Prospect Capital Corporation
Q2 2015 Earnings Call Transcript

Published: 9 Sep 2015

[Operator:]

Greetings, and welcome to the Pep Boys' second quarter 2015 earnings conference call. [Operator Instructions] It is now my pleasure to introduce your host Mr. Joe Buscaglia, VP of Finance. Thank you, sir. You may begin.

[Joseph Buscaglia:]

Good morning, and thank you for participating in the Pep Boys second quarter fiscal 2015 earnings conference call. On the call with me today are Scott Sider, 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, Scott will provide opening comments regarding our results and on 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

[Scott Sider:]

Thank you, Joe, and good morning. I'm excited to join today's call as CEO for Pep Boys. Before I turn the call over to our CFO, David Stern, to present our quarterly results, I'd like to share some of my thoughts about the company and the opportunities we have as the nation's leading automotive aftermarket service and retail chain. I've been learning much about Pep Boys from our leadership team and have visited over 70 of our stores. We have a great foundation, solid balance sheet, iconic brand, great locations and associates. After Dave update you on our second quarter results, I will provide you with an update on how we plan to gain traction on the initiatives, started under John Sweetwood's leadership, and how the Pep Boys team will expand its leadership position and improve shareholder value. We will differentiate ourselves by focusing on customer and employee satisfaction, expense control through process improvement and topline revenue growth. We will take advantage of being in a strong growth industry that is highly fragmented on the service side, and use our retail footprint and supply chain to help fuel our service growth. Our most significant opportunity is topline revenue growth. We are laying the foundation to create a sales and services culture, focused on maximizing the value of each transaction and building customer loyalty. We expect service, including commercial, tires, equipment, fleet, partnerships and digital sales to lead the way. With respect to our previously announced strategic review process, my only comment is that the process is continuing. Again, there is no set timetable for the process, and we do not intend to disclose or comment on further developments regarding our review, unless and until the Board approves a specific action or otherwise concludes its review. I will now turn the call over to our CFO, David Stern.

[David Stern:]

Thank you, Scott. Good morning, everyone. This morning I will review our results under 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 second quarter of 2015 were $526.5 million, an increase of $800,000 from the second quarter of 2014. The increase was driven by an increase in comparable store sales of 0.3% or $1.6 million, partially offset by lower sales at non-comparable locations during the quarter of $800,000. Comparable store merchandise sales increased by 0.5%, while comparable store service revenue declined by 0.4%. Gross profit, which includes service payroll, warehousing and occupancy costs, for the second quarter of 2015 was $127.6 million, an increase of $3.3 million or 2.6% from the second quarter of 2014. Gross profit margin was 24.2% of sales, an increase of 60 basis points from the prior year's quarter. Excluding the impairment charges of $1.7 million and $2.7 million in the second quarters of 2015 and 2014 respectively, gross profit margin increased by 40 basis points to 24.5% in 2015. The selling, general, administrative expense rate decreased 60 basis points to 22.3% of revenue in second quarter of 2015. SG&A expenses for the second quarter were $117.3 million, a decrease of $3.3 million or 2.8% from the second quarter of 2014. The decrease was primarily due to reduced media expense of $2.2 million and lower employee cost of $2.3 million, partially offset by $1.1 million of charges related to our annual meeting and strategic review process. Operating profit for the second quarter was $10.6 million, an increase of $7.3 million from the prior year. The current year includes the impairment charge of $1.7 million, the charge of $1.1 million for the annual meeting expense and strategic review and $300,000 for severance charges. The prior year results included an asset impairment charge of $2.7 million and a severance charge of $800,000. Income tax expense for the second quarter of 2015 was $2.9 million or an effective rate of 38% compared to an income tax expense of $800,000 or 130% for the comparable period last year. Net earnings for the second quarter of 2015 were $4.8 million or $0.09 per share compared to a net loss of $300,000 or $0.00 per share in the second quarter of 2014. Year-to-date earnings through the second quarter were $16.7 million or $0.31 per share compared to net earnings of $1.3 million or $0.03 per share over the comparable period last year. I'll now turn to results on the line of business, as opposed to GAAP basis for our service center and retail operations for the second quarter of 2015. The service center business, which includes service labor revenue and installed merchandise, generated revenue of $290.8 million in the second quarter of 2015, an increase of 0.9% or $2.5 million compared to the second quarter of 2014. This increase was primarily due to higher comparable store sales of 0.6% or $1.6 million and increased sales of $900,000 from non-comparable locations. Comparable service center revenue increased in tires by 3.3%, partially offset by other maintenance and repairs, excluding tires, which decreased by 0.9%. Service center gross profit was $63.7 million, an increase of $3 million or 5% from the second quarter of 2014. Excluding impairment charges of $600,000 and $1.4 million in the second quarters of 2014 and 2015 respectively, service center gross profit as a percentage of service center revenue was 22.1%, an increase of 60 basis points from the comparable period of last year, primarily due to increased leverage of employee costs. The retail business generated sales of $235.7 million in the second quarter of 2015, a decrease of 0.7% or $1.7 million from the second quarter of 2014. This decrease was due to flat comparable sales and a decline of sales in non-comparable locations. The retail business generated gross profit of $63.9 million for the second quarter of 2015, an increase of $200,000 from the second quarter of 2014. Excluding impairment charges of $1.1 million and $1.3 million in the second quarters of the current and prior year respectively, retail gross margin was 27.5%, an increase of 20 basis points from the comparable period last year. I'll now turn to the balance sheet and cash flow. Cash at the end of the second quarter of 2015 was $62.4 million, an increase of $24.4 million and $24 million from the prior year and comparable quarter last year, respectively. Debt net of cash at the end of the second quarter was $132.6 million, a decrease of $43.4 million and $51 million from the prior year end and comparable quarter of last year, respectively. Inventory at the end of the second quarter was $636.7 million, a decrease of $20.3 million and $23.9 million from the prior yearend and comparable quarter of last year, respectively. Capital expenditures year-to-date through the second quarter were $22.1 million and $39 million for the first half of 2015 and 2014, respectively. Capital expenditures for the first half of 2015 included, in addition to, our regularly scheduled store investments, distribution center improvements and information technology enhancements; the addition of one Supercenter and the conversion of nine stores to the Road Ahead format in the Baltimore market. With the completion of that market in the lower cost format, we are going to learn from that process before proceeding and do not anticipate more conversions during the year. With that, I'll turn the call back to Scott to discuss our initiatives.

