Executives
Tim Ryan – Director of Investor Relations
Darrell Webb – Chairman of the Board, President & Chief Executive Officer
James Kerr – Chief Financial Officer & Executive Vice President
Analysts
Jeffrey S. Stein – Soleil Group
William Armstrong – C. L. King & Associates, Inc.
Anthony Lebiedzinski – Sidoti & Company, LLC
Bill Detulio – Boenning & Scattergood
Mark Mandel – FTN Equity Capital Markets
Jo-Ann Stores, Inc. (JAS) F2Q10 Earnings Call August 26, 2009 5:00 PM ET
Operator
My name is Sara and I’ll be the conference operator today. At this time I’d like to welcome everyone to the Jo-Ann Stores fiscal year 2010 second quarter conference call. All lines have been placed on mute to prevent any background noise. After the speaker’s remarks there will be a question and answer session. (Operator Instructions) I’d now like to turn the call over to Tim Ryan.
Tim Ryan
Welcome everyone to Jo-Ann Stores fiscal 2010 second quarter conference call. In just a minute Darrell Webb, our Chairman, President and Chief Executive Officer and Jim Kerr, our Chief Financial Officer will review our second quarter financial results and discuss our guidance for the full year fiscal 2010. They will then respond to your questions.
After the market closed this afternoon, we issued our second quarter earnings release. If you’ve not received it you may obtain a copy from the investor relations section of our website at www.JoAnn.com. This conference call is being recorded and is available through Wednesday, September 2nd by dialing 1-800-642-1687. The conference ID number to access this call is 22939701. In addition, this call is being webcast over the Internet and it can be accessed through the website mentioned earlier by selecting investor relations at the bottom of the website. For those with access, it is also available through www.StreetEvents.com. A replay will be available shortly after the call and may be accessed at www.JoAnn.com and www.StreetEvents.com.
Before we begin I would like to remind you that any forward-looking comments made during this call are subject to certain risks and uncertainties which may cause results to differ materially from our current expectations. These risks and uncertainties that are most likely to cause our results to differ materially from our current expectations are included in the press release issued this afternoon and also in our periodic filings with the SEC.
Now, I’ll turn the call over to Darrell.
Darrell Webb
Jo-Ann Stores achieved strong operating and financial improvements in the second quarter. The strategy to revitalize our store portfolio, enhance our merchandise offering and constantly improve store conditions is clearly making a difference in our performance. We’ve made meaningful progress in providing a compelling shopping experience and customers are rewarding us for the positive changes.
Same store sales increased 1.8% for the second quarter on top of a 3.3% increase last year. In spite of the challenging economy, we’ve delivered same store sales growth in eight of the last 10 quarters. Customer traffic increased to 4.1% in the second quarter while average transaction size fell 2.3% as customers continued to resist buying higher ticket items. We saw a consistent pattern of strong sales in the basic categories I’ve mentioned over the past few quarters including quilting, yarn, food crafting and kids’ crafts.
The new product assortment and planogram in our jewelry making category is also performing very well. On the other hand, seasonal categories continue to struggle with double digit decreases. Fortunately, we anticipated a decline in seasonal sales and bought less merchandise to limit our exposure to clearance markdowns. Our small format stores have recently performed better than large format stores with a traffic increase of 4.8% and same store sales gain of 3.9% for the quarter. The small format remodel and optimization programs are driving additional customer traffic and sales while the absence of custom framing and other high ticket items reduces the impact from slower sales in those categories.
Small format stores have also experienced a larger sales increase when Wal-Mart removes fabric from nearby stores. Based on field surveys by our district managers, we believe Wal-Mart has removed fabric from approximately 457 stores through July of this year and is on track for the roughly 700 remodels and fabric withdrawals that we anticipate this year. Thus far, Wal-Mart has removed fabric from just over 1,300 stores and we estimate that over 2,000 Wal-Mart stores continue to sell fabric.
