Baby Superstores Q2
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Baby Superstores Q2
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(FOOL CONFERENCE CALL
SYNOPSIS)* By Debora Tidwell (MF Debit)
Baby Superstores <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: BSST)") else Response.Write("(NASDAQ: BSST)") end if %> UNION CITY, Ca., August 28, 1996/FOOLWIRE/ --- Baby Superstores released Q2 earnings last night and held their quarterly conference call this morning. Sales for Q2 increased 59% to $103 million. Comparable store sales were 0.41%. They reported a net loss for the quarter of -$11.7 million or -$0.61 per share. This was well below analyst consensus estimates of a loss of -$0.07 per share.
The company is extremely disappointed with their Q2 results. They are all focused on resolving the operating issues that they indicated were primarily caused by their rapid growth. They stated that they owe it to their shareholders to fix these issues as soon as possible and their management team is dedicated to correcting the situation.
To briefly describe the inventory situation, they have current substantial markdowns during the second quarter predominantly related to price reductions in national and private label apparel and shoes as well as intentional reductions in the variety of products they offer. In addition, in order to transition to a new inventory control system, the company conducted a full chain-wide physical inventory at the end of Q2. This resulted in the reduction in inventory which is reflected in the Q2 financial results. They have taken several corrective measures to insure that this event does not recur.
While they are extremely disappointed with their Q2 performance and will focus heavily on improving internal controls and rectifying the inventory situation, they cannot ignore their ongoing business. Thus they continue to aggressively review all aspects of their operations to improve sales and stabilize their operating margins. These past few months have been difficult for them, but they believe wholeheartedly in the Baby Superstore concept and remain committed to growing their business over the long term. They believe the operating issues they faced are caused largely by their rapid growth and the challenge of managing this growth. While they expect 1996 to be a transition year, they are committed to building a stable platform for their company's future growth.
THE FINANCIAL EFFECT OF THE INVENTORY REDUCTION
In order to transition to a new inventory control system, the company conducted a full chain-wide physical inventory at the end of Q2 1996. The inventory loss as a result of the implementation of the new financial inventory system and related chain-wide physical inventories totalled approximately $12 million at cost. Excluding this charge, gross margin would have been 21.5% for the quarter.
While some amount of the inventory reduction recorded in Q2 may relate to shrinkage or other inventory losses incurred in earlier periods, they are presently unable to determine such amounts, if any, and accordingly have recorded the entire reduction in Q2.
In addition, the company incurred markdowns at cost during Q2 of approximately $9 million, far in excess of any historical quarterly levels. These markdowns were primarily related to price reductions in national and private label Spring and Summer apparel and shoes as well as the SKU reduction initiatives previously announced.
In order to insure that this will not re-occur, they have added key personnel to their loss prevention, internal controls, auditing, and internal audit functions. They have also implemented the new financial inventory control system, improved inventory related security, and are committed to quarterly chain-wide physical inventories until reliability of the new system is insured. In addition, beginning in August 1996, they enhanced their store manager bonus program to include responsibility for the entire store's profitability including gross margin.
DETAILS ON THE FINANCIAL RESULTS
Sales for Q2 were $102.6 million, a 59% increase from sales of $64.5 million in Q2 1995. Sales for the first half of 1996 rose 59% to $209.3 million from sales of $131.8 million for the first half of 1995.
Comparable store sales for Q2 increased 0.4%. There were 37 such stores at July 31, 1996. They include in their comp number only those stores that are older than 12 months and have not expanded or relocated. Comparable store sales were adversely impacted by the effects of opening new stores in existing markets and by efforts to reduce inventory levels. Excluding just 4 cannibalized stores, comparable store sales would have been approximatley 2.5% higher. Comparable store sales for the first half of 1996 increased 4%.
They opened 4 new stores in Q2 -- Denver CO, San Antonio TX, Chesapeake VA, and Tulsa OK -- which was consistent with their previously announced plans, ending the quarter with 68 stores. They ended the quarter with approximaately 2.4 million square feet.
Gross margin was 9.4% for Q2, down from the 28.7% in the same period of 1995. The gross margin decline can be attributed primarily to the inventory reduction previously discussed as well as substantial markdowns of private-label apparel and shoes which did not generate significantly higher sales dollars and had a substantial impact on gross margins in Q2. These markdowns amounted to nearly $9 million at cost.
However, they are successfully selling through this merchandise and are comfortable with their inventory levels as they enter the second half of 1996. The company incurred all markdowns deemed necessary in order to sell through the excess Spring and Summer clothing inventories.