[Scott Sider:]

Thanks, Dave. In the second quarter we drove double-digit sales growth in commercial, driven by our unique ability to offer tires as part of our client offerings. Other key current and go-forward initiatives includes growth in national accounts, e-commerce enhancements, a commercial specific loyalty program, optimize inventory assortment planning and expanding the number of commercial sales markets. Comparable tire sales were up 3.3% for the second quarter. We continue to see strong sales in national brands. We are working on expanding our tire segment by increasing the number of brands and increasing the on-site availability, as we redefine the retail space within the Supercenters. Fleet services increased year-over-year by over 11%, as we continue with our selling strategy at the national, regional and local levels. We expect continued growth in the B2B, vehicle repair and maintenance lines of our business. Additionally, the fleet sales team expansion into new markets will help fuel our continued growth. We will leverage our 800-plus corporately operated stores, which can handle a wide assortment of our customers needs. We are making changes to the store organizational structure. We are combining the management of the retail and service segments at the store level into a single General Manager role. This change is reducing our labor cost as well as improving our customer satisfaction by being able to cross-utilize our employees. Inventory rationalization continues, as we look to reduce overall inventory by eliminating non-core products and reducing assortment. Cost of goods is driving our redefinition of inventory and product mix. We are expanding our CRM efforts in order to make our marketing dollars more productive, as we worry more about our customer's wants and needs. To summarize, our team is focused on improving our customer experience, reducing cost and driving revenue. I want to thank the entire Pep Boys team for their hard work and support. Operator, we will now open the line for questions.

[Operator:]

[Operator Instructions] Our first question comes from the line of [ph] Carolina Jolly with GS Research.

[Unidentified Analyst:]

So as I'm closing on three months since you were named CEO, do you have any thoughts as to what you personally would recommend to the Board, as the best avenue for Pep Boys to pursue i.e. what is Pep Boys? Is it a retail business that maybe can contract out its repair business or do you think you are best equipped to maybe your repair business and sell or contract out, I guess, your retail business?

[Scott Sider:]

I mean, we're operating both a retail and a service business at this point in time. And that's how we're managing the business and I think both of them have significant opportunities.

[Unidentified Analyst:]

Do you think that you would see any -- what would the contracts, I guess, be like when regarding to any of that?

[Scott Sider:]

I'm not sure any -- when is the contract?

[David Stern:]

I'm not sure which contracts you're referring to. I guess, as you mentioned in your call, we've got the retail side of the business and the service side of the business. We have stated previously, we'll continue to focus and lead with the service side of the business. Our new store development is focused certainly stronger towards the service side of the business. Having said that, there is significant opportunity on the retail side as well particularly on commercial, which for us rolls up and is consolidated in the retail side of our results.

[Operator:]

Our next question comes from the line of Bret Jordan with Jefferies.

[Bret Jordan:]

Question on the Road Ahead. And I guess, as we look at the performance that we're seeing across the board and with Baltimore up now, I mean how many of the Road Ahead stores that you have reformatted are hitting the IRR target for that investment? And I guess, to some extent, what was the cost on those Baltimore units? And maybe you cold give us some feeling for that decision to stop Road Ahead conversions at this point?

