JOAN - JOANN Inc. (JOAN) Q2 2023 Earnings Call Transcript

JOANN Inc. (JOAN)

Q2 2023 Earnings Conference Call

September 1, 2022 17:00 ET

Company Participants

Ajay Jain - Director of Investor Relations

Tom Dryer - Vice President & Interim Chief Financial Officer

Wade Miquelon - President & Chief Executive Officer

Conference Call Participants

Presentation

Operator

Good day, and thank you for standing by. Welcome to JOANN's Second Quarter Fiscal 2023 Earnings Conference Call. [Operator Instructions]

I would now like to hand the conference over to your speaker for today, Ajay Jain, Head of Investor Relations. You may begin.

Ajay Jain

Thank you, operator, and good afternoon. I’d like to remind everyone that comments made today may include forward-looking statements, which are subject to significant risks and uncertainties that could cause the company’s actual results to differ materially from management’s current expectations. These statements speak as of today, and the company undertakes no obligation to update or revise any forward-looking statements to reflect subsequent events, new information or future circumstances. Please review the cautionary statements and risk factors contained in the company’s earnings press release and the recent filings with the SEC.

During the call today, management may refer to certain non-GAAP financial measures. A reconciliation between GAAP and non-GAAP financial measures can be found in the company’s earnings press release, which was filed today with the SEC and posted on the Investor Relations section of JOANN’s website at investors.joann.com.

On the call today from JOANN are Wade Miquelon, President and Chief Executive Officer; and Tom Dryer, Controller and Interim Chief Financial Officer. During the question-and-answer portion of the call, we’ll also be joined by Chris JOANN’s Executive Vice President and Chief Customer Officer.

I will now turn the call over to Wade for his prepared comments.

Wade Miquelon

Good afternoon. Welcome to JOANN's second quarter fiscal 2023 earnings call. I'd like to begin my comments by acknowledging the recent passing of our Chief Financial Officer, Matt Susz. Matt was a very talented leader who served in a variety of senior financial roles during his 26-year career at JOANN. While Matt passing was devastating, we are very fortunate to have Tom Dryer, our controller and 30-plus year at JOANN veterans studding on an interim basis as a CFO while we undertook the search for a permanent CFO. Thank you Tom for that.

Following our announcement earlier today, I'm very pleased to welcome Scott Sekella, our incoming CFO effective -- role effective September 26. Scott comes to JOANN with the wealth of experience and increasing responsibilities in finance across many diverse organizations, including Ford Motor company, Pfizer and Henkel cracks and most recently at Under Armour. Please join me in welcoming Scott at JOANN team. We're very excited to have him on board and he's an exceptional talent.

I also want to take the opportunity to welcome Mario Sampson to the JOANN leadership team. Mario will oversee the supply chain operations and has held senior roles in companies and logistics planning vision transportation at a variety of national retailers, including Amazon, Unique Industries, Macy's target, most recently at outlet. We're very excited to have Mario on board to help lead JOANN through increasingly complex supply chain environment. And we're confident that Mario will help per store and level of normalcy to our supply chain related to cost as well as lead the supply chain transformation for JOANN into the future.

Regarding Men's trends, as you're aware, there are many cross currents impacting retailers during this earnings season. Geopolitical uncertainty, inflationary pressures and supply chain challenges remain some of the defining issues impacting our customers in the current environment. The recent data points on the economy offer further competition in my long-held view that we are in the midst of a recession.

Both to other discretionary and specialty retailers, however, we tend to get impacted earlier from the economic downturns, but we also tend to recover much faster. That has certainly been the case in previous cycles. I'm also pleased to report that as we enter into a more mature phase in the post-pandemic period, we continue to see strong engagement from both crafting and selling enthusiasts.

Our overall comp trend is strengthening. And as of now, we believe at least at that should be the case for the balance of the fiscal year. Concurrently, our cost outlook is also beginning to show signs of improvement. This favorable revenue and cost dynamic will enable us to generate a high level of free cash flow and pay down debt during the back half.

While I'm encouraged by the steady improvement in our operating performance in recent months, we still remain vigilant given the overall economic environment. The biggest opportunity for JOANN the months ahead is in relation to our cost structure. And over time, we feel that the current economic headwinds will actually help to remedy the supply chain balances and generate significant cost savings for JOANN going forward.

