Cost Plus Inc. (CPWM)

Q3 2008 Earnings Call

November 20, 2008 at 4:30 pm ET

Executives

Barry Feld - President, Chief Executive Officer, Director

Ann Morante - Vice President of Finance

Jane Baughman - Chief Financial Officer, Executive Vice President

Timothy Lester - Vice President, Controller & Principal Accountant

Analysts

Budd Bugatch - Raymond James and Associates

David Weiner - Deutsche Bank

Marion Lee - D.A. Davidson & Co.

Joan Storms - Wedbush Morgan Securities Inc.

Presentation

Operator

Good day ladies and gentlemen and welcome to the third quarter 2008 Cost Plus earnings conference call. My name is Kristin. I will be your operator for today. At this time, all participants are in a listen only mode. We will conduct the question-and-answer session towards the end of this conference. (Operator Instructions). As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the call over to Mr. Barry Feld, Chief Executive Officer of Cost Plus World Market. Please proceed, sir.

Barry Feld

Thank you, Operator. Good afternoon everyone and thank you for joining us to discuss our third quarter results. With me today for the conference call are Jane Baughman, our Executive Vice President and Chief Financial Officer, Ann Morante, Vice President of Finance, and Tim Lester, Vice President, Controller and Principal Accounting Officer.

Following my opening remarks, Jane will discuss the financial results in more detail after which I will make some concluding remarks and then we will open it up for the Q&A portion. But before beginning today’s discussion, I would like to ask Ann to go ahead and read the Company’s Safe Harbor Statement.

Ann Morante

Certain forward-looking statements regarding the Company’s future performance and initiatives will be made during this conference call and will usually be preceded by words such as believe, anticipate, project or expect. Any such forward-looking statements are subject to known and unknown risks and uncertainties that could cause actual results to differ materially from those expressed or implied by these statements.

Examples of such risk factors include, but are not limited to the following. Changes in economic conditions that affect consumer spending, timely introduction and customer acceptance or merchandise offerings, changes in the competitive environment, foreign and domestic labor market fluctuations, interruptions in the flow of merchandise, increases in fuel and transportation costs, currency fluctuations, unseasonable weather, terrorist acts or our nation’s response thereto, a material unfavorable outcome with respect to litigation, claims, or assessments and changes in accounting rules and other regulations. A more complete listing of risk factors is included in Company documents on file with the Securities and Exchange Commission.

Barry Feld

Thank you, Ann.

We are pleased to report our third consecutive quarter of positive customer accounts and conversions despite the further weakening of the economy and one of the few retailers to achieve this bottom-line guidance.

Additionally, we have lowered per store inventories and passed our peak credit borrowings well within our credit line. We attribute this success to our unrelenting focus in commitment to our strategic turn around initiatives. It is important note that our third quarter sales performance was consistent throughout each month of the quarter and that each month stood on its own. Our traffic was steady throughout the quarter and we do not experience the sharp fall off in sales as the quarter progress.

Our same store sales for the month of October were down 3%. The fundamentals of our marketing and merchandising efforts remain the right ones to pursue and are achieving the necessary results by driving more traffic to our stores. Nevertheless, consumers have become increasingly more cautious with their purchases. They are clearly buying less as evidenced by the drop in units per transaction and lower average ticket we are currently experiencing.

At the end of the third quarter, combined accounts payable and credit borrowings were $15 million higher than last down $27 million from the $42 million year-over-year increase at the end of the second quarter. The Company’s seasonal borrowings peaked in November at a $125 million versus the peak of $120 million last year and well within the $200 million credit facility. The Company still maintains ample liquidity and flexibility to complete the turnaround.

Total spending for fiscal 2008 capital project is forecast to be $12 million to $13 million, which complete all the contractual capital commitments in progress since beginning the turnaround. In fiscal 2009, we expect to spend $3 million to $5 million in capital maintenance requirement. By tightly controlling discretionary capital spending we will further improve the Company’s liquidity position.

We also continue our intense focus on inventory management and most significant source in use of cash. Average inventory per stores down approximately 4% at the end of the third quarter and projected to decrease further by fiscal year end. We are now realizing the benefits of productivity improvements begun in the supply chain last year. And opportunities still remains next year at further reduced view count and excess weeks of supply both in the distribution centers and in the stores.

