November 2007 Archives

On 20 November 2007 Dick's Sporting Goods (DKS) held its third quarter 2007 conference call. Seeking Alpha provided Dick's conference call transcript, which I found invaluable.

The earning release provided the overall framework of information. During the conference call, the company elaborated on the earnings release during its prepared remarks. Later, during the question and answer session, the analysts asked their questions. I did not find too many noteworthy questions, but I did find that the question and answer session provided more general information about the Dick's. I enjoy listening to how ably the executives are able to respond to questions and how they frame their answers. I am impressed by Dick's management, because they are executing against their business plan and because they have a clear vision of how they plan to continue to grow the business.

Third Quarter Results

• Net income was $12.2M, an increase of 57% over the prior year's result of $7.8M;
  • EPS was $0.10, an increase of 43% over the prior year's result of $0.07;
• Net Sales increased 18% to $838.8M with a 7.2%;

• According to the company's press release:

  "Our performance this quarter demonstrates once again how our emphasis on execution, combined with the strength of our business model delivers consistent financial performance. Improved margins, greater efficiencies, the strength of our golf business and strong cash flow continue to drive our earnings increases. As we head into our seasonally largest quarter, our inventory is on plan and our stores are well positioned to deliver solid results," said Edward W. Stack, Chairman and CEO.

Stores

• In first quarter, the company opened 25 Dick's Sporting Goods Stores;

Year To Date Results

• Net Income was $81.9M, an increase of 82% (prior year was $44.9M);
• EPS was $0.71, an increase of 73% (prior year was $0.41);
• Net sales increased 28% to $2,675.8M with comparable sales up 2.3% (or 1.7% adjusting for the shifted retail calendar), additional stores, and the inclusion of Golf Galaxy in the results.

As noted at the outset, please note Golf Galaxy acquisition and its effect on the financial statements.

Current 2007 Financial Outlook

Full Year 2007

• Company increased guidance for the year:
  • Estimated 117 million shares outstanding;
  • EPS $1.29 (prior estimate was $1.24 – $1.25);
  • Revised estimate represents 26% EPS increase over last year;
  • Comparable store sales expected to increase 2.0% (last year was 6.0%); and
  • Company has opened 46 new Dick's Sporting Goods stores and has relocated one Dick's Sporting Goods store, and expects to open 16 new Golf Galaxy stores.

Fourth Quarter 2007

• 119 million shares outstanding;
• Consolidated EPS $0.59 ($0.60 last year);
• Comparable store sales are expected to increase approximately 2.0%, or approximately 2.5%, adjusting for the shifted retail calendar which compares to a 2.0% increase in Q4 last year;
• Plans to open 4 new Golf Galaxy stores.

Quoting from Seeking Alpha's transcript:

I [Edward W. Stack - Chairman and Chief Executive Officer] am pleased to report the results of our third quarter, a quarter in which we have achieved our comp sales guidance and exceeded our earnings guidance. Our performance for this quarter demonstrates once again our emphasis on execution combined with the strength of our business model delivers consistent financial performance. This quarter we generated net income of $12.2 million or $0.10 per diluted share, which is $0.04 above the high end of our guidance on a split adjusted basis and is $0.03 over last year. Higher margins, continued efficiencies in freight and distribution, strong cash flow and the performance at Golf Galaxy all contributed to earnings greater than guidance. Total sales for the quarter increased 18% to $839 million. At Dick's Sporting Goods stores comp sales decreased 2.5%, which is in line with our guidance. Adjusting for the shift in the retail calendar comps sales at Dick's stores declined 1% also in line with our guidance of an 8.9% gain over last year. As a reminder, this quarter's results were affected by the shift in the 2007 retail calendar, which positively impacted quarters one and two and is offset in the third and fourth quarters. In addition, last year's third quarter benefited from some very favorable cold weather that we did not expect to repeat.

During the quarter, we saw increases in our golf, license, and footwear businesses. These gains were offset by declines in cold weather and hunting apparel.

At Golf Galaxy stores, pro forma comp sales decreased 2.7%. Comp sales at Golf Galaxy stores increased 4.7% on a pro forma shifted basis. Our private label and private brand program continues to be an important element of our assortment, and we are on track for these products to represent approximately 15% of sales this year compared to 14.1% in 2006. For competitive reasons, we are no longer to planning to disclose penetration levels on a go forward basis.