Turning back to the financial results, gross margin was a highlight of our performance again as we achieved a 170 basis point increase over the prior year. The five key factors I’ve referenced in recent quarters continue to drive the improvement. They include: more direct importing; lower transportation expenses; product cost deflation on imports; less fashion and seasonal inventory; and new systems controls on markdowns. I would also note that our merchandising team continues to become more sophisticated with promotional markdown management. The team has learned through a great deal of trial and analysis to utilize the best mix of marketing events and discount strategies to optimize growth in both sales and gross margin dollars.
We achieved SG&A expense leverage of 140 basis points for the quarter. Payroll savings in our stores and distribution centers from more efficient work processes are driving most of the benefit. As a result of improving sales, margin and expenses, we were able to reduce our second quarter loss to $0.13 per share from a loss of $0.47 per share last year. We won’t be satisfied until we achieve consistent profitability in the second quarter but we are pleased to report positive earnings of $0.21 for the first half of this year and a $0.56 per share improvement over last year’s first half.
I’m proud of our team for making this level of progress during such a challenging economic environment. Part of that progress is due to revitalizing our store portfolio. We opened there new stores during the quarter and have opened 15 year-to-date. We also completed 11 remodels and 98 store optimization projects in the second quarter. We expect to open approximately 20 new stores, remodel approximately 30 stores and also complete over 180 small format optimization projects this year.
In terms of information technology, one of our major initiatives this year involves replacing our forecasting and replenishment system. The roll out of our new JDA demand and fulfillment application is underway and proceeding on schedule and within budget. We have over 10,000 SKUs active on the new system and we’re on track to complete the transition to the new system during the first quarter of next year.
In summary, I’m encouraged by the company’s performance through the first half of this fiscal year and I’m confident that sales and earnings will exceed our original plans for the full year. Therefore, we are raising annual guidance to reflect the stronger first half results and our latest expectations for the second half of the year. Jim will review the details on guidance in just a few minutes. But, I also want to remind everyone that roughly 55% of our annual sales and the vast majority of our annual earnings are generated during the second half of each fiscal year when seasonal category sales represent a greater percentage of the business so I’d like to add a note of caution about extrapolating our current results through the second half of the year when it’s still not clear what the economy and the retail operating environment will bring.
With that, I’ll turn the line over to Jim Kerr.
James Kerr
First, I’ll go through the second quarter and year-to-date financial results and then I’ll wrap up with an update on our outlook for fiscal 2010. Net loss for the second quarter improved to a loss of $3.2 million or $0.13 per share versus a net loss of $11.7 million or $0.47 per share for the same period last year. Year-to-date net income was $5.4 million or $0.21 per share versus a net loss of $8.7 million or $0.35 per share in the prior year. Net sales for the second quarter were $419.4 million up 4.1% compared to the prior year. Same store sales increased 1.8% versus an increase of 3.3% for the same period last year. Positive same store sales were due to higher traffic partially offset by a decrease in average ticket.
Large format stores accounted for 53.9% of total second quarter sales and small format store accounted for 44.3%. Internet sales through www.JoAnn.com accounted for the remaining 1.8% of sales. Same store sales for large format stores increased .1% for the second quarter in addition to an increase of 2.3% for the same period last year. The sales performance of our large format stores is being impacted by the mix of seasonal and higher ticket items which have been underperforming in this environment.
Same stores sales in small format stores increased 3.9% for the second quarter versus an increase of 4.4% for the same period last year. We continued to see the ongoing benefits from store remodels and optimizations in our small format stores as well as benefits from capitalizing on competitive changes in the sewing business. Our sewing business represented 52% of our second quarter sales volume and increased 5.1% on a same store sales basis. We continue to experience positive same store sales in the majority of our fabric and sewing notions merchandise categories.
Our non-sewing business represented 48% of our second quarter sales volume and was down 1.9% on a same store sales basis primarily due to seasonal categories. Year-to-date net sales have increased 3.6% to $879.4 million. Year-to-date same stores sales increased 1.4% versus the same store sales increased of 3.9% for the same period last year. Year-to-date same store sales for large format stores were down .2% while small format stores were positive 3.4%.
