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Tuesday Morning (NASDAQ:TUES)

Q2 2014 Earnings Call

January 30, 2014 4:30 pm ET

Executives

Jennifer Sanders

R. Michael Rouleau - Chief Executive Officer and Director

Jeffrey N. Boyer - Chief Financial Officer, Chief Administrative Officer and Executive Vice President

Analysts

Mark K. Montagna - Avondale Partners, LLC, Research Division

Seth Sigman - Crédit Suisse AG, Research Division

Justin Ruiss - Sidoti & Company, LLC

Wayne J. Archambo - Monarch Partners Asset Management, LLC

William Wolf

Operator

Good day, ladies and gentlemen, and welcome to the Tuesday Morning Corporation Second Quarter 2014 Results Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded.

I would now like to introduce your host for today's conference, Jennifer Sanders. Ms. Sanders, you may proceed.

Jennifer Sanders

Thank you, operator, and good afternoon, everyone. I'd like to welcome you all to the Tuesday Morning Corporation's Fiscal Second Quarter 2014 Earnings Conference Call. On today's call are Michael Rouleau, Chief Executive Officer; and Jeff Boyer, Executive Vice President, Chief Administrative Officer and Chief Financial Officer.

If you've not yet received a copy of today's earnings release, you may obtain one by visiting the Investor Relations section of Tuesday Morning website at www.tuesdaymorning.com.

Before we begin today's discussion, I would like to make you all aware that some of the information presented today may contain forward-looking statements that involve risks and uncertainties that could cause actual results to differ materially from those implied in the forward-looking statements.

Information regarding the company's risk factors was included in our press release and is also included in the company's filing with the SEC. Reconciliation information related to non-GAAP financial measures discussed on this call may be found in the company's second quarter earnings release and on the company's website under investor information. We will start with a few opening comments from Michael Rouleau and Jeff Boyer will give the financial review of the quarter. Michael will then follow-up with the company's progress in the second quarter and the plans for the remainder of the year. At the close, we'll open up the call for your questions. Michael?

R. Michael Rouleau

Thank you, Jen, and good afternoon, everyone and thanks for joining us on the call today. As many of you may remember from our last conference call, there are plenty of challenges and opportunities here at Tuesday Morning, and based on the prior experiences of many of our management team and our time spent here together, we have a well thought out plan as we have prioritized our work very carefully. In a few minutes, I want to describe to you some of the progress we have made since our last call.

Before Jeff provides a financial review, there are 3 key measures that I believe tell a story of our progress. Number one, our quarterly comp store sales results; number two, our inventory turnover and current condition of our inventory; and three, our overall financial condition.

First, our comp store sales are up 3.1% and held up well on a shorter weather affect, a very competitive holiday season. If you exclude the non-core categories that we exited last year, and this is a very important point, our ongoing core categories drove a comp store sales increase of 7%.

Second, our inventory turnover continues to improve. On a trailing 12-month basis, our turnover has climbed 2.5x versus 2.1x last year at this time, almost a 20% improvement. And at the end of December, our inventory was much fresher and more current. 80% of our inventory was under 6 months old this year versus last year when only 2/3 of our inventory was that current.

And third, and very important, our cash position at the end of quarter 2 was $53 million versus $48 million at the same time last year, with no debt and limited use of our revolver during the quarter. Currently, as of the end of January, our cash balance is approximately $18 million higher than this time last year.

Overall, I'm very pleased with all the work we have accomplished on Phase I of the turnaround and especially, our performance on these 3 key measures.

I'm going to be back in a few minutes to provide more specifics on this quarter's accomplishments and our plans for the remainder of the year. Now, let's turn the call over to Jeff.

Jeffrey N. Boyer

Thanks, Michael, and good afternoon, everybody. Earlier today, the company reported net sales for the second quarter ended December 31, 2013, of $285.8 million, a 0.2% increase from $285.3 million for the same period last year. Year-to-date, net sales totaled $469.4 million, an increase of 2.5% from $458.1 million for the same period last year.

Comparable store sales for the second quarter increased 3.1% and were comprised of an increase in customer transactions of 7%, offset by a decrease in average ticket of 3.9%. As most of you know, as part of the company's turnaround strategy, the company determined in fiscal 2013, that certain categories were non-core, such as women's apparel and footwear and decided to significantly downsize or exit those businesses.

Overall, our comparable store sales were affected by these exits but it's important to know that as Michael mentioned, that our ongoing core categories performed well and were up approximately 7% on a comparable store basis in the quarter. Core businesses that demonstrated exceptional strength included Furniture, up 57%, Sheets, up 23% and Home Decor, up 20%. Total comparable store sales for the year-to-date period ended December 31, 2013, increased 5.4%, comprised of an increase in customer transactions of 9.4%, offset by a decrease in average ticket of 4%.