By all metrics, the company continues to perform very well. Switching away from quantitative to qualitative observations, the company sounds very well run. The executives on the conference call have a firm command of the facts and fully understand their markets. I have a strong sense that they understand their business extraordinarily well. Having just finished listening to Zale Corporation's (ZLC) conference call, I find the two conference calls an interesting study in contrast.

• Company reiterated again this quarter that its debt attributable to the Golf Galaxy acquisition will be retired by yearend; much of the $147 million has already been repaid;
• Private labels are providing strong wins and there is the opportunity to take private labels from Dick's to Golf Galaxy;
• Company, because of its store locations and products, has not experienced adverse consequences from the weak housing markets;
• Company does not see irrational pricing in its markets, though it noted that Texas Academy is providing strong competition;
• Company reiterated that it will be reducing its advertising in print and increase its advertising in television and direct mail, the direct to consumer marketing;
• Dick's Sporting Goods will continue its 15% new store growth, roughly 40% of the new stores in 2008 will be in new markets and much like 2007, with about half the stores will open in the third quarter with the other half split among quarters one and two.

I found the company's remarks concerning its consumers interesting.

Brian Nagel - UBS

And then final question, just we got... there's been a lot of reports lately from a lot of different retailers who speak to weakness out there in the consumer. You guys are performing very well. As you look at your business even more granularly, have you seen any impact as far as buying patterns from your consumers that suggest that your core customer is more pinched?

Edward W. Stack - Chairman and Chief Executive Officer

We haven't, and I've said this for a number years that our business really travels in a narrower band than the economy as a whole. Based on staying... keeping our business focused on that core athlete and outdoor enthusiast, we are not going to see the lows when the economy is a bit more difficult, but then on the other hand and I'm sure everyone will forget this when the time comes, when the economy turns around, we won't...we don't expect to see the big spike in our business either.

The company made similar comments during its last quarterly conference call, but it was reassuring to see it reiterate that it does not expect to be as adversely affected as many other retailers.

As a repeat of my article on Dick's prior quarter, I remain pleased with the company's progress. Because management is performing well and because there remains plenty of opportunity for expansion, I am a satisfied shareholder.

Disclosure: I am long Dick's Sporting Goods stock.

I listened to Zale Corporation's (ZLC) first quarter conference call on Tuesday 20th of November, read the company's press release, and read Seeking Alpha's transcript.

Before launching into the company's conference call, I will provide highlights in point form from its first quarter earnings release.

I have inserted some spaces for my blog. These spaces might not be necessary, depending on your browser.

• A net loss of $28.4 million or $0.58 per share;
• For the same period last year, the company $26.4M or $0.55 per share;
  • I believe the loss last year included $4.8 million or $0.10 per share because the derivative accounting treatment of its gold and silver contracts;
• Revenues for the quarter ended April 30, 2007 were $377 million compared to $382 million last year, a decrease of 1.3%;
• Comparable store sales for the third quarter decreased 0.4%;
• The sale of Bailey Banks & Biddle was completed on 9 November 2007;
• Cash warranty sales, Bailey Banks & Biddle, increased $9.5 million over the first quarter last year and revenues recognized were $6.1 million less than in the prior year as a result of the change made in the warranty offering; and
• Company has embarked on a $200 million share repurchase program.

I will quote from the Company's press release regarding its forward guidance.

The Company updated its second quarter guidance to reflect the sale of Bailey Banks & Biddle, anticipated share repurchases and sales trend. It now expects comparable store sales of flat to slightly negative. Earnings from continuing operations are expected to be in the range of $1.60 to $1.65 per diluted share. There was an approximate $0.27 reduction in earnings expectations due to the sale of Bailey Banks & Biddle with the remainder of the adjustment being the benefit of any share repurchases offset by the Company's cautious outlook for the Holiday season.