Our organization has absorbed in excess of $100 million of increased supply chain cost and product cost inflation on an annualized basis. We continue to roughly $40 million of unmitigated Section 301 tariffs imposed on goods imported from China. Having said that, we feel that ocean freight cost pressures as well as certain product costs have peaked and they should begin to improve as we head into fiscal 2024.

As I said earlier in my comments, our operating performance has improved since we reported our first quarter results. Recall that we reported our quarterly results in June, our inter-quarter sales trend for Q2 has already shown some signs of improvement. Our cases continue to improve as we ended the quarter with 4 consecutive months of sequential improvement.

During Q2, our revenue declined by 6.8% with total comparable sales decreasing by 6.2%. Our digital business was a significant bright increasing by 2.2% during the quarter and accounting for 12% of our Q2 revenue. Trends for transactions and average ticket both improved on a sequential basis in Q2. Based on a 3-year comparison relative to pre-pandemic level, our sales were slightly positive improved by roughly 400 basis points on a sequential basis from last quarter.

Also encouragingly, while adjusted gross profit declined by 9% compared to last year, increased by 7% compared to pre-pandemic levels in fiscal 2020. Among our merchandising divisions, our own seasonal business was particularly strong in Q2. We finished the season with healthy sell-through of our spring and summer goods, along with encouraging results of early fall and Halloween set. Additionally, a number of our important selling categories was back half of the year ended the quarter with good momentum.

We also continue to see the increase in our average unit retail outpaced an increase in our cost of goods. This is a function of strategic pricing and promotional actions we discussed on our first quarter earnings call. Importantly, the rollout of retail price increases has not come at the expense of incremental units or transactions.

The quality of our inventory is extremely healthy as clean up has been in our recent history. We manage our inventory build in Q2 strategically with an eye on getting in front of any further supply chain disruptions. During the quarter, we pulled forward received the fall and Halloween seasonal inventory in order to optimize the flow of product across a distribution network to better align the demand.

We are already seeing the benefit of that decision in sales. Meanwhile, we're also continuing to invest in basics and other critical categories for the back half of the year. These actions have better positioned JOANN for our crucial holiday selling season.

Recall that on our last earnings call, we mentioned that we would continue to build inventory units in the second quarter while also taking actions to reduce inventory receipts in the back half of the year. We are executing at a high level on these plants and have reduced our back half merchandise receipts by $120 million.

Given these and other actions, we expect to be significantly free cash flow generative through the end of the year. I also take the opportunity to remind investors that our business is highly seasonal and the vast majority of our annualized earnings and cash flow take shape after Labor Day. This seasonal dynamic is an important consideration to keep in mind with respect to our inventory position over the next 2 quarters. By year-end, our inventory cost and inventory units should both decrease materially compared to the fourth quarter of fiscal 2022.

Next, I'd like to discuss the opportunities that lie ahead in addressing our ongoing ocean freight challenges that I previously referenced. Ocean freight costs peaked during the fourth quarter of fiscal 2022. Since then, we've seen sequential improvement in each quarter, and we are seeing continued signs of stabilization in container freight rates. We expect further sequential improvement with ocean freight costs in the back half of fiscal 2023.

As Tom will lay out more detail, we're implementing a wide range of cost reduction efforts and working capital initiatives and have a comprehensive action plan in place to capitalize on lower ocean freight as these headwinds transition tailwinds later in the year.

In the meantime, we're continuing to manage our cash position and balance sheet very carefully. Although we've seen improvement in our sales cadence, our assumptions remain that the macro environment will remain challenging at least through the end of the current fiscal year. There's been no settlement change in our capital allocation strategy or in relation to our store refresh program since our last date in June.

Our Multi brokes distribution center in West Jefferson, Ohio is set to go live in our coming months. This facility will help to improve our operating efficiency and significantly enhance our auto channel growth capabilities. In the weeks and months ahead, I'll have more to share about our various growth initiatives as they go live. Our wholesale partnership with JDM group is going well, and our sales are ramping nicely.

Separately, we made a recent investment in Q combines cutting-edge augmented reality and artificial intelligence technologies with premium art content to allow users to create a very visual on standing work of our. This product is now available online and in our stores with additional information on joann.com.