They were sucessful in stabilizing the percentage of sales represented by commodity products for Q1 and Q2 1996. In both quarters, commodities represented approximately 10% of total sales. In addition, gross margins in this category stabilized as well. Gross margin was 18.8% for the first half of 1996, down from 28.8% in the first 6 months of 1995. Excluding the $12 million inventory reduction, the gross margin for the first 6 months of 1996 was 24.7%.
SG&A expenses, which include depreciation, were 27.3% of sales in Q2 1996 as compared to 21.8% in Q2 1995, an increase of 550 basis points. The increase can primarily be attributed to necessary increases in infrastructure in such areas as operations, loss prevention, accounting, inventory control, and merchandising as well as lower than anticipated comparable store sales. SG&A as a percentage of sales for the first 6 months was 24.7% compared to 21.6% in the same period a year ago.
Their operating loss was 17.9% of sales in Q2 1996 as compared to operating income of 6.9% of sales in Q2 1995. The operating loss was 5.9% of sales in the first 6 months of 1996 compared to operating income of 7.2% of sales in the same period of 1995.
Their net loss for Q2 was $11.7 million or $0.61 per share compared to net income of $3 million or $0.15 per share in Q2 1995. The net loss for the first 6 months of 1996 was $8.4 million or $0.44 per share compared to net income of $6.2 million or $0.32 per share in the same period of 1995.
They ended the quarter with an inventory of approximately $87 million, which included approximately $1.6 million of merchandise in transit. Inventory is turning for the chain at more than 3.5 turns. Inventories on a per-square-foot basis were down nearly 25% from Q2 1995 to Q2 1996. They believe that their inventory levels during Q2 1996 were lower than desired levels and potentially contributed to lower than expected comparable store sales results.
They ended Q2 with a very strong balance sheet. They have approximately $95 million in cash, cash equivalents, and marketable securities. All their excess cash funds are kept conservatively invested in short-term cash, cash equivalents, or marketable securities.
They have not executed their bank facility, they simply had a commitment with their bank. They are currently talking with the bank. They have simply not closed on the facility because they did not want to pay non-use fees. So, they do not have an executed bank facility right now. Their inventories and fixtures are completely unsecured, so they have over $100 million of unsecured assets as well as $95 million in the bank. They are working with banks but want to make sure that they don't pay a very high fee on an unused credit line. They are meeting with the bank in September to get a line of credit in place.
OPERATIONAL DISCUSSION
While they have had problems, they cannot ignore their ongoing business. During the quarter they opened 4 new stores. They ended the quarter with 68 stores in 18 states averaging approximately 35,000 square feet. They have opened 10 stores year-do-date, 2 since the quarter ended in Baton Rouge LA and Minneapolis, and are currently on track to open 22 new stores in 1996. Five of these 22 stores will be relocations of existing superstores.
They estimate opening 6-8 new stores each in Q3 and Q4 1996. The typical store costs them, on a net basis, around $1.5 million including the net investment in inventory. They are committed to the 12 stores for this year. As relates to next year, they have 4 leases currently signed and many in a pipeline to be signed. So that is a roughly $18 million commitment and they have $95 million in the bank.
They are also looking at a facility they will probably build in early 1997 in Texas which is a $7 million investment, not including equipment and other costs, which will cut a lot of their cost of distribution out into Texas and Arizona.
On a competitive front, Babies R Us currently has 3 stores in operation, one of which is in the Atlanta market and competes with Baby Superstore. They have been pleased to date with the performance of their stores in this area against the Babies R Us concept. Babies R Us has announced that they expect to open 8 stores in 1996, 3 of which will be in Atlanta and will compete with Baby Superstore.
They are currently operating their new online touch-screen computerized expectant-mother registry in the Atlanta market and they anticipate rolling this new registry out into the chain beginning in the coming months.
The first shipment of Baby Superstore brand diapers has just hit their stores and they are very excited about this new program and the potential for improved margins in the commodities area. They have made considerable progress with their SKU-reduction program and feel that the majority of their efforts in this area have been completed.
In addition, they have successfully sold through the bulk of their Spring and Summer private label apparel inventory. They have also marked down and sold through most of their shoe consolidations. While these efforts have had a substantial adverse impact on their results in the first half, they are comfortable with their assortments as they move into the second half. In fact, they feel their private label design team has done an excellent job in improving their apparel collections. They have upgraded the quality, created more stylish designs, enhanced the cohesiveness, and maintained the value for Baby Superstore customers. They are very excited about the progress they have made in this area. This merchandise is scheduled to be in their stores by Spring 1997.