[David Stern:]

We have grandly opened the Baltimore stores. And as we talked about, they were completed in a lower cost format. We had said early on in this process that we anticipated that as we went through we would learn which aspects of Road Ahead were more impactful. And that was based on qualitative information as well as quantitative information. With that, we put that in place in the Baltimore market. And the cost and they are average $300 to $350, which is about a 40% reduction from the prior Road Ahead remodels. And I give that range, because some stores are just were conducive to that and it takes less construction to complete it. As far as returns on the stores, we have completed a number of stores. In aggregate, they are achieving what we want. And while they may be acceptable, I'm not sure that they are optimal, and that's the logic of going in and having the reduced cost model. However, since we're under the strategic review process, that we talked about previously, we're limiting our capital expenditures. And for the rest of the year, we want to limit the CapEx, as I mentioned, and also get the learnings from the Baltimore market to make sure that what we thought was going to be the outcome are in line with what we actually see and that will influence any decisions going forward.

[Bret Jordan:]

And then, I guess, as we sort of follow-up on that question, as you limit CapEx and a working inventory down, you have feeling for what your net debt position might be at yearend?

[David Stern:]

We haven't disclosed that yet, but we do anticipate a continued reduction in inventory. We've got inventories $23 million lower than it was in the same time last year. And merchandising team has done a lot of work as far as rationalizing that inventory. And we've got a number of products that have been rationalized, meaning they've been taken off of the replenishment system, but they haven't sold through yet, almost by definition those products that are taken, that are rationalized or slow moving. And so we expect to see continued inventory reduction as we move forward through the year.

[Bret Jordan:]

And then one final question on that inventory line. As you focus more on this commercial business and the potential to get national account, is there a level at which you can't take inventory down further, because you need the fill rates and branded parts to satisfy that commercial customer base?

[Scott Sider:]

I mean, there will be a point that that will happen. On the hard parts, there will be a point that we won't be able to take the inventory down, but the selling floor really is where we're focusing on the reduction and we think the biggest opportunity is.

[Operator:]

Our next question comes from the line of James Albertine with Stifel.

[James Albertine:]

Just real quick one, to get your take on sort of the state of the consumer, as you've seen in the most recent quarter and your anticipation kind of looking ahead into back half of this year, if you could answer that maybe, with one eye towards retail and one eye towards service, just kind of what you're seeing general trends?

[Scott Sider:]

I think the actual consumer on both sides, both on the service and retail side, has been relatively good. I mean, obviously, for us, like Dave mentioned earlier, we're focusing more on the service side of the business, but both sides of the business where we see traffic doing well.

[James Albertine:]

Are you still seeing any kind of sort of deferred maintenance cycle flowing through the service side to the extent the consumers are maybe electing to put off non-essential repairs?

[Scott Sider:]

No, I don't see any signs of that at this point.

[James Albertine:]

And from a competitive perspective, just update us on kind of what you're seeing in terms of promotional cadence looking ahead, maybe first on the tire side, and then separately, maybe some insights on more of the hard parts of retail side of business?

[Scott Sider:]

On the tire side now, I would say, looking back, I don't think it's been anything unusual. No more promoting than in previous years. I mean there are some promotions, but no more than in previous times, and that would be a hard part.

[James Albertine:]

And the last question. Just maybe what you're seeing as it relates to opportunities for acquisitions, and whether that's a commentary on multiples that you're hearing or seeing out in the market, or just in terms of the sheer volume or pipeline as you understand it? And I would suspect, and look for you to confirm whether that's mostly service and tire centers that are falling into the M&A camp?

[Scott Sider:]

I mean, for us, we're in a strategic review process, so I really couldn't comment on any of that right now.

[Operator:]

Our next question is a follow-up from the line of Bret Jordan with Jefferies.

[Bret Jordan:]

Quick question, again, following on tire commentary. Did you give the comp dollars versus units? I mean, as you've transitioned to more branded tires there should be some transaction inflation, but could you talk about what you're seeing from a unit volume?

[David Stern:]

We're pleased with our tire performance. This is our fourth consecutive quarter of positive comps. And for each of these last four quarters, our unit volume has been positive. Specifically, in the second quarter, our unit volumes increased by 60 basis points. Our total comp for tires was up 3.3%, so the remaining was the average unit increase of 2.7%, which as you referenced is consistent with our growing trend of being more and more branded.

[Bret Jordan:]

Could you tell us what the percentage of tire mix that was branded was?

[David Stern:]

Yes, it's roughly two-thirds is branded.

[Operator:]

Thank you. Ladies and gentlemen, there are no further questions at this time. I would now like to turn the floor back over to management for closing remarks. End of Q&A

[Scott Sider:]

Well, thank you everyone for calling in. And talk to you soon. Take care.

[Operator:]

Thank you, ladies and gentlemen. This does conclude our teleconference for today. You may now disconnect your lines at this time. Thank you for your participation. And have a wonderful day.