Over the course of the past two and a half years, we have completely refilled our merchandise assortment consistently offering products that are unique, authentic, and affordable. The reintroduction of every day low price points provides our customers with the ability to purchase distinct products from around the world on a limited budget.

During August, the Company’s focus on back-to-school and small space living, offering a variety of products for the dorm room or first apartment including, desks, bookshelves, glassware, stacking mugs, plates and beddings.

In September, the Halloween and Fall [Harbor] Shops launched, replacing the Back-to-School shop in the center of the store. We built on several key successes from last year in the home decorating category and expanded our assortment of Halloween consumables and specialty lines providing a one-stop solution for Halloween decorating and entertaining.

Both the Living Furniture events and the Rug Caravan launched in October performed well despite an increasingly challenging economic environment. We also launched our Fall Line event which included the broad selection of value price and premium lines from around the world. Customer’s response for our Fall line event exceeded both our sales and margin projections.

Our October results continue to demonstrate that when we promote high quality merchandise in an exceptional value our customers due respond. One of the Company’s distinct advantages from its competition is the consumable side of the business. The Company delivered a positive count in consumables during the third quarter driven by success in our Halloween Shop, Fall [Harbor] Shop, and Fall Wine Event. This further illustrates the customers’ willingness continue spending on impulse items as well as holiday entertaining and decorating items when offered at affordable prices.

Additionally, we have continued to expand our assortment of World Market branded products, offering customers high quality food and beverage items at exceptional value. These products are designed to generate incremental sales and repeat business from our loyal customer.

World Market is uniquely positioned to meet the needs of cost-conscious consumers as well as to attract new customers that might have historically shopped at higher end and other specialty retailer. We are a one-stop destination for creative gifts and affordable home decorating and entertaining needs. We have lowered our price points across all of our businesses. We have new lists in all of these merchandise categories, approximately 80% of our skews are now under $20 and 60% around our $10 providing high quality, low costs gifts.

Consumables, gourmet food and wine will represent approximately 45% of our sales during the fourth quarter. World Market brand consumables reinforce brand loyalty at the customers’ home and drives repeat visits in our stores.

The Company’s fourth quarter guidance contemplates the extremely competitive retail environment and today’s adverse economic impact on consumers spending. Additionally, Thanksgiving falls one week later this year in line with the normal ramping of the business for the holiday season and making the sales build even less predictable. However, with less than 20% of sales coming from furniture and 45% of our sales coming from consumables in the fourth quarter, we are well positioned to be the one-stop destination for unique and affordable gifts under $10 and affordable home entertaining and home decorating need.

I will now turn the call over to Jane to review the third quarter financial highlights, after which I will make some concluding remarks before opening up the call for the question-and-answer portion.

Jane Baughman

Thank you, Barry. As a reminder, the Company reports separate results for continuing and discontinued operations in the third quarter of 2007 has been restated to include the 13 stores closed in the first quarter of 2008 as discontinued operations. The income statement included in this afternoon’s press release fairly breaks out the results from continuing and discontinued operations, both for the current year and prior year period. The Company’s balance sheet presentation remains unchanged.

Total net sales for the third quarter of fiscal 2008 were $213 million, a 0.8% decrease from the third quarter of fiscal 2007. Same-store sales for the third quarter decreased 3.4% compared to a 4.3% decrease last year.

Customer count increased 1.9% east and decreased 1.5% in the west primarily due to the California markets. The average transaction decreased slightly to $36.79 or 3.6% below last year. The mix between home and consumables as a percentage of total net sales was 63% and 37% respectively, for the third quarter of 2008 versus 64% and 36% respectively for the third quarter of 2007. The increase in consumables and pure units per transaction were the primary factors in our average ticket reductions.

Year-to-date, net sales of $645.6 million is 3.1% higher than the first three quarters of fiscal 2007. Same-store sales have decreased 0.6% year-to-date versus a 6.7% decreased last year. For the first nine months customer accounts has increased 2% over 2007 level.

Gross profit rate for the quarter was 26.3% versus 28.2% last year by a margin decrease due to a shift in sales mix and residual fuel and currency pressures. While the market did experience a recovery in fuel and currency factors as the third quarter progressed, these costs were still considerably higher than the third quarter of fiscal 2007.