For the full year ending July 31, 2008, the Company now expects earnings per diluted share from continuing operations of $0.86 to $0.91 after adjusting for the Bailey Banks & Biddle sale and the cautious outlook for Holiday. The Company continues to expect the increase in unrecognized revenues on the balance sheet to be approximately $80 - 90 million for the fiscal year which represents approximately $1.00 in future earnings per share before the benefit of any share repurchases.

By looking at Yahoo's chart of Zale's year-to-date stock price, we know that this has not been a banner year for Zale. A couple key questions for me, who has a short position in the stock, are as follows: one, has the company's outlook changed; and two, has the stock fallen enough to represent fair value?

With regard to the first question, I do not see any fundamental changes. Yes, the company sold Bailey Banks & Biddle, but the rest seems to be status quo. Indeed, from Seeking Alpha's transcript, we have the following:

Let me know give you a quick update on our various strategic initiatives in progress to date. The first component of our strategy is the focus on our core mall business. We have identified three key initiatives to drive improvement. The first is a pilot to build a best in class customer experience which we believe can result in significant growth in same store sales. First and foremost in the focus on the customer. Areas of emphasis include product knowledge training and training in consulted selling. Next, are changes in work flow to free up the associates time to spend with the customer. Then, there are product assortment improvements, policy changes and tools to support and overall improved experience. The test is currently live and on track for the pilot stores to deliver increased sales of a trend for holiday.

The second initiative is focused on increasing gross margin through continued growth in direct sourcing, refinements in pricing and improvements in our supply chain strategy to drive cost savings. We also see an opportunity to improve store return by focusing on assortment optimization and gross margin return on investment in space and inventory. This includes a shift in assortment mix toward core diamond summaries, decreasing investment and non-core summaries and a reduction in the gap in SKU count between high volume and low volume stores in the diamond wedding categories.

The third major initiative is a continued emphasis on a return on capitol. This means putting a sharp lens on all real estate decisions and evaluating store-by-store performance based on return on capitol. This focus applies to new and existing stores. We will close stores that are not meeting their cost of capitol and where it is unlikely operational improvement would get it even close to the hurdle. We will also scale back investment in new stores for the Zales and Gordons brands until we have made progress in making operational improvements. Where we will invest is in those brands and formats that produced the highest returns on capitol: Canada, outlets and .com.

Let us take a look at three strategic initiatives. The first initiative on focus on mall business sounds to me a typical blocking and tackling. I do not see anything strategic about running the business with good business practices. In my view, this initiative signals sloppiness on the part of management for past sins. Moving along to the second initiative, again, I think focusing on SKU and supply chain management is just sound business practices. There is nothing extraordinary, nothing new or novel—just more blocking and tackling. And the third initiative of focusing on a return of capital is nothing new or novel either. In fact, I wonder if Zales will scale back at the wrong time. Just as the housing crisis deepens and opportunities present themselves to secure long term inexpensive mall leases, does the company leave because of a temporary dip in consumer spending in the housing affected regions? Indeed, the company references the housing debacle later in the question and answer section of the call.

Betsy Burton

I clearly believe that it is macro. I think if you talk to vendors, we are tracking actually, slightly better than some of our competition. But, clearly mall traffic is down anywhere from 4-6% is what I hear. So, I think clearly, this will be a challenging macro environment, in particular, for mall jewelry. But again, we believe that we have opportunity because of some of the executional issues last year. But, clearly we are feeling the same trend. You know, the Middle American customer has been hit hard by whether it is the housing market bubble, whether it's being overextended in credit in general, the high cost of gas, all of that is hitting our core customer which, you know, let's say income in the $50-$100,000 range. So, clearly it's a phenomenon that is affecting all retailers that have, especially have purchases that are discretionary. Then, on top of that you're fighting for dollars with the iPod and flat screen TVs.

The second question concerning whether the stock price has fallen far enough to represent fair value is more interesting, at least to me. The company has a market capitalization of roughly $1 billion and an enterprise value of about $1.3 billion. Just prior to the question and answer section of the conference call, the company indicated that it expects $125–150 million in operating cash flow. In my view, the company is at or near fair value.

Rather than discussing all the details of the conference call, I am taking a macro view. In short, nothing has fundamentally changed with the company's business model. In the near term, the company will struggle as will many other retailers with the housing debacle. Longer term remains the question: Does the company make substantial changes to its business model over the next few years or will it stay with the status quo?