Well, to conclude, I'm pleased we ended the quarter with momentum and on a more solid foundation than we began. As an organization, with prime for holiday selling season with exciting product assortments heading into the back half of the year. I'm thankful the hard work of the team across the country and what they're doing to navigate through this tough environment.

From those in our store support center in to our distribution center comes and our 20,000 team members in our stores, we remain focused on our customer and all we do and will be an even stronger company from this very hard work.

And with that, I'm going to turn the call over to Tom Dryer for a more detailed overview of our financial performance. Tom?

Tom Dryer

Thank you, Wade, and good afternoon. As Wade mentioned, JOANN's operating performance improved during the latest quarter, and we have strengthened our financial position compared to 3 months ago when we reported our Q1 results.

While the economic backdrop remains pressured, our sales trends have continued to improve. We also have taken concrete steps to lower inventory receipts during the back half of the year. These actions will put us in a stronger position to pay down debt by year-end.

Net sales for our second quarter totaled $463.3 million, a decline of 6.8% compared to last year with total comparable store sales decreasing by 6.2%. Relative to pre-pandemic levels in the second quarter of fiscal 2020, our sales were slightly positive with increased profitability over the same period across all divisions.

Our cadence improved during Q2, and we finished the quarter ahead of our expectations. The trends for transaction count increased on a sequential basis, and we also experienced a 3% increase in average ticket over last year, driven by our recent pricing actions. Our e-commerce business was particularly strong in Q2, growing by 2.2% over last year with an acceleration in growth towards the end of the quarter.

Our gross profit in Q2 was $214.9 million on a GAAP basis, reflecting a 20% decrease from last year. We incurred $27.1 million of excess ocean freight cost during Q2, which was below our internal forecast. Notably, we didn't incur any excess ocean freight cost over the corresponding period last year.

After adjusting for these noncomparable expenses, our gross profit of $242 million declined by 9% compared to the same quarter last year and increased by 7% compared to pre-pandemic levels in fiscal 2020. Our gross margin rate on a GAAP basis was 46.4% in Q2, a decrease of 730 basis points from last year and reflecting a 580 basis point impact from increased supply chain costs, of which the biggest contributor was excess import freight.

After adjusting for excess import freight costs, our gross margin of 52.2% decreased by 150 basis points from last year. We experienced increases in domestic freight expense due to rising carrier rates and fuel costs as well as higher shrink costs related to the start-up of our new multipurpose distribution center located in West Jefferson, Ohio. These negative factors were partially offset by improved pricing efficiency, optimized promotional offers and lower levels of overall clearance markdowns due to improved inventory quality.

Selling, general and administrative expenses increased by 4.7% compared to the second quarter of last year, driven by increased distribution costs of earlier arriving seasonal merchandise. We also incurred incremental costs associated with our new multipurpose distribution center in West Jefferson, Ohio.

Our direct store expenses were slightly lower than the same period last year. And as mentioned previously, we are implementing targeted cost reductions to meaningfully improve our expense outlook for the back half.

Our net loss in Q2 was $56.9 million compared to net income of $5.2 million last year on a GAAP basis. Loss and adjusted EBITDA of $8.9 million compared to income of $23.5 million in the same quarter last year. I want to emphasize the adjusted EBITDA performance in Q2 should be considered somewhat of an anomaly and it should not offer any direct read through on our financial performance or profitability for the remainder of the year.

Based on seasonality, Q2 normally represents our low watermark in relation to our annual sales and profitability. For historical context, we also reported slightly negative EBITDA on an adjusted basis in the second quarter of our pre-pandemic year.

On June 24, we paid our quarterly dividend of $0.11 per share, and we've also declared our upcoming quarterly dividend to be paid on September 23 to shareholders of record on September 9.

Moving on to our balance sheet. Our cash and cash equivalents were $21.5 million at the end of the second quarter. Our long-term net debt was slightly over $1 billion, reflecting a $240.9 million increase over last year. The biggest driver for this increase was the impact of excess ocean freight expenses, which was not affected over the same period last year.

We continue to believe that our long-term leverage target of 2x adjusted EBITDA is achievable. Relative to the prior quarter, our payables to inventory ratio was at a more normalized level of 36% in Q2. We are still planning for $60 million to $70 million of CapEx spending this fiscal year. Our store refresh program remains on track, and we've completed 16 projects built far with another 18 planned for the remainder of the current fiscal year.