On a year-to-date comparable store basis, again, our ongoing core categories also continue to demonstrate strength and were up 10% year-over-year. Year-to-date, our strongest performing core categories were Rugs, up 41%, Home Decor, up 19% and Housewares, up 17%.

Including business turnaround related charges, the company reported net income for the second quarter of $17.7 million, or $0.41 per share, and $5.7 million, or $0.13 per share for the 6 months ended December 31, 2013. This compares to a net loss of $21.5 million or $0.51 per share, in the same period last year for the quarter, and a net loss of $28.4 million or $0.68 per share for the 6 months ended December 31, 2012.

In addition to the fiscal 2013 merchandise exits I previously mentioned, the company's fiscal 2014 second quarter results include a $1.8 million inventory evaluation charge related to the exit of additional non-core apparel businesses, including women's intimates and sleepwear categories and select children's apparel lines, and $244,000 for the turnaround related SG&A expenses. Excluding these turnaround charges, non-GAAP net income for the second quarter was $19.3 million, or $0.45 per share, compared to non-GAAP net income for the second quarter a year ago of $15.5 million, or $0.37 per share. For the year-to-date period ended December 31, 2013, non-GAAP net income was $9.4 million or $0.22 per share, compared to non-GAAP net income of $9.6 million or $0.23 per share -- and $0.23 in the same period last year. In today's press release, we've included tables that reconciled GAAP to non-GAAP operating income and loss, net income and net loss, and net loss and net loss per share for the second quarter of fiscal years 2014 and '13 and the 6 months ended December 31, 2013 and December 31, 2012. We believe these non-GAAP financial measures provide a more informative comparison of the underlying operating results for the company. Additional details concerning these charges are included in our 10-Q.

Gross margin for the second quarter was 34.8% of sales compared to last year's second quarter gross margin, up 21.6%, which includes a non-cash inventory evaluation charge that was incurred in connection with the decision to accelerate the movement of certain non-core inventory. Excluding the charges for exiting non-core categories in the second quarter of fiscal 2014 and the same period last year, our non-GAAP gross margin for the second quarter was 35.4% of net sales compared to 36.2% for the second quarter last year. This 80-basis-point reduction in gross margin represents a sequential improvement versus the 290 basis point year-over-year gross margin contraction we experienced in the first quarter.

Looking forward, we expect this margin contraction to stabilize by the end of the fourth quarter as our strategy of shallower purchases and faster turns is expected to result in lower levels of markdowns.

Second quarter SG&A expenses decreased 3.7% to $81.1 million compared to $84.2 million for the second quarter last year. As a percent of net sales, SG&A was 28.4% of sales versus 29.5% in the same period last year. Excluding business turnaround costs from the comparable periods, SG&A was 28.3% of sales compared to 27.6% in the same period last year. The increase of 70 basis points is primarily associated with our decision to increase payroll spend at the store level in order to better serve our customers, as well as the implementation of new store level and corporate incentive plans.

Due to the accounting on our deferred tax valuation allowance, no tax expense has been incurred on pretax income for the second quarter. In addition, no tax expense will be recorded on operating profits until the deferred tax valuation allowance has been fully utilized.

In the second quarter of fiscal 2014, our federal income tax expense was fully offset by a course on a reduction in our deferred tax valuation allowance. As of December 31, 2013, our deferred tax valuation allowance was $18 million.

Moving to the balance sheet, we ended the quarter with inventory down $4.7 million or 2.3% to $203.6 million from $208.3 million a year ago. On a per store basis, inventory increased 0.6% from the same period last year. With our merchandising strategy focused on broader assortments and shallower purchase levels, we expect inventories to be below last year for the balance of this fiscal year.

Note that our inventory on a unit basis is 14% below last year but inventory has a much higher value per unit as the inventory value in the prior year's second quarter was reduced by the $42 million inventory valuation reserve. Our inventory turnover for the trailing 4 quarters is 2.5 turns and compares favorably to our prior year trailing fourth quarter turnover of 2.1 turns. As Michael mentioned, we believe the quality of our inventory has improved considerably.

We continue to benefit from a strong balance sheet. Cash and cash equivalents were $53.3 million at December 31, 2013, with no cash borrowings outstanding under the line of credit and availability on that line of credit of $99 million compared to a cash and cash equivalent position of $48 million at the end of the second quarter. Currently, as Michael mentioned, as of the end of January, our cash balance is approximately $18 million higher than the same time last year.

During the second quarter, we invested $5.5 million in capital expenditures, primarily for store systems, such as our new POS registers, store relocations and capital improvements exits in stores. During the second quarter of fiscal 2014, we opened 1 new store, closed 2 and relocated 1, ending with a store count of 819. Since the end of the second quarter in fiscal 2013, we have opened 4 stores, closed 28 and relocated 18. We continue to be very pleased with our new and relocated store performance. Our new stores are exceeding their pro formas in our 18 relocated stores continue to deliver a sales increase in excess of 50% versus the same period last year. In the second half of our fiscal year, we expect to open approximately 18 stores, close 12 stores and relocate 17.