Given that the stock price has fallen to levels where the stock is now longer a raging short, I must decide what to do next. I am inclined to wait until early in the New Year. Perhaps after the weak retail sales, the share price will be weaker too. Offsetting that is the share repurchase program. I do not see any drivers for creating a substantially lower or higher stock price. Thus, I am inclined to close my short position in the near future.

Disclosure: I am presently short Zale stock.

Slightly over two years ago, I wrote a brief article about a documentary shown on Canadian Broadcasting Corporation (CBC) concerning the kidnapping of Ingrid Betancourt.

I noticed today on the BBC New website an article that Hugo Chavez, the president of Venezuela, might play an instrumental role securing her release.

Mr Chavez repeated his conviction despite the lack of proof that Ms Betancourt, kidnapped in February 2002, was still alive.

"Ingrid is alive. I'm absolutely certain," Mr Chavez said.

"We will do everything humanly possible to achieve (her) release and not only hers, but the release of all the candidates."

Despite my misgivings toward Chavez's leadership of Venezuela, I applaud his work toward freeing Colombian hostages. I hope he is correct that Ingrid Betancourt is alive. According to the article, FARC is supposed to provide evidence by yearend that the hostages are alive. And one can hope that the freeing of the hostages can lead to further improvements.

Given the latest OPEC discussions, I am curious how oil prices, U.S. dollar, and commodities in general will perform on Monday. According to the New York Times article Critics Assail Weak Dollar at OPEC Event (free registration required), Venezuelan President Chavez and Iranian President Ahmadinejad made disparaging remarks toward the U.S. dollar.

“The dollar is in free fall, everyone should be worried about it,” Mr. Chávez told reporters here. “The fall of the dollar is not the fall of the dollar — it’s the fall of the American empire.”

During a news conference after the meeting, Mr. Ahmadinejad added: “The U.S. dollar has no economic value.”

Mr. Ahmadinejad said that oil, which was hovering last week at close to $100 a barrel, was being sold currently for a “paltry sum.” And Mr. Chávez predicted that prices would rise to $200 a barrel if the United States were “crazy enough” to strike at Iran, or even at his own country.

If these two clowns do have an effect within OPEC to switch away from the U.S. dollar, then that might have an adverse effect on the dollar. I also curious if their actions will encourage others to want to diversify their currency holdings. Do Russia, China and other countries make more of a concerted effort to diversify?

I am not sure what to make of this development. However, it does bear watching.

As preparation for this article on Blue Nile, Inc. (NILE), you might wish to review some of my prior articles:

• Impressive First Quarter For Blue Nile;
• Not Paying Attention To The Blue Nile Bears;
• Blue Nile Bull And Bear Square Off; and
• Citigroup Upgrades Blue Nile; and
• Outstanding Second Quarter 2007 For Blue Nile.

To set the stage, I used Yahoo's financial website to pick up the analysts' estimates prior to the conference call.

I updated the table below to reflect actual values and company forward guidance.

As you review and compare the information above to my prior articles, you will note that guidance has gone up, again. Blue Nile is a classic underpromise, overdeliver company.

This most recent quarter's results are strong, indicative of a well managed and growing company. To be honest, I was unsure of the company's performance this quarter. With the housing and energy issues, I was unsure of the company's performance. The company's performance, however, indicates that it is doing well.

From the company's conference call transcript (courtesy of Seeking Alpha):

Analyst for Imran Khan - JP Morgan

A quick question just about holiday sales. Are you expecting non-engagement sales to trend, given the tightening economy? Have you seen any changes in competition domestically from people such as Amazon for holiday season?

Diane Irvine

In terms of holiday trend, I think as we had mentioned in our comments earlier, as we have started the quarter we're seeing very strong momentum so that is great. I think in terms of consumer spending or what you see more broadly, I think we have always said we don't exactly know. I think there's a very strong argument that when you look at engagement, that is less discretionary. I can only point to what we're seeing, which is great strength in the business, even stronger at the beginning of Q4 I'd say than what we saw in Q3. Of course we are taking share, so I think we're a bit different than you see in retail broadly. But I think we feel very optimistic today in that we're well positioned for the holiday season.