Second quarter gross margin rate increased 170 basis points to 49.3% while the first half increased 190 basis points to 48.8%. As a percentage of net sales, SG&A expense for the second quarter improved by approximately 140 basis points to 46.1%. Year-to-date SG&A expense improved by approximately 70 basis points to 43.6%. Our improved SG&A leverage reflects the continued focus on managing our costs which have increased by 2% on a year-to-date basis. For the same time period, net sales increased 3.6%. Year-to-date store pre-opening and closing costs were up $1.1 million to $6.4 million. During the first half of fiscal 2010 we have opened 15 openings and closed 21 stores compared to last year when we had opened three stores and closed nine stores.
Interest expense in the second quarter decreased by $.7 million due to lower average debt levels. Year-to-date interest expense decreased by $1.5 million. We ended the quarter with $460.1 million in inventory, a $12.5 million or 2.6% decrease versus a year ago. Basic inventories are relatively flat versus the second quarter last year with most of the reduction coming out of our fashion and seasonal inventories. We continue to see high distribution center service levels and good in stocks.
Total borrowings were $50.5 million versus $100 million at the end of the second quarter last year. We currently have approximately $270 million of excess availability under our senior bank credit facility. In addition, we have $80.2 million in cash on hand versus $41.2 million at the end of the second quarter last year. Year-to-date capital expenditures were $9.8 million net of landlord allowances of $6.9 million. Investment in IT and store related expenditures including store remodels and new store openings represented the majority of the capital spending.
We are pleased with our progress thus far in to fiscal 2010 and we are raising our full year earnings per share guidance by $0.65 primarily due to better than expected results in the first half. We now expect full year earnings per share to be in the range of $1.35 to $1.50. We remain optimistic regarding the performance of our core sewing and craft categories however, based on the challenging economic environment, we anticipate the negative sales trends in our seasonal business to continue. Seasonal is a larger portion of our business in the second half than in the first half.
As a result, we are forecasting same store sales to be flat to up 1% for the full year, implying second half same stores sales could be down slightly. Regarding gross margins, for the balance of the year, we expect continued year-over-year rate improvement with more opportunity in the fourth quarter due to markdowns taken last year to sell through seasonal merchandise. For SG&A, we do not expect the same level of improvement for the balance of the year that we saw in the first half based on our current sales expectations.
In addition, in the back half of last year, we did not book any incentive compensation whereas this year we expect to book incentive compensation expense based on our current year outlook which will put additional pressure on our SG&A rate. Our full year earnings per share guidance represents a $0.59 to $0.75 improvement over the prior year excluding gains on debt repurchases. Through the first half, we’ve realized a $0.56 earnings per share improvement or $0.53 excluding gain on debt purchases.
You can find other key considerations related to our outlook in the earnings release issued today. At this time, Darrell and I would be happy to address any questions you may have.
Question-and-Answer Session
Operator
(Operator Instructions) Your first question comes from Jeffrey S. Stein – Soleil Group.
Jeffrey S. Stein – Soleil Group
A couple of questions, first of all a question for Jim, looking at the sequential improvement you saw in last year’s gross margin from Q2 to Q3, it went from 47.6% to 49%, is there something about the sequential shift in quarters that causes the gross margin to rise or was it just better markdown management last year?
James Kerr
Q2 is typically when we have our [POG] markdown so when we reached that merchandise category we have markdowns in the second quarter where we don’t have that as much in the third quarter. That would be one of the reasons.
Jeffrey S. Stein – Soleil Group
So in terms of the margin trend year-on-year it sounds to me like you would expect your gross margins in Q3 to be up. Would you see them being up possibly as much as they were in Q2 year-over-year?
James Kerr
We’re not going to comment specifically on Q3 gross margin improvement. We’ll say that we do expect improvement in gross margin rate in Q3 but we’re not going to specify to what extent.
Jeffrey S. Stein – Soleil Group
You mentioned the fact that you’re going to be accruing for incentive compensation this year, was there any accrual booked in second quarter? Can you tell us which quarters in the back half of the year we might expect an accrual?
James Kerr
We would have booked incentive comp both in the first and second quarter of this year so that’s included in the results we’ve issued. Then, our forecast includes an estimate to be booked in the third and fourth quarters where as last year based on what happened with results in the third and fourth quarter we didn’t have to provide for any incentive comp in the back half of last year.
Jeffrey S. Stein – Soleil Group
Did you provide for incentive comp in the first half of last year?
James Kerr
Some, yes.
Jeffrey S. Stein – Soleil Group
So your expenses were only up 0.9%, you’ve talked in the past about a 2% leverage point. It sounds to me like you’ve made some, I wouldn’t call them permanent, but there have been changes in your model, it sounds like store payroll and distribution payroll that might be sustainable over the intermediate term. So, should we expect some year-over-year growth in SG&A to be more in line with what we saw in the first half of the year or certainly the second quarter?
James Kerr
In terms of SG&A dollars we would expect an increase in SG&A dollars both in Q3 and Q4 with a higher increase in Q4. Part of that is based on the incentive comp that we need to book. In terms of leverage, we still believe over the long term 2% probably is about right in terms of comp sales we need to leverage SG&A. We’ve been fortunate this year from an operational standpoint both on the store side and the DC side, those teams delivering exceptional performance there.
Part of it is if you remember from our original guidance, we had planned for -2 to -4 sales. As we’ve exceeded our sales expectations pretty significantly in the first half we’ve done a nice job of managing expenses through that and not letting them rise at the same rate which has provided us with some nice leverage in the first half.
Jeffrey S. Stein – Soleil Group
And it sounds like pretty much you’re not altering your back half of the year forecast at all, would that be correct? Relative to where you were initially?
James Kerr
We never gave quarterly guidance. The current guidance that we give implies a slight improvement in the back half year-over-year on an EPS basis. That’s what we said.
Jeffrey S. Stein – Soleil Group
One more question and then I’ll pass it on to the next questioner, in the second quarter were your margins on seasonal products higher, lower or roughly the same as a year ago?
Darrell Webb
I can tell you that the gross margin was better. We are still seeing double digit decreases in sales trends but the gross margin is trending in the right direction.
Operator
Your next question comes from William Armstrong – C. L. King & Associates, Inc.
William Armstrong – C. L. King & Associates, Inc.
Jim, I think I heard you say that you thought the opportunity to increase gross margin would be greater in the fourth quarter versus the third, why would that be?
James Kerr
If you look back to last year, last year Q3 we had a 100 basis point improvement in gross margins so we’re going to be cycling up against that whereas in Q4 last year we had 160 basis points decline in gross margin. That was all due to seasonal markdown. So, assuming seasonal goes as planned, we’ll be able to make up that $160 that we lost last year due to seasonal.
William Armstrong – C. L. King & Associates, Inc.
Given the level of underperformance of the large stores versus the small and in particular seasonal and high ticket items have you given any thought to radically reducing your exposure to those categories on a more permanent basis? Does that make any sense and would there be anything you could replace those categories with?
Darrell Webb
Bill, as you know with the remodels we’ve been doing on the small format stores and the optimizations we have been recapturing some underutilized space and adding some more basics and reducing some of the seasonal exposure. We’ve done a little bit of that in the large stores as well but we don’t have the categories to back fill, we’ve just got excess space in a lot of those large format stores. So, we’ve recaptured some of it to provide more space for seasonal crafts but really at this point it’s just dialing down the buy that we make going in to the season to be appropriate for how much business we can do.
James Kerr
With our go forward prototype being in the 24,000 to 25,000 square foot range also helps minimize the exposure to some of those categories as well.
William Armstrong – C. L. King & Associates, Inc.
Are there any hot product trends out there either in crafts or in fabrics that are worth calling out? Anything similar to some of the scrapbooking or the yarn that we saw earlier in the decade, anything out there that may be exciting?
Darrell Webb
I mentioned a few of the categories that are doing very well for us, yarn in particular. We will actually do more yarn business this year than we did when the category peaked call it five years ago. That category is back with a vengeance and doing very well for us.
William Armstrong – C. L. King & Associates, Inc.
But nothing that would be sort of out of the ordinary? It sounds like your success has been pretty broad based among lots of different categories?
Darrell Webb
Right. We’ve called out the fact that the core categories, the basics across the board are doing pretty well, some stronger than others. But, there isn’t a brand new category emerging at this point.
Operator
Your next question comes from Anthony Lebiedzinski – Sidoti & Company, LLC.
Anthony Lebiedzinski – Sidoti & Company, LLC
You’ve done a very good job of cutting your costs and improving your margins. What are the greatest opportunities going forward in terms of improving the margins?
Darrell Webb
I think if you look at our business in segments, on the seasonal side we’ve migrated a lot of that business to [Lee & Fung] as a direct important agent for us so probably well developed on that side in terms of optimizing margin. In the fabric part of the business, we’re probably only 50% or 60% of the way through migrating more of that to direct importing. We still have another year or two of significant cost opportunity in fabric. Then, you look at the craft business and based on the nature of that business with so many SKUs, relatively small size and so on, it’s very difficult to import directly so we are not very well developed on direct importing so not as much opportunity in that category in the near term.
Anthony Lebiedzinski – Sidoti & Company, LLC
Also, I was wondering if you guys could give us some flavor as to what you expect for store growth for next year, any sort of idea? Also, for store closings over the next year or two?
Darrell Webb
We will open more stores next year than this year. We will also remodel more stores. We’re in the process of finalizing those plans and we’ll be prepared to share them with you after our third quarter.
Anthony Lebiedzinski – Sidoti & Company, LLC
As far as the outperformance, I think this goes back to the earlier question about the outperformance of the small format stores and when you look at their same store sales versus the large format stores is this just a function of the seasonal product being so weak or do you think once the economy bounces back you’ll see actually the large formats doing better than the small formats?
Darrell Webb
I think this is a relatively short term phenomena. As we’ve mentioned, the Wal-Mart impact certainly on a smaller sales base of a small store distorts the sales growth there. All of the work that we’re doing on remodels and optimizations is distorting in a positive way the sales in the small stores so I wouldn’t say it’s anything structural between the two different models, it’s more of some current events.
Operator
Your next question comes from Bill Detulio – Boenning & Scattergood.
Bill Detulio – Boenning & Scattergood
Looking at gross margins for this quarter, you had mentioned that there are five main key factors that drove it, was there one factor that stood out from the others as far as really driving the margin up?
Darrell Webb
Not really, we sort of list them in the magnitude, the sequence, of the direct importing have the best impact primarily in the fabric categories and then the transportation expense being second. But, it’s not like one is 80% of the benefit.
Bill Detulio – Boenning & Scattergood
Focusing on transportation costs, are you assuming further [inaudible] that fuel prices kind of remain stable in your assumption of gross margin or do you have a different take on that?
Darrell Webb
We see fuel prices rising slightly in the next couple of quarters. Most recently, we were paying about $2.68 a gallon for diesel, I think we’re modeling about $3 in the current quarter so we do see it going up a bit.
James Kerr
In terms of the impact on gross margin, as we get in to the back half those prices Darrell just talked about become more comparable to where they were in the back half of last year whereas in the first half we’ve been getting the benefit from going up against much higher prices in the prior year.
Bill Detulio – Boenning & Scattergood
In SG&A, could you tell us what the bonus accrual was for the quarter?
James Kerr
We don’t give out the specifics on the total company payout. The details for the named executives would be in our proxy but we don’t give out the total.
Operator
Your next question comes from Mark Mandel – FTN Equity Capital Markets.
Mark Mandel – FTN Equity Capital Markets
On the sewing business, a 5.1% increase on a same store basis, how much would you say of that increase came from market share gains versus industry growth?
Darrell Webb
We’ve commented before that there isn’t a great independent data source for tracking the industry. There isn’t a third party syndicated firm like a Nielsen or an IRI so we don’t have a great measure of industry growth or shrinkage. Our sense though is that the industry has been fairly stable for several years so we would have to assume that the majority of that increase would be from gaining share.
Mark Mandel – FTN Equity Capital Markets
Have you seen any increase in the mix shift within that category, fabric versus you mentioned notions, machinery, anything that’s noteworthy there?
Darrell Webb
The only thing noteworthy would be sewing machines, that category has suffered along with the other high ticket categories in this economy although we are starting to see that turn a bit most recently here.
Mark Mandel – FTN Equity Capital Markets
Now, I know you’ve already addressed this question to some decree and somebody already asked it but, when you look at your – you know, you raised guidance and cash flows and you look out next year in terms of your expansion and optimizations and remodels and you look at the real estate market and what’s happening there with rents coming down, are you thinking more aggressively now than you did say three months ago in terms of what you might plan in the year ahead?
Darrell Webb
I think the answer is yes although, we’ve had a very disciplined approach to managing our real estate strategy so we’re going to continue to be very disciplined in how many stores we open, how selective we are on individual sites. But yes, I think the numbers we will share after the third quarter will be slightly higher than what we might have been thinking three or six months ago.
Operator
Your next question comes from Jeffrey S. Stein – Soleil Group.
Jeffrey S. Stein – Soleil Group
Darrell, I’d like to go back to the question on market share and I’m wondering, when Wal-Mart pulls out of a store, I’m wondering what kind of a pop you get perhaps in the first three months, six months and if you’re using that to perhaps gage what share of Wal-Mart’s business from that store you’re pulling out within let’s say the first 12 months?
Darrell Webb
Jeff, as you can imagine there are a lot of different scenarios out there. If Wal-Mart remodels and removes fabric from a store in a market where they have three other store within a 10 mile radius, we don’t get nearly the lift that we would see in a market where it’s the only Wal-Mart store and we’re the only other fabric store. So, there isn’t really a one size fits all answer to the question, it’s really store-by-store, market-by-market. Now clearly, we’ve done a lot of analysis and said, “Okay, what are the averages and what do we need to be prepared for in terms of allocating additional merchandise to support the extra volume?”
Jeffrey S. Stein – Soleil Group
Can you talk about the lift you’re getting from the optimization program and then the lift you’re getting from the remodels and which provides the higher return on investment?
Darrell Webb
The optimizations, by the time we get through this September, we will have completed all but about 20 of our small format stores so, we have lost our control group. The last quarter we spoke to this we said that we were seeing an incremental 100 to 150 basis points in same store sales versus the control group we had at that time but, I can’t really speak to it today because we have touched almost all the stores. As far as the remodels, we are continuing to see more than an 800 basis point delta to the chain average for small format stores when we do a remodel.
Jeffrey S. Stein – Soleil Group
So given that, might you also accelerate the number of remodels that you do next year?
Darrell Webb
I think that’s a fair assumption, yes.
Operator
Your next question comes from William Armstrong – C. L. King & Associates, Inc.
William Armstrong – C. L. King & Associates, Inc.
Darrell in markets where Wal-Mart exits, does that give you any additional pricing power on the fabric side and might that be contributing to any of your margin improvements?
Darrell Webb
Well, we have not really looked at it in that way Bill. Really, what we have to consider is price elasticity and Wal-Mart tends to play at the very low end in the fabric category so in order to capture those customers and make them customers of Jo-Ann Stores, we have to make sure we have a compelling offer at the entry price point as well as the better quality. But, we don’t see it as an opportunity to raise prices.
Operator
There are no further questions at this time. I will now turn the call over to Mr. Webb.
Darrell Webb
Well, we just appreciate everyone calling in and participating in the call today. We look forward to talking with you after our third quarter. Thank you.
Operator
This concludes today’s conference call. You may now disconnect.
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