As an organization, we are taking a multipronged approach that will enable JOANN to be significantly cash flow generative over the balance of the year. A major priority was to lower our inventory receipts by $120 million, which we have executed upon. This will enable a reduction in net debt planned of a similar or even greater magnitude in the back half.

To reiterate Wade's comments, the inventory build during Q2 was planned as we pulled forward receipts of selected seasonal inventory in order to optimize the products and throughput across our distribution network and to ensure our stores were in stock in time for the peak selling season. These actions were consistent with our fiscal 2023 inventory planning process that we developed many months ago.

As part of our receipt reduction, we've taken a very surgical approach to ensure we can still deliver on our internal sales expectations. These inventory actions should be much better reflected in our year-ending balance sheet. Please keep in mind that the nature of our inventory build during the first half of fiscal 2023 is fundamentally different from what you're currently hearing from many other retailers in relation to excess inventory challenges that, in many cases, were not planned for.

In addition to the seasonal inventory that was pulled forward in Q2, we still had a residual impact from excess import freight costs originated late last year. These costs were embedded in the carrying amount of inventory reported for Q2 as well as in our prior quarter.

In general, we are not challenged by excess inventory issue that would lead to increased or irrational promotional activity during the back half. While we will still see higher inventory levels over last year in our third quarter, this is due to late holiday receipts last year that we will land on time this year. We have a very good handle on our seasonal inventory needs, and we've been deliberate not to overinvest in certain fashion and seasonal merchandise for our fall and holiday selling season.

We also expect very little clearance inventory at year-end. Our inventory remains very clean and clearance represents just 5% of our total inventory. For JOANN, this is a historically low level of clearance inventory. Our plan for clearance inventory is also 5% of total inventory at year-end.

As it relates to our cost reduction plans, we are also taking steps to optimize our store labor hours later this year, in part driven by investments in technology, such as our new POS system and the shifting of some e-commerce orders to our new multipurpose distribution center.

Consistent with the decision to better align our inventory needs with demand, we have the flexibility to adjust store hours across our store fleet and in our distribution network. This reduction in store labor, in addition to the optimization of our ad spend, will be major components of our cost reduction efforts during the back half of the year.

The final piece of our action plan to drive higher levels of free cash flow in the back half involves ocean freight. We have a number of supply chain tailwinds that are already taking shape, including the ongoing relief we're seeing in spot rates from ocean freight carriers.

As Wade mentioned, we expect to see further sequential improvement in relation to excess ocean freight costs over the balance of the year. Excess ocean freight costs are again expected to decline slightly on a sequential basis in Q3.

Based on year-over-year comparisons, we expect a modest increase in excess ocean freight costs in the third quarter versus last year. More importantly, we anticipate that year-over-year comparisons will improve very meaningfully in Q4 and that comparisons are set to improve further in fiscal 2024.

On a cash basis, the improving outlook for ocean freight expenses will be even greater compared to the P&L impact during the back half. On a cash basis, we expect to spend $50 million to $60 million less in total ocean freight costs in the back half of fiscal 2023 compared to last year.

Based on the cumulative level of cash generated by our improving operating performance, targeted cost savings, a less pressured supply chain outlook and our inventory reduction plan, we intend to substantially delever our balance sheet by year-end relative to Q2 levels with the target range in the low to mid $800 million range for net debt.

There are no significant changes in our capital allocation priorities. While we have adopted a very disciplined focus on generating positive free cash flow going forward, we have a sufficient level of liquidity with our balance sheet to continue to make appropriate investments, including in our store refresh program and with our Blue Ocean growth initiatives.

While we do not provide formal sales or earnings guidance for fiscal 2023, overall, we are encouraged by the sequential improvement in our recent sales performance. We do not anticipate we will generate positive comparable sales in Q3. However, we do anticipate further sequential sales improvements as we move throughout the balance of the year.

Apart from working capital improvements, the biggest opportunity for JOANN in the months ahead is regards to our cost structure, both in relation to supply chain as well as product input costs, given the retrenchment of oil and certain commodity prices and the current strength of the dollar relative to many geographies where we source product.

With that, Wade, Chris and I will be happy to take your questions.

Question-and-Answer Session

End of Q&A

Ladies and gentlemen, this concludes today's conference call. You may now disconnect.

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