In terms of competition, I would really just point to what Mark talked about earlier, that I feel every quarter we get ahead of the competition and really expand our lead. Mark mentioned our international business as being larger than any of the US competitors in terms of engagement online. I think we need to continue to get better and better at what we're doing, which is why we focus so heavily on the customer experience. I think you see that happening.

Similar to my prior article on Blue Nile's last quarter, rather than parsing through the conference call in detail, I am going to provide some quick snippets to give you a sense of how the company is performing.

• Net sales of $67.4 million, an increase of 26.5% over the third quarter of 2006;
• Gross profit grew by 28.4% to $13.4 million, and operating income grew by 67.3% to $3.6 million;
• Net income of $3.0 million and net income of $0.18 per share, representing an EPS growth of 63.6% over the same period last year;
• In Q3, total orders increased 16.3% as compared to a year ago.
• Average selling price per order was $2,093 in the third quarter, up 11% to $1,884 from the same period last year;
• Website traffic growth strong, stronger than it has been during the last couple of years; and
• Sales and merchandise priced above $25,000 grew by over 50%.

Similar to the last quarter's earnings release and conference call, I did not find anything any weaknesses or causes for concern. The company is performing extraordinarily well and is getting bigger and stronger with time. The key consideration is valuation, of course. Let us look at some quick numbers.

The values quoted above will be modified once the company's latest results are incorporated. You should keep in mind that in two to three months the forward P/E will be based upon 2009 earnings, not 2008. If assume 25% growth in earnings for 2008 and 2009, then 2009 earnings will be about $1.60 per share. With the current price of about $80 per share, Blue Nile has about 50 multiple on forward earnings for a company that is growing at 25%. Because the company is still in the early phases of its growth, I think the valuation is very reasonable.

Note that my 25% growth value was arbitrary. The company exceeds 25% growth for many of its metrics. I chose 25% because it was a convenient number that was near the net sales growth this quarter. My guess is that the actual growth rate will be higher.

Blue Nile indicated that it is taking share away from other jewelry retailers. As mentioned in my prior Blue Nile earnings, I believe we are witnessing a transfer of value from the traditional retailers to Blue Nile and its customers. Thus, I am not fussed about the current forward P/E ratio because one, Blue Nile is performing exceedingly well operationally and two, Blue Nile is still a relatively young and relatively small company with plenty of potential growth ahead of it.

According to Yahoo and Short Squeeze there are about 3.36 million shares short, which with a float of 11.25 million shares, means that about 22% – 30% of the shares outstanding are short. That translates into a short interest ratio of about 5 to 8 days. Remember, the short interest ratio is the number of days of average trading to equal the total outstanding short position. Both providers indicate that the number of shares short increased from the prior month's value of 3.46 million shares. While both providers' values are reasonably close to one another in our situation, I find it helpful to check both.

I continue to be an enthusiastic supporter of Blue Nile. Today the S&P is down 1.88% to 1491.72, while NILE is up 9.31% to $81.63. Prior to the second quarter (not third), the price was near $83. The stock price has been volatile during the recent quarter with the price having reached slightly over $100 and falling back to low $70s before bouncing back today to the low $80s.

As stated in my first quarter summary, I do not have a target price for Blue Nile. I continue to monitor the stock. I believe the company is well managed and poised for even greater success. For those that are interested in investing in Blue Nile, I highly encourage you to read the conference call transcript to form your own independent assessment. My enthusiasm for the company and its stock are not a recommendation. You must perform you own independent analysis and make your own independent decisions.

Disclosure: I am long Blue Nile stock, short calls, for a net long position. Please note, I maintain a core long stock position and trade around Blue Nile using both stock and options.

Update

The market closed down today. The Dow fell 360.92 to 13,300.02, a loss of 2.64%; S&P fell 44.65 to 1,475.62, a loss of 2.94%; and Nasdaq fell 76.42 to 2,748.76, a loss of 2.70%. Blue Nile stock closed up $6.83 to $81.51, a gain of 9.15%.

Calgary model Judith Aldama is featured in the photograph above, which is hosted at Flickr. If you click on the picture of Judith, you will be taken to where you can view a larger version and see even more pictures of her.