As we mentioned on the last call, our new and relocated store activity is weighted to our fiscal fourth quarter ending June 2014 as we've been refining our new store pro forma and our store layouts in order to optimize our financial returns.

Now, I'll turn the call back over to Michael.

R. Michael Rouleau

Thank you, Jeff. On our last call in October, which was just really -- just a little over 3 months ago, we committed to a set of turnaround initiatives that were very significant and would start to move the company through the turnaround and would also be in place in preparation for the holiday season. So I want to give you an update on these Phase I commitments today.

If you remember, we committed to clean, well merchandised stores. They are significantly improved over where they have been just a short time ago. We were in many of them around the country this holiday season, and we personally witnessed the positive change and the corresponding level of enthusiasm from our customers.

We committed to a broader assortment of fresh, better quality, strategy related merchandise. We cleaned up the mess in our stores and then we made significant changes to upgrade and clarify our assortments. Those improvements were highly visible to customers visiting our stores.

We committed to better merchandise values. Many of our prices are sharper as we started to return to the value proposition that was a big source of strength for the company in the past.

We committed to improvements in our stores with the implementation of new cash registers that really moved the customer through the checkout process and more store staff hours in the months of November and December when we had the opportunity to make a lot of new friends. We accomplished both.

We committed to improving the look and execution of our circulars, our website and our weekly e-mails. They have all been changed for the better and they are all much more impactful and effective than in the past.

We committed the start of the transition to store standardization. One way, the best way versus 819 different ways which we have in the past. We started with the implementation of our new end cap merchandising program during the holiday season, where all stores throughout the chain featured the same merchandise in the same location on 6 key end caps. We learned a lot, we sold a lot of merchandise and we will expand on that program this year and next holiday season as well.

We committed to a much cleaner seasonal inventory after Christmas. Unlike the past where we carried over the prior season's seasonal merchandise on the selling floor, we are out of Halloween, we are out of Thanksgiving and most all Christmas merchandise is now sold out.

We committed to fresh merchandise receipts from the January and February time period. Throughout the month of January and February, new merchandise receipts are or will be flowing into our stores as we move into the spring-summer period.

If I had to grade our performance to all our commitments for the holiday selling season, I would give us a solid B. If you were in the store during the holiday season as we were, you had to notice the significant improvements and we believe we made a lot of new customer friends who could see and experience the difference at Tuesday Morning. I also think our store comp sale results for the quarter support my comments today.

While we have made tremendous progress this quarter, I just know how much better we can be. Now, I want to talk you through the next phase of our turnaround. As many of you know, I have been in this position as interim CEO since February and on a permanent basis since August. As we talked on the last earnings call, we spent the first several months looking backwards, cleaning up the many challenges we inherited. We then shifted over for about 3 months to quickly get prepared for and manage through the holiday season, which we just concluded. We are now focused on what I would call Phase II of the turnaround, the phase we are in now.

In Phase II, there are 7 key initiatives that we expect will get us through the turnaround and which we will now focus the whole organization on over the next 6 months. Broadly speaking, you could put them under the general heading of making our stores much more appealing and competitive. Here are the 7 initiatives: first is the continuation of the implementation of our updated merchandise strategy, which calls for branded, better best quality merchandise. We made great progress on moving up our quality levels and selling off the lower quality merchandise. We are rebuilding and solidifying our relationships with vendors who are with us and aggressively pursuing those who we want to be part of our future offerings. We are making nice progress in this effort.

Second is the successful transition at our stores from the merchandise we exited to the merchandise that will take its place. We have discontinued and sold-out of numerous business in our stores, women's sportswear, footwear and other non-core categories. And just recently, we also made the decision to get out of all remaining apparel, like intimate apparel, sleepwear, exercise apparel and select children's apparel in the upcoming third and fourth quarter. We are pursuing additional growth categories that make sense to our business and make our consumer offerings more competitive and appealing. In addition, we have a tremendous amount of sales upside in the existing categories. We will be implementing these category changes throughout the chain with completion expected around September 1 of this year. In addition, we may do some adjustments to our stores to accommodate a more logical store layout. This project is going to be a major undertaking and is being planned now. It may not be perfect by September, but we expect to have the stores in pretty good shape. All new or relocated stores opening this spring and summer will reflect this newer store prototype offering and layout. But because of the complexity of this merchandising transition this spring, new or relocated stores may not be in the final form until fall.

Third is a reduction in clearance merchandise. Our commitment to our new merchandise strategy, which calls for a broader assortment and shallower purchases of each item, meaning new treasures arriving every day versus the unprofitable, narrow and deep purchases of the past will lead us to a continued reduction in clearance merchandise and markdowns. This leads us then to more profit on each sale. Positioning ourselves with current and ever-changing inventory is a significant sales and gross profit opportunity for us, and we are looking at this upcoming fall season for all of this to come together.

Fourth is the disciplined seasonal buying process. