Prospect Capital Corporation
Q4 2014 Earnings Call Transcript

Published: 14 Apr 2015

[Operator:]

Greetings, and welcome to the Pep Boys' Fourth Quarter 2014 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions]. As a reminder, this conference is being recorded. I would now like to turn the conference over to Mr. Sanjay Sood, Chief Accounting Officer for Pep Boys. Thank you, Mr. Sood. You may now begin.

[Sanjay Sood:]

Thank you. Good morning and thank you for participating in the Pep Boys' fourth quarter fiscal 2014 earnings conference call. On the call with me today are John Sweetwood, Interim Chief Executive Officer; and David Stern, Executive Vice President and Chief Financial Officer. The format of the call is similar to our previous calls. First, John will provide opening comments regarding our results and our strategic priorities, and then David will review the financial performance, balance sheet and cash flows. We will then turn the call over to the operator to moderate the question-and-answer session. The call will end by 9.30 AM. Before we begin, I'd like to remind everyone that this conference call is governed by the language at the bottom of our press release concerning forward-looking statements, as well as SEC Regulation FD. In compliance with these regulations, we are webcasting the conference call on investorcalendar.com. For anyone on the webcast who does not have financial statements, you can access them on our Web site, pepboys.com. I will now turn the call over to John Sweetwood, our Interim Chief Executive Officer. John?

[John Sweetwood:]

Thank you, Sanjay. Good morning, everyone. To review fourth quarter performance, I’d like to refer you back to our last quarter’s call and pull out a quote. I said, “Our challenge in the total business now is to scale cost to better match revenue generation. We’ve continued to take cost out of the business while focusing investment in those areas which are generating the best and most immediate returns. Currently, those areas, which are growing most robustly; commercial, fleet, tires and digital are depressing total margins. However, as unit growth continues in those areas, margins are expected to grow as well.” That’s the story of the fourth quarter. Comp sales again rose in service as they did in commercial, fleet, tires and digital. But as predicted, the mix depressed margins and thus operating profit. We also suffered from a number of non-operating expenses and we weren’t able to get cost out as quickly as hoped. But programs were initiated, which are already beginning to generate savings. Dave Stern will take you through the results in detail. To continue with the progress predicted in the quote, what’s the state of the business now with only three weeks left in the first quarter of 2015 and are the desired results being generated from recent areas of focus and investment? The simple answer is yes, they are. Commercial sales are growing at a double-digit rate with refinement of distribution, a commercial specific Web site, a commercial specific loyalty program and our unique ability to include tires as part of the Pep Boys product offering. And margins are expanding as expected. Our bay occupancies are being filled as fleet business is growing also at a double-digit rate, as we better serve and expand our customer base with additional sales personnel and expanded services. Our digital business is both growing sales and expanding margins. We’re striving to capture more than our fair share of business from industry customers who prefer to purchase products on the Internet. We’ve partnered with third-party marketplaces for both product sales and service business. We’re also not only making service appointments easier by offering them online through our Web site but are sourcing a significant part of that business from customers new to Pep Boys, and each day more of our capabilities are mobile enabled. Our inventory is shrinking. It’s been managed more effectively and efficiently with the introduction of a contemporary replenishment process and aggressive rationalization of the slowest moving items, thus generating fast returns and higher gross margin returns on inventory. We’ve implemented a new labor scheduling system to further refine matching staffing to transactions and are seeing immediate expense reductions as well as better serving of our customers. Our tire sales and the associated services are tracking ahead over 5.3% growth reported for the fourth quarter, as we add more premium brands and expand in-store inventory to better serve customers by having the tires they need available when they want them. Following the program initiated to focus on in-store discounts, there has been 130 basis point reduction to-date, which is generating significant monthly savings. And last but certainly not least, the Road Ahead program is proceeding with ongoing refinement to generate meaningful learning, higher returns on investment, increased sales and increased customer counts. So in summary, sales are growing, expenses are falling, margins are recovering and inventory is shrinking and turning faster. 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 on both a GAAP and a line of business basis. The last page of our press lease includes financial information in the line of business format. Sales for the fourth quarter of 2014 were 502.4 million, an increase of 6.7 million or 1.4% from the fourth quarter of 2013. The increase was driven by an increase in comparable store sales of 1.3% or 6.2 million and higher sales at non-comparable locations during the quarter of 500,000. Comparable store sales revenue increased by 5.1% and comparable store merchandise revenue increased by 0.2%. Gross profit, which includes service payroll, warehousing and occupancy costs, for the fourth quarter of 2014 was 99.7 million, a decrease of 4.3 million or 4.2% from the fourth quarter of 2013. Gross profit margin was 19.8% of sales, a decrease of 120 basis points from the prior year. Excluding the impairment charges of 2.3 million and 2.8 million in the fourth quarters of 2014 and 2013, respectively, gross profit margin declined as John referenced by 120 basis points to 20.3% in 2014. The selling, general and administrative expense rate increased 140 basis points to 23.7% of revenue in the fourth quarter of 2014. SG&A expenses for the fourth quarter of 2014 were 118.8 million, an increase of 8.2 million or 7.4% from the fourth quarter of 2013. This increase was primarily due to higher payroll of 3.2 million primarily due to the reversal of short-term compensation accruals in the prior year as opposed to the current year in which those accruals were reversed before the fourth quarter. Other expense drivers were higher media spend of 1.2 million, recruitment fees and severance payments of 1.1 million, increased store selling expenses of 700,000 due to store growth and higher software expenses of 700,000. During the fourth quarter, we assessed the carrying value of the goodwill on our balance sheet and determined that we should reduce that value by 23.9 million and took the related non-cash charge to earnings. Operating loss for the fourth quarter was 28.8 million, a decrease of 22.2 million from the prior year. The current year includes a net charge of 11.9 million comprised of the previously referenced 23.9 million goodwill impairment charge, and a 2.3 million asset impairment charge partially offset by a 14.3 million gain on the sale of properties. The prior year results included an asset impairment charge of 2.8 million. Interest expense for the quarter was 3.6 million in line with or 100,000 below that from last year. Income tax benefit for the fourth quarter of 2014 was 5.7 million or an effective rate of 18% compared to an income tax benefit of 6.8 million or 68% for the prior year. The net loss for the fourth quarter of 2014 was 26.7 million or $0.50 per share compared to a net loss of 3.3 million or $0.06 per share in the fourth quarter of 2013. The net loss for the full year of 2014 was 27.3 million or $0.51 per share compared to net earnings of 6.9 million or $0.13 per share for fiscal 2013. The 2014 results include on a pre-tax basis a net charge of 24.5 million comprised of the 23.9 million goodwill impairment charge, the 7.5 million asset impairment charge, $4 million charge for litigation and a 2.9 million severance charge partially offset by a 13.8 million gain on the sale of properties. The 2013 results included on a pre-tax basis a net charge of 8.7 million comprised of 7.7 million asset impairment charge, $600,000 severance charge and a 400,000 charge to refinance. I’ll now turn to our results on a line of business as opposed to a GAAP basis for our service center and retail operations for the fourth quarter of 2014. Service center business, which includes service labor revenue and installed merchandise, generated revenue of 280 million in the fourth quarter of 2014, an increase of 4% or 10.9 million compared to the fourth quarter of 2013. This increase was primarily due to higher comparable store sales of 3.2% or 8.4 million and increased sales of 2.5 million from non-comparable locations. Comparable service revenue increased in both tires by 5.3% and all other maintenance and repairs, excluding tires, by 2%. The service center gross profit was 48 million, an increase of 5.9 million or 14% from the fourth quarter of 2013. Excluding impairment charges of 1.6 million and 1.8 million in the fourth quarters of 2014 and '13, respectively, service center gross profit as a percentage of service center revenue was 17.7%, an increase of 140 basis points from the same period in the prior year, primarily due to increased leverage of employee and occupancy costs as a result of increased sales. The retail business generated sales of 222.4 million in the fourth quarter of 2014, a decrease of 1.8% or 4.2 million from the fourth quarter of 2013. This decrease was due to lower comparable store sales of 1% or 2.2 million and a decline of 2 million from sales at non-comparable locations. The retail business generated gross profit of 51.7 million for the fourth quarter of 2014, a decrease of 10.2 million or 16.5% from the fourth quarter of 2013. Excluding asset impairment charges of 700,000 and 900,000 in the fourth quarters of 2014 and '13, respectively, the retail gross margin was 23.6%, a decline of 410 basis points from the same period in the prior year. The decrease in retail gross margin was primarily due to lower product margins driven by sales mix, as previously discussed and higher promotions. I’ll now turn to the balance sheet and cash flow. Cash at the end of the fiscal year was 38 million, an increase of 4.6 million from the prior year end. Inventory at the end of fiscal 2014 was 657 million, a decrease of 15.4 million from the prior year end due to our inventory rationalization initiative. Accounts payable, including the trade payable program at the end of the current year 2014, was 358 million, a decrease of 17.8 million from the prior year end. Accounts payable to inventory ratio was 56% compared to 57.4% in the prior year end. Capital expenditures for 2014 were 67.3 million and primarily consisted of the addition of 19 service and tire centers, two Supercenter relocations, the addition of 47 speed shops within existing Supercenters, the conversion of 28 Supercenters and two service and tire centers to the Road Ahead format, remodels in progress and required expenditures for information technology enhancements including our ecommerce initiatives, as well as our standard facility improvements. Capital expenditures for fiscal year 2013 were 54 million. Net proceeds from site sales were 20.2 million primarily related to locations sold in the fourth quarter of 2014. I’ll now shift to a review of our key strategic initiatives. The first is to lead with and grow our service business through enhanced customer experience, expansion of our double-digit growth in the fleet business and new service and tire centers built in the Road Ahead format. Our second key initiative is to transform the store experience with a physical remodel and associate training program with the Road Ahead. The Road Ahead initiatives have been completed in the Tampa, San Francisco, Boston, and Charlotte markets. The fiscal remodels and associate training in the Denver and Cincinnati markets are complete. Denver will grand reopen later this week and Cincinnati will grand reopen in May. Construction in Baltimore, which will be our first full market test of the reduce capital investment or Road Ahead remodel will be completed in the second quarter. As of the end of the fourth quarter, 97 stores or 12% of our 806 locations were in the Road Ahead format. The third key initiative is to grow our digital business in both service and retail. During the fourth quarter, digital sales, which includes service appointments and retail sales, continued to grow at a strong rate, up 43% for the quarter and representing 6% of total sales. The fourth key initiative is to accelerate the strength we’ve seen in the commercial business through emphasizing our ability to include tires as part of the offering, refining our commercial specific Web site and introducing the commercial specific loyalty program. 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 from Brian Sponheimer of Gabelli & Company. Please go ahead.

[Brian Sponheimer:]

Hi. Good morning, John. Good morning, David. How are you?

[John Sweetwood:]

Good morning.

[David Stern:]

Good, thanks.

[Brian Sponheimer:]

David, can you just really quickly go through these one-time items again. I think I caught that – you sold 22.2 million of properties in the quarter and that that was the 14 million gain on sale?

[David Stern:]

That’s correct.

[Brian Sponheimer:]

All right. And can you talk about just the process, where are these properties and how robust is this pipeline for doing – for continuing down this path?

[David Stern:]

Sure. These were three properties that were sold in the fourth quarter. I don’t want to get into specific locations, but they were on the East Coast and on the West Coast. Obviously, you do the math; relocations with that amount, these were highly valued properties. And properties that by any measure other than return on their fair market value were strong properties, but given what their fair market value were made sense to go ahead and rationalize them. And we’ve got – the retail leasebacks was a - [inaudible] sold units. Of the three, one was technically a sales leaseback but I just want to spend a little bit of time because it was an atypical sales leaseback. Typically, you would think of a sales leaseback as being a financing transaction and this was definitely not the case. This was a site that we were going to sell and at the end as we were wrapping up the final details, we were able to negotiate a short-term control of that site. It’s only five years in which we got control. And again, as I mentioned, it’s a strong performing site, so we want it tied up for the period of time that we can. So technically, one of them was a sales leaseback that wasn’t a financing arrangement.

[Brian Sponheimer:]

And the pipeline or the ability to do more of it in 2015?

[David Stern:]

You’ll see some more. And again, it’s difficult to – we’re definitely active and looking at how we should rationalize our store base. It’s hard to give a concrete number to you simply because we need another side of the transaction to complete the deal.

[Brian Sponheimer:]

All right. Just moving along, weaker gross profit at a fairly significant contraction, can you bucket the mix versus a higher promotion as far as what led to that contraction in gross margin?

[David Stern:]

Right. As John had referenced, we had given a lead that margins were going to be difficult in the fourth quarter and that they are in fact recovering in the first quarter. And this is part of what we’ve seen as the shift from – our commercial business is particularly strong. Of course, DIY is higher margins and part of that is just the cyclical shift that we’ve seen and we’re then correcting our expense structure recognizing that shift. And so it was more shift less promotional, but we shouldn’t have that promotional effect in the first quarter.

[Brian Sponheimer:]

All right. And John, can you talk about the tire market in the quarter, what you saw from a volume price competition perspective? And what the effect was, if any, of the implementation of the tariffs?

[David Stern:]

Sure. We had a strong quarter in comps. We were up 5.3 in tires. And that’s our second consecutive quarter of being up in tires. Brian, if you think back a little ways, we used to talk about our maintenance and repair business comping positively, but our tire business comping negatively. We’ve now got both of them comping positively. And we’re exceeding last quarter’s 5.3% comps and this quarter to-date. And that’s a function of we got increased tire capacity in the stores and in market through our hub network, a broader assortment in the stores and in the market. We’re continuing our shift to a branded product, developing a tire culture in the stores and we’ve improved our online capability. So, we feel good about the direction tires are going. Regarding the tariffs, we’re not seeing cost changes from our suppliers and there’s no material impact on the market, and it’s really fundamentally different from the last higher tariff in both a macro and a company specific level. Just starting at the macro level, raw material prices are down to both rubber and oil and also at the macro level, manufacturing is dispersed. There’s more capacity in North America as well as other locations outside of China. And then to bring it down to a company specific level, our assortment has fundamentally changed from what it was last time. And so being much more brand focused, we’re less reliant upon Chinese imports.

[Brian Sponheimer:]

All right, thank you. Last one from me, just update on the search for a permanent CEO?

[John Sweetwood:]

We’re close, down to the finalists certainly. We would expect to be announcing the new CEO in the not too distant future with the normal variables existing of offer made, offer negotiated, offer dealt with. But we’re close and definitely down to the finalists.

[Brian Sponheimer:]

All right, thank you. I’ll hop back in line.

[John Sweetwood:]

Thanks, Brian.

[Operator:]

Thank you. The next question is from Bret Jordan with BB&T Capital Markets. Please go ahead.

[David Kelley:]

Good morning. This is actually David Kelley in for Bret this morning. Just a couple quick questions as well from my end. Just wondering if you would provide a little more color on the inventory rationalization initiatives here, what’s the timeframe we’re looking at? What are your thoughts going forward as far as inventory levels, where you would like to be?

[David Stern:]

Sure. As a base, we’re down 15 million from what we were last year at the end of the year. It’s an aggressive process that the merchandising team is going through. Now it never goes as quickly as we would like it to be, because we go through that rationalization process, we mark certain products to not be on replenishment but of course by the very nature of those products, they are the slower moving products. And so to reap the benefit of that action, we need to sell through that product and then in this case with the requirement not replenish it. So, I think we’re expecting to see sequential improvements throughout the remainder of this year.

[David Kelley:]

Okay, great. Thank you. And then a couple of quick questions on the Road Ahead and maybe if you can just update us on some of the more recent Road Ahead conversions, what you’re seeing on those markets, maybe Boston and San Francisco in particular, now that they had some time post update, what you’re seeing from a traffic standpoint, what some pros and cons, what will be the outperforming areas or the underperforming areas in those markets, that would be great?

[David Stern:]

Sure. With the Road Ahead markets, we’re continuing to see the lift and this lift is taking place across each line of business. We’re seeing an increase in our customer counts but we’re also seeing a skewing of that customer count more along the lines of what I referenced earlier with our tire assortment. Our tires have been skewing more toward branded. We’re seeing a similar demographic shift in our Road Ahead markets. Having said that while we’re pleased with the results of the Road Ahead markets have generated while they’re adequate, I’m not sure that they’re optimal and as we have initiated the full Baltimore remodel with a lower cost structure. Ideally obviously, we continue to see the traffic in sales increases but at a lower cost investment, that’s just focusing on those portions of the Road Ahead remodel that we believe are the most impactful. So while we feel good about that, we want to get the data from that to substantiate what we believe from the Baltimore remodel.

[David Kelley:]

Okay, great. Thank you. And then beyond Baltimore, were you looking at expanding this initiative into incremental newer markets or is this still a wait and see market-by-market see as we go approach?

[David Stern:]

We’re going to continue. Again, the results that we have we haven’t announced the markets subsequent to Baltimore yet but we are going to proceed.

[David Kelley:]

All right, great. Thanks. And then one final question, I will pass along as well, and just want a clarification here on tires at 5.3%, is that the sales comp or the unit comp for the fourth quarter?

[David Stern:]

That is the sales comp.

[David Kelley:]

Okay. And then maybe just a little color on the units as well, that would be great.

[David Stern:]

Yes. Units were relatively flat. We’ve seen that it’s more been in the increased pricing again as we’re shifting the balance of business more towards branded.

[David Kelley:]

All right, great. Thank you.

[David Stern:]

Thanks.

[Operator:]

[Operator Instructions]. The next question is from James Albertine with Stifel. Please go ahead.

[James Albertine:]

Thanks for taking the question and good morning, everyone. Just a quick follow-on to that last question when you said the units were flat and your shift to branded, is that dictated by what you’re seeing in the market, i.e. Chinese tire prices going higher and so therefore people are demanding those less or is this more of a long-term structural mitigation strategy versus being – having a mix that wasn’t optimal before?

[David Stern:]

As John responded, it’s more company specific and that we have expanded our offering to include more branded lines; Michelin and Continental, Pirelli. And again, it’s not just where we’re focusing on those tires, it’s also where we’re going in Road Ahead. It’s really consistently what we’ve been offering. So we think it’s more of a company specific shift versus a macro shift.

[James Albertine:]

I appreciate that color. And apologies, I don’t have my notes in front of me from the last quarter, but did units stay relatively flat as well on a sequential basis or did you see some erosion as prices went up?

[David Stern:]

Yes, units were relatively flat, up slightly, but potentially flat.

[James Albertine:]

Interesting. Thank you. So really what I wanted to ask more about in terms of your capital allocation strategies and you laid out a framework there at the very top of service and tire centers, I noticed your account went a little bit higher in the fourth quarter from third quarter, just some very basic questions. First, service and tire centers, should we understand those to be service and tire only no retail component whatsoever?

[John Sweetwood:]

That’s right using our nomenclature, service and tire centers sometimes we refer to it as SSC [ph] as a service-only-location.

[James Albertine:]

Very good. So what’s the market as you’re seeing from a valuation perspective in terms of acquisition multiples?

[John Sweetwood:]

Our service and tire centers are predominately organic growth. We’ve been very pleased with our new site [indiscernible] aggregate where we’re picking the specific location that we want and developing it in the Road Ahead format.

[James Albertine:]

Understood. And then as it relates to the Road Ahead format, given the progress that you’ve seen, I think we’re now just about a year out, maybe a little bit beyond a year out from when this program initiated in Tampa, if I recall correctly. Within your existing markets and given some of your key public competitors and what they’ve been reporting from a comp sales perspective, how have you been sort of chipping away, if you will, at their outperformance? Is there something discernible that we can point to now that it’s been 12 months with respect to traffic or is there some sort of framework that you can give us. They’re not ideally comping it sounds like but certainly out comping your portfolio average. Just help us with the numbers around that. That was going to be 12% of your portfolio and growing. We imagine it will be positive impactful in future quarters.

[David Stern:]

Right. So as we look at Road Ahead, we’ve said that for any project we require at least a 15% IRR. And so on aggregate, Road Ahead needs – or a specific store needs to comp at about a 13% to generate that IRR. But the fact that we’re continuing to do – you can read into that that we’re achieving at least that. Having said that, we are trying to reduce the aggregate cost of the remodel. So for instance, in Baltimore, we’re remodeling the entire market and really focusing on those areas that are the most impactful. Regarding comps in aggregate, which I think was the first part of your question, if you look at it by service and our service competitors and retail and our retail competitors, and certainly we’ve fallen short on the retail side. Now to do that, there’s several things that we’re doing. One is a heavier focus on commercial, as we’ve talked about. During the quarter, we have implemented a new inventory replenishment system which is really focused on the sales floor, so we expect to see good things out of that, it’s continuing with the speed shops as well and as we go forward enhancing our inventory assortment process.

[James Albertine:]

That’s very helpful. Then last, if I sneak one more in, on ecom, it sounds like it’s a growing but still relatively small part of the portfolio in terms of the needle moving or impactful any time soon. Can you just help us understand what’s the metrics around the ecommerce business and maybe a timeframe as you see it to where that can really start to move the needle from an EPS standpoint? Thanks.

[David Stern:]

Sure, and it’s one of the key initiatives that we’ve got is expanding our digital sales. And when we reported digital both on the service side through appointment scheduling as well as on the retail side through pick up in store or shift to home sales. So it is growing rapidly. It was up 43% in the fourth quarter, so a big increase, but to your point off a relatively small base it now is 6% of our total sales base.

[James Albertine:]

Great. Thanks, again.

[David Stern:]

Thank you.

[Operator:]

Thank you. We have no further questions in queue at this time. I would like to turn the conference back to management for any closing remarks.

[John Sweetwood:]

All right. Well, I appreciate your time, interest and questions and as usual, we’ll be available for a follow-up discussion. Thank you.

[Operator:]

Thank you. Ladies and gentlemen, this does conclude today’s teleconference. You may disconnect your lines at this time and thank you for your participation.