They are very pleased with the new additions to infrastructure they have made. Their new leaders have already made significant contributions to strengthening the company going forward. They have filled many of the positions they set out to fill this quarter. They presently have their entire operations team intact including 14 district managers, 3 regional managers, and a Director of Operations, and made other infrastructure additions in nearly all areas of the company. They will still add resources to infrastructure on a prudent basis with many of the needed additions already in place, but a few key roles such as the Chief Information Officer which is still vacant.
In the operations department, the Director of Operations is a new position and they have filled it with Greg Treadway from Wal-Mart. The district managers have come from within the company and from other retailers such as Target, Wal-Mart, and Office Depot. They have added a lot of additional buyers to their merchandising department including a person from Gymboree who is heading up the private label program and their domestic label program in clothing. They hired a divisional manager from Wal-Mart who is heading up their hard goods. They recently added a new person who will be joining them in the next couple of weeks, also in the hard goods area and also from Wal-Mart. In their accounting department they have added two controllers, one controller that heads up their Accounting and Financial area and a second one heading up their Merchandising area. They have a totally operating Loss Prevention Department with three people added to travel out to the stores on a daily basis in the three regions they have. They are continuing to look into the MIS area and are actively recruiting a CIO. They are continuing to review all of their distribution center needs and are up to speed there with a director in charge of distribution.
The Director of Operations has been aboard for 3 months now and is making substantial headway. Coming from Wal-Mart as a Wal-Mart District Manager and several other positions at Wal-Mart, Baby Superstore felt that there were a lot of things that Wal-Mart knew about rapid growth and how to control that growth and accountability that was interesting to them. They have been particularly successful at bringing in a lot of people at various levels because of the new director. One of the most fascinating parts to Baby Superstore is the negotiating skills Wal-Mart taught these people in dealing with suppliers and they want to learn a lot about how Wal-Mart does that and by increasing the "Wal-Mart flavor" in their buying department they are confident they can make more contributions to their margin.
For Q3 they estimate comp store sales results to be flat to low-single digit level increases. At the present time they estimate that comparable store sales guidance beyond Q3 will be closer to previous guidance of low to mid single digits.
Regarding gross margins, in light of currently available data, they would estimate that gross margins for the remainder of 1996 will be down at least 150 basis points over 1995 levels. While they believe they will leverage the infrastructure additions as they build more sales into 1997, they continue to expect SG&A expenses as a percentage of salese to be up over historical levels. At the present time they only expect marginal profitability in the second half of the year.
SUMMARY OF PREPARED REMARKS BY THE COMPANY
They know that they have disappointed analysts and shareholders as much as they have themselves and want people to know that they know they can do better. Baby Superstores is taking aggressive measures to rectify the operating issues that they have encountered.
They expect that the district manager program instituted during Q2 will allow for more operational excellence and consistency in their store basis. Basically, this operation will allow them to put accountability at the store level for all measures of profitability and to regularly measure the success of that effort. In general they are aiming to have one district manager for about every 5 stores which will allow very frequent visits to the stores. They are already beginning to see the results of these efforts. Their training programs have been greatly improved as they continue to strategically align their company against compettion. They continue to
be enthusiastic about their efforts in the private label area. They are working hard to position the company to regain their earnings momentum as quickly as possible. They continue to firmly believe in the Baby Superstore concept. They have encountered issues primarily as a result of their rapid growth and are committed to continuing the growth of the company in a controlled and health fashion. Their new store openings continue to be well received and, in fact, their two most recent store openings set back to back, had sensational grand opening results.
They have a very strong balance sheet. With $95 million in cash and cash equivalents, they are poised to continue controlled growth without immediate need to access additional funding.
As a result of their aggressive markdowns, SKU reductions, and other merchandising strategies, their inventories are as well positioned as they've seen in recent history.
They have been able to continue to recruit high quality talented individuals who are excited at the opportunity to bring their fresh new ideas into the company and be part of Baby Superstore's turnaround.
QUESTION AND ANSWER SESSION
The company was asked to talk about what the issue was with the accountants related to the delay in the reported earnings and why, if they are not making a profit now with their current level of business why they are continuing the rapid growth.
The company responded that they put the information out as soon as it was available. They felt an obligation to make absolutely certain that their accountants had fully signed off on everything they were releasing. In terms of the expansion, they don't believe that management has made any decisions as it relates to 1997 and beyond or has announced any changes that relate to 1997 and beyond. Basically they are committed to controlled growth and they've got to make sure that they build their infrastructure so they are comfortable with this growth going forward. How fast they grow has got to be a function of how their new hires become productive and how these initiatives are undertaken. One other issue is that the 22 stores they are opening this year were signed leases and already put-to-bed deals and they felt it was prudent for the company to move forward with these 22 stores.