Third quarter SG&A expenses, the percentage of net sales was flat to last year at 36.9%. Included in SG&A expense is a $1.1 million non-cash charge for the write down of assets for five stores. Additionally, advertising expense in store payroll each increased by approximately 30 basis points as the percentage of net sale.

These line items were more than offset by savings achieved from ongoing corporate cost reduction initiative.

Year-to-date, SG&A expense as a percentage of net sales was 36.2% or 10 basis points higher than the first three quarters of fiscal 2007.

Offset to unexpected spending to review the Pier One offer and the store impairment, the year-to-date SG&A percentage would have been 40 basis points lower than the prior year.

Depreciation expense in the third quarter of fiscal 2008 was $8 million compared to $9.1 million for the same period last year. Year-to-date depreciation expense was $25.7 million in fiscal 2008 versus $26.9 million for the first three quarters of fiscal 2007.

Capital investments in the third quarter for 2008 project were $3.2 million versus $7.4 million for 2007 projects.

Third quarter pre-opening expenses of 84,000 was 618,000 lower than the third quarter of fiscal 2007. We opened no new stores during the third quarter versus opening three new stores in the third quarter of last year.

Year-to-date in fiscal 2008, we expect $3.2 million to open 15 stores versus $2.9 million to open 13 stores in 2007.

The third quarter loss before interests and taxes from continuing operations or EBITDA loss of $22.6 million was $3.4 million higher than the prior year.

For the first three quarters of fiscal 2008, the EBITDA loss of $64.3 million is $4.1 million above fiscal 2000, with the cost to respond to the Pier One offer and the non-cash impairment driving the variance.

Net interest expense was $3.7 million in the third quarter of fiscal 2008 compared to a $3.4 million for the third quarter of fiscal 2007. Year-to-date interest expense of $9.9 million compared to $8.2 million on the first nine months of 2007.

Our tax benefits for the nine months ending November 1, 2008 of $1.3 million is the reflection of several discreet tax events and the ongoing effect of maintaining valuation allowance on the deferred tax assets.

The Company’s net loss for the third quarter of fiscal 2008 including discontinued operation was $25.8 million or $1.17 per fully diluted share compared to a net loss of $13.9 million or $0.63 per fully diluted share in the third quarter of fiscal 2007. Through the first three quarters of fiscal 2008, the net loss of $84.4 million or $3.82 per fully diluted share compared to a net loss of $43 million or $1.95 for fully diluted share for the same period in fiscal 2007. Included in the fiscal 2007 results is the $27.4 million income tax benefit. Again, this is important to point out that the comparability of the net loss numbers is dramatically expected by the valuation allowance on the deferred tax assets that were taken in the fourth quarter of fiscal 2007.

Total inventory decreased to $13.8 million or 4.2% to $314.3 million when compared with last year. On a per store basis this represents the 3.9% decrease and gave us great confidence in our ability to reach the previously stated objective of a $25 million inventory reduction or 9% per store by year end.

Accounts payable was $82.7 million versus $81.1 million last year. At the end of the third quarter, there were a $117.4 million in borrowing and $10.4 million in letters of credit drawn under our $200 million revolving line of credit excluding the $50 million accordion feature. Subsequent to the end of the quarter, we reached our peak season of borrowing requirements at $125 million.

In this afternoon’s press release, we have provided our outlook for the fourth quarter of fiscal 2008. The Company expects total fourth quarter revenue in the range of $356 million to $374 million based on the same store sales performance in the range of -1% to -6%. We will open no new stores in the fourth quarter of fiscal 2008.

For the fourth quarter of 2008, the Company is projecting a profit from continuing operations before interest and taxes in the range of $10 million to $18 million versus a comparable profit of $20 million last year. The Company expects depreciation expense in the fourth quarter of $8 million. Capital spending is expected to be approximately $3 million in the fourth quarter which is primarily to complete the 2008 capital projects began earlier this year.

I would like to turn the call back over to Barry Feld for his concluding remarks.

Barry Feld

Thanks Jane.

