank you for your detailed answer. As a follow-up, how should we think about, if you think you can kind of parse out your best performing stores in the portfolio, how should we sort of analyze the comparable operating margin goals as it relates to those stores. Obviously there is pure play service, peers [ph] that you have and also retail peers [ph] that are kind of a wide variation of margins. So how do we think about your model in the ideal sense, just forgetting for the moment time to get the entire portfolio there, sort of your go and up margins? And then separately just as a follow-up to the last quarter call, you mentioned the CEO announcement as imminent a few months ago. Is that something we should expect to hear maybe next week at the shareholders meeting or how should we think about that announcement in the near term. Thanks again.

[David Stern:]

Sure. And I'm not sure, I'll take the first part of that question, this is Dave. John will take the second part of that question regarding the CEO search and James I'm not sure I've got your question correct, but as we look at returns across the portfolio, we've got about 800 stores. We don't have stores which would make sense to rationalize now beyond which what we've done. Last year, we've rationalized more stores than we have in any other recent year and so we are pruning the network as appropriate. There are some stores which of course we will shutter when the lease expiration period comes up and as we’ve demonstrated in Q1 that the $10 million sale of leasehold interest and then in Q4 with $20 plus million in sales we’re also open to rationalizing more higher valued owned real estate or in the case of this quarter real estate which we have a long term leasehold interest. As we look at these 800 stores of course we don’t have just the retail business or service business and we’ve gotten both and so we look at optimizing both of those knowing that there is an interaction between the two. And so as we go through network thing that’s how we assess it on a store by store basis, and as we’ve demonstrated our willingness to rationalize where appropriate.

[John Sweetwood:]

Regarding the CEO, I am not sure that we are imminent with -- that we are very close, the process has continued and we are now very close and hope to make an announcement in the not too distant future.

[James Albertine:]

Great, thanks again.

[David Stern:]

Thanks Jamie.

[Operator:]

Thank you. [Operator Instructions]. The next question today is coming from the line of Brian Sponheimer with Gabelli & Company. Please proceed with your question.

[Brian Sponheimer:]

Hi, good morning, guys.

[David Stern:]

Good morning, Brian.

[Brian Sponheimer:]

Just a couple of questions on the Road Ahead. If you can talk about the Baltimore stores and maybe some of the physical differences with 350 store versus the $500,000 stores that have been in the other six markets?

[David Stern:]

Sure, and Brian this is based on we haven’t had a full test of a reduced model investment yet and so the change that we made have been based on both qualitative and quantitative information. In the other Road Ahead we know what the increase in stores have been by line of business. We also get feedback from our associates and from our customers that’s more on the qualitative side. But incorporating this information the difference would be, I will start with the where there is not a difference and that’s in the associate assessment and training. We feel very strong that that’s a critical component of this and we’ve got a lot of positive feedback on the lounge, the significantly larger [Technical Difficulty] with other enhancements in it as well. And the exterior we need to show people that it is a different Pep Boys. Now where there are reductions are internally as far as moving racking, [less] expensive signage that’s being put in place. So it’s more tweaking around the edges but it’s individually small change, a large number of individually small changes and spending a little bit less investment here because we are moving around the plan against to a lower degree, we also have not put the investment in the floor.

[Brian Sponheimer:]

Okay, that’s helpful. It’s been a couple of minutes to talk about the digital side of the house and the potential opportunity that it gets your brand out to potentially younger consumers that maybe looking more to shop via mobile.

[David Stern:]

Sure, we have we are continuing to grow our digital sales at about a 50% year-over-year clip. We put significant marketing into that, the SEM. We are seeing some of the benefits particularly you made the points that some of this is age dependent on service appointments, which we are seeing a lot of pickup in specifically a younger demographic, making online appointments. And that does a couple of things for us. It enables us to obviously capture the sales but it also helps with labor scheduling. The more appointments that we have in place the greater lead time we’ve got to make sure we’ve got the right level of technician, not too high and not too low to service any particular state of business. We’re also seeing an increase in product sales online as we’re offering more and more product via our website.

[Brian Sponheimer:]

All right, thank you. And just one last one, I was a little bit surprised to hear that store rationalization, at least as far as how you guys seeing it has gone, just talk about kind of that decision and also as you see the potential to not renew leases, as you work, let's say calendar '15 and calendar '16, how many of those stores are potentially up for that sort of treatment?

[David Stern:]

Sure, I’ll -- to address the first part of that, I am not sure what I conveyed, but I certainly didn't mean to convey that rationalization is done. I only referred to Q4 activity as well as $20 million plus in sales, Q1 of $10 million sales leasehold interest. Closures of some stores have taken place last year, more than prior years and I meant that to be more indicative of the process that's in place, not a completion of a process.

[Brian Sponheimer:]

Okay. All right. Thank you very much.

[John Sweetwood:]

Thanks, Brian.

[Operator:]

Our next question is coming from -- is a follow-up from the line of Bret Jordan with BB&T Capital Markets. Please go ahead with your question.

[Bret Jordan:]

David, just talking about inventory little bit and we've had a couple of quarters working that number down, you're talking about maybe some more efficient distribution. Where do you see the actual store level inventory, is there product that gets taken out of the network and the dollar per square foot in the box will remain the same and I guess if we think about absolute inventory targets, where do you see the number being?

[David Stern:]

There are a few things going on with inventory Bret. One is the enhanced replenishment and to be honest with you that caused a little bit of an uptick in inventory in Q1, because we rolled out an enhanced inventory replenishment system and what that does, of course, is it take it from the old logic to the new logic, utilizing the new logic anything which is assessed, any SKUs which are assessed as being, as not having enough units in the store, gets an immediate bump, as we purchase that inventory. The down side of that comes later -- the decrease in inventory comes later as the inventory in which your new logic assesses your overstocking is sold through and by definition that's slower moving inventory. So that replenishment system is in place. What in the process is the enhanced assortment which has not yet been rolled out, but we're working through that and that’s again to get the right inventory in the right stores and really selecting not just an assessment of the inventory residing in the store but what inventory should be in a specific store. [indiscernible] continued decreases as we go throughout the year in inventory, so I think we'll continue to see some of these benefits. There is some rationalization of parts and we'll also see some clearance of older product as well.

[Bret Jordan:]

Okay. And I guess when we look at tires and your shift to branded tires that would be inflating the inventory value, I guess, what's the mix of brand versus house, the Futura and Definity versus what you're selling for Michelin and Pirelli?

[David Stern:]

At a higher level, if we just thought branded for a minute, we've got 60%-65% is branded. Within that the house brands are now less than 20%.

[John Sweetwood:]

And the shift that we've seen toward branded is really consistent with what we've been seeing quarter-over-quarter and consistent with the Road Ahead initiatives that we've discussed.

[Bret Jordan:]

Okay. And then one last question, you mentioned fleet growth double-digits, what percentage of service is now fleet?

[David Stern:]

I don't have that in front of me, Bret. I'll get back to you with that.

[Bret Jordan:]

All right. Thank you.

[David Stern:]

Thanks Bret.

[Operator:]

Thank you. At this time, we've reached the end of our question-and-answer session. I'll turn back the floor to management for closing comments.

[John Sweetwood:]

Well, I appreciate your time and questions and as usual we will be available to take questions after the call. Thank you.

[Operator:]

Thank you. This concludes today's teleconference. You may disconnect your lines at this time. We thank you for your participation.