The company was asked to explain at what point the auditors came in, took a look at the numbers relative to the $12 million inventory loss, and since there was a year-end audit two quarters ago, did $12 million disappear over the last two quarters or was there a new method in place that suggests this $12 million was spread out over a longer period of time. Then, now that the company has these new inventory control procedures in place, what's to suggest that, if there was a shrinkage problem, that the shrinkage problem is going to go away.
The company responded that they did have a complete audit by a Big 6 firm at the end of the year and they do utilize quarterly review procedures in each of their quarters. They got their auditors involved in the normal course and engaged them to do more comprehensive procedures as they did in Q1, in light of the problems they had in Q1. This information took some time to compile and they put the information out on the wires as soon as it was fully available. In terms of how the amount ultimately was recorded, they said that while some of the inventory reduction recorded in this quarter possibly could relate to shrinkage or other inventory losses that they incurred in the earlier periods, they are really unable to determine those amounts and therefore have put the entire adjustment into this quarter.
The company was asked, with regard to the $9 million in markdowns they had in Q2, where the markdowns occurred. The company responded that the majority of the markdowns occurred in their Spring and Summer apparel, both Baby Superstore brand and domestics. The vast majority of the $9 million was in that area. They got overbought in that area, some of the styles they had did not perform properly, and they just had too much inventory and had to liquidate it. They were able to reduce their receipts of Fall and upcoming merchandise lines to what might be a more appropriate sell-through rate. They would like to have a lot more stylish fashions coming in for the Fall and won't be able to see a lot of the results of that until Spring 1997. But they were able to influence a lot of the styles that are coming in through the efforts of their division in soft goods and were able to stop some styles that they knew weren't going to be properly produced and to cut down on the styles that are coming in.
One of the analysts commented that the company "keeps mentioning that the issue is that you are growing rapidly and that the problems relate to this rapid growth. But, you know, there's a lot of great retailing companies that have grown rapidly for many many years. What I am trying to understand here is that this all seems to relate to management. It doesn't seem to relate to the concept, because Toys R Us is doing quite well with the concept. So what is the real issue here in terms of top management? Are you guys really up to the job of building this company?"
The company responded that those issues are going to be discussed by their Board and they have a Board meeting today. Their current feeling is that they are up to the job. As major shareholders, co-founders Jack Tate and Linda Robertson (two of the three people on the conference call in addition to CFO Jodi Taylor) together own over half of the company. They obviously concluded that they need a lot more management from larger companies. If they were to conclude that they need to bring in outside management at the highest levels, they have no problem doing that because it is to their benefit, so all issues are up for review.
One of the analysts stated that he was still "baffled by the $12 million inventory loss and specifically if you can't identify the sources of the loss, how can you change your control systems to solve that problem?"
The company answered that they have called in teams of people to do a complete systemic review for them to make sure that, to the extent that they have any weaknesses in systems, that they were taken care of. The company's focus has been to make sure that they have their arms around loss prevention issues within their stores as they have entered into some of these new urban markets and have new experiences that they previously never encountered.
The analyst came back and said "Let me understand -- the principal amount of the $12 million would be due to loss prevention in the urban markets?" The company responded that they didn't think that was a fair statement. The analyst came back with "In the 4th quarter we had the shortfall because we weren't recording the cost of sales and the letters of credit on your private label and that was a $2.5 million hit. Are some of those issues still flowing into this $12 million or is there another set of issues?" The company said they are not related. The analyst asked the company to state the 3 issues that account for the $12 million and the company indicated that they couldn't do that beyond what they have already given because the answers are not able to be "black and white" quantifiable. The analyst responded that this was the premise of his question, how are they able to redesign the inventory control systems if the company is not able to identify the sources of the problem? The company responded that Deloitte and Touche had sent in their top retail auditors, including people that specialize in this area, and they have examined the improvements in Baby Superstore's retail inventory system and how they operate and it is that type of assurance the company is utilizing to make sure it is going to be accurate.
~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~ * A Fool conference call synopsis represents an effort to highlight the salient points of a conference call and should not be taken as an authoritative accounting or transcription of the entire event. Note: Statements made by a company other than historical information may constitute forward-looking statements for which the company can claim protection under the Safe Harbor Act. Please consult the company's filings with the SEC for information on risk factors which might cause actual results to differ materially from the information contained in these forward-looking statements. * A Fool conference call synopsis represents an effort to highlight the salient points of a conference call and should not be taken as an authoritative accounting or transcription of the entire event. |
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Copyright 1996, The Motley Fool |