The entire organization remained tightly committed to our strategic turn around initiatives which will return the Company to profitability over the long term. We believe that we are making significant progress in that direction. We have reversed the multi year decline in customer count by recapturing our loyal customer base through our marketing in remerchandising efforts.

We have increased our conversion rates to a major initiative at the store’s associate level. We will continue intense efforts to drive up the average spend for customer with higher units per transaction. While we anticipate ongoing margin pressure in light of a highly promotional market place, our merchants continue to work diligently with our suppliers to restore our historical profit margin.

Fourth quarter guidance provides for EBITDA in the range of $18 million to $26 million. I want to assure that the Company is able to maintain ample liquidity and flexibility to complete our turn around.

With that I would like to turn the call over to the operator, so we can move on to the Q&A portion of the call.

Question and answer session

Operator

Ladies and gentlemen, (Operator Instruction). Your first question comes from Budd Bugatch – Raymond James and Associates.

Budd Bugatch – Raymond James and Associates

My major question is do you project to be out of the revolver by a year end?

Jane Baughman

Our high end of guidance at the -1% count for the fourth quarter would enable us to pay down the revolver at the end of December. But on the low end, we would not be able to do so.

Budd Bugatch – Raymond James and Associates

Barry, when you look at the sales and conversion rates, any additional color on that that you can give? There is no question that these have become very difficult times and you did not see any drop in traffic after mid September for example?

Barry Feld

No we did not. But our traffic remained quite constant throughout the quarter, while we do not publish the specific conversion rate metrics. We have also seen steady improvements in the conversion rates. Where we continue to see pressure, is we are converting primarily at smaller ticket items as we sell through the metrics we put out there, the consumable business continues to grow. But, there is daily pressure on the higher price point.

Budd Bugatch – Raymond James and Associates

When you are looking forward, do you still see pressure on buyer margin or is it simply the de-leveraging impact or how do you think about that?

Jane Baughman

No. We are still anticipating pressure on buyer margin as we go through the fourth quarter. All of the goods that were purchased for fourth quarter selling were acquired during period where we had the pressures from fuel and the weaker dollar.

Budd Bugatch – Raymond James and Associates

So going into next year, can you quantify for us, should the IMU be helped by lower acquisition cost? Not necessarily from the vendors but certainly getting the goods to you that close cost had rather come down.

Jane Baughman

Yes. If the current dollar levels as well as oil prices are sustained into next year, then yes, we will definitely have a benefit on IMU. I would not speculate at this point how much that would be.

Barry Feld

But I think on of the issues that some of these metrics are so unpredictable at this juncture. But, if the current rates of the cost of oil and fuel and the dollar, as it relates to a lot of the foreign currencies that we use remains at the level it is currently at, we would obviously see good benefit from that.

Budd Bugatch – Raymond James and Associates

Assuming the same kind of promotional environment, my metrics tell me somewhere, I guessed around 500 basis points have improved from acquisition cost things that I am looking at.

Barry Feld

I do not want to speculate, Budd.

Budd Bugatch – Raymond James and Associates

If it were that, how would you treat back the [IMU]? Would you pass it through the customer or would you bank a little bit of it or bank most of it?

Barry Feld

Well, we really held the line on our everyday low price strategy. We took a few selected price increases which we were getting pressure but we would remain quite competitive in terms of our pricing and so I would anticipate a little bit of both. We would take some of it down but where you had opportunity based on the competitive environment to maintain certain price points you would take some benefit there as well.

Operator

Your next question comes from the line of Dave Weiner - Deutsche Bank.

David Weiner - Deutsche Bank

So, just a follow up on that last answer you gave, Barry on, actually I lost my track so let me ask something different.

Barry Feld

The last question, were you talking about if we were starting to get some positive benefit in terms of margin when we actually essentially lower prices could be that much more competitive or will we take that benefit to the bottom line?

David Weiner - Deutsche Bank

Yes, right. Sorry, thanks for reminding me. Two little questions here; so, I assume from your answer then that that the fuel, improvements in currency and fuel from today's trends have not been paid then to 4Q.

Barry Feld

That is correct.

David Weiner - Deutsche Bank

Okay, fair enough. As impairment from this quarter, was that contemplated in the guidance you gave on the second quarter call? Was that part of the guidance? Were you looking for that as impairment?

Barry Feld

Yes, that was contemplated.

David Weiner - Deutsche Bank

That was and do you kind of play any, within the current 4Q guidance?

Barry Feld

Well we do our annual assessment and those five stores were measured throughout the course of the quarter based on our 2007 assessment. So, we do not anticipate any additional activity as it relates to impairment and so we would post holiday and do our full year analysis.

David Weiner - Deutsche Bank

Got you and then last one, you mentioned helping gross margin, maybe it was SG&A some corporate cost savings initiatives. Can you just remind what those are, just broadly?

Jane Baughman

Well, you are seeing the ongoing benefits of the headcount reduction we had earlier this year as well as improvements in supplies and travel and a variety of other line item.

David Weiner - Deutsche Bank

Supplies and travel meaning kind of corporate supplies and travel?

Jane Baughman

No, store supplies.

David Weiner - Deutsche Bank

Store supplies, corporate travel, right okay.

Jane Baughman

We did not have the same experience in the third quarter as we did in the first half with regards to health claims.

David Weiner - Deutsche Bank

Okay, right sorry. And then just one last one; in terms of leases that are up for next year, are there any opportunities there to renegotiate a lower rent?

Barry Feld

Actually, that is a major initiative as you would expect. I am sure that is the case of so many retailers out there but we are in constant communication and follow on negotiation with all of our landlords across the country and anywhere where we have opportunity whether it is because of a tenant within a center that we operate has closed or options that come up where there is opportunities for renegotiation and we are consistently looking at ways to mitigate occupancy cost whenever that opportunity does arrive.

Operator

Your next question comes from the line of Marion Lee - D.A. Davidson.

Marion Lee - D.A. Davidson & Co.

Just few questions; what is the percentage of ownership that would trigger the shareholder right or [poison pill] and my second question, if you could repeat what the current amount available is on your credit facility?

Barry Feld

Yes, it is 15%. If an individual were to exceed 15% that would trigger our [poison pill] and then on our line…

Jane Baughman

It is $75 million. We have the full $200 million available to us at this point. At the peak, we were at 1.5.

Operator

(Operator's Instruction) Your next question comes from the line of Joan Storms - Wedbush Morgan.

Joan Storms - Wedbush Morgan Securities Inc.

Some things I have been hearing from some other companies that potentially benefit margin next year and I am wondering if you guys are thinking the same thing. First is on sort of the cost of good side. We are hearing from the likes of like Pier 1 and Crate and Barrel a little bit. They are working with their vendors and like we saw inflation earlier, you are going to be seeing some deflation and so they are seeing some favorable cost in orderings sort of strain into summer merchandise and then also related to that is on the fuel cost and transportation that is one.

Barry Feld

So, let me address the first one, Joan and that as you know, we begun to turnaround. One of the things that we did quite aggressively was we reconfigured many of our supplier relationships to get back to the smaller longer term suppliers. It is important for us that we have a balanced relationship with these suppliers so they have the opportunity to make money and we have the opportunity to make money and so what we do not want to do in good times or bad is put a disproportionate amount of strain on some of these smaller suppliers which could equate into stabilizing them. That being said, we have worked quite diligently to get cost reductions with many of these valued relationship which has enabled us to roll out our everyday low pricing strategy. As I mentioned on the call with 80% of our store now under $20 and 60% under $10, it is absolutely critical that our suppliers work with us in a very cost-effective manner. So, I do not know if that directly answers your question but I would say we have had this ongoing initiative to work in conjunction with suppliers to really maximize our ability to have low retail and maximize our ability to have acceptable margins along with that.

In terms of fuel cost as we have mentioned earlier, we have not based into our guidance the current trends in fuel cost and I would agree with other retailers that if this price per barrel of oil were to continue and the price for gasoline, diesel, bunker fuel, whichever in case you would be talking about were to continue to decrease, we would obviously get, there will be material benefits in that in terms of certain portions of our cost to good sold from there.

Joan Storms - Wedbush Morgan Securities Inc.

Okay, I guess on just, because the first time we really heard you talk about higher cost of good coming from overseas that is really sort of last quarter and we had heard you talk about it before and then now we are hearing about sort of deflation so that is why.

Barry Feld

But a lot of that was primarily driven by fuel.

Joan Storms - Wedbush Morgan Securities Inc.

Okay. And then the second part is on occupancy. I think you touched on this a little bit that a lot of retailers are talking because people are not opening, retailers are not opening as many stores and pushing back on leases that they have already signed. The developers are having problems getting centers opened, etc. and so when leases come to you, retailers do not have any ability and sort of have the upper hand in negotiations and I was wondering how many leases you have coming up this coming year in '09 and whether you feel that that is favorable for you.

Barry Feld

Well, I do not want to get into specifics, Joan, as it relates to individual leases that are coming up although I think it is an important question. I just do not want to get into that type of detail as it relates to the process but we look at them on a case by case basis and I think it is also good to a degree. While retailers do see this as an opportunity as we did to adjust the occupancy cost, I meant the number of lease centers are owned by REIT. I mean there is only a certain level of flexibility that landlords have as it relates to their own personal liquidity and balance sheet and so where we see opportunity, we are going after it but our expectation is they are going to be dramatic in widespread reduction in occupancy cost simply because I do not think a lot of the landlords around the country in these various, as you know we are not mall based. We are primarily in open centers and power centers and town centers around the country and again we look on it in a case by case basis but I do not see a widespread dramatic decrease in occupancy cost related by rent negotiation because I think they are only going to be able to go so far in this one.

Joan Storms - Wedbush Morgan Securities Inc.

Okay and then can you talk a little bit about what your marketing plans are for holiday this year and also with regards to last year.

Barry Feld

Well, as we talked about in various conference calls, when we set up on the turnaround, we did widespread testing and evaluation of many media vehicles and analyzed our advertising spend and the type of media we would be using to attract both new trial and bring back our existing customer base in each market and settled on principally a use of someday a Todd Magazine type format which we do quite regularly in each market. We also use selectively radio. We have a comprehensive marketing and advertising program as it relates to our internet initiative and other selective PR and media vehicles. So we look at it on a market by market basis and again our principal media which talks to both our existing customer base in new trial in the form of print primarily on Sundays and then supplemented by a variety of other formats that we put out there.

Joan Storms - Wedbush Morgan Securities Inc.

Okay. On spend wise, is it about the same as last year?

Barry Feld

Yes, we typically we are on between 5.5% and 6% of sales on advertising annually.

Joan Storms - Wedbush Morgan Securities Inc.

Also with regards to promotions, can you say anything about what you maybe doing Black Friday or over that weekend?

Barry Feld

Well, I do not want to get into specific but I will simply say that as you were seeing in September, we started to turnaround. We were heavily coupon oriented and we spent the year working ourselves off coupon. We stayed clear of coupons and we really play off of our everyday low price value positioning and so when we talk about promotion, it is really putting extraordinary and unique items out there at value price points that really are exceptional in the market place. So, we drive traffic through the use of everyday pricing and it is built into our margin and our IMUs and retail pricing structure versus couponing or blasting off massive high-low promotional activity at certain points throughout the course of this season.

Joan Storms - Wedbush Morgan Securities Inc.

Okay and then last question, I do not know if you can comment about this at all but it is probably in your guidance. What impacts you might have had about in the Southern California fires, these people that we are talking about that impacting the account?

Barry Feld

No, I mean we have some stores impacted by the fires and certainly Sta. Barbara and then Orange County but Joan as we both know, at any point in time, there is always something in some part of the country that is going to impact some of our stores whether IT in Houston or liquidation event taking place in Ohio and Michigan. So, I really try and stay clear of whether or external events that impact our business because we simply a, have not control over and b, you are always going to have that happening at some place in the country at any given point in time.

Joan Storms - Wedbush Morgan Securities Inc.

Okay, great. Well, thank you. Congratulations on keeping your customer count up.

Operator

(Operator's instruction) At this time, there are no further questions. I would like to turn the call back over to Mr. Feld.

Barry Feld

Thank you, operator. Thanks again for all of your interest and support. We look forward to reporting our fourth quarter activity. We know we are all in challenging and unprecedented time so we wish all of you well in whatever endeavors you are embarking on and we look forward to reporting after we get through the holidays. Thank you very much.

Operator

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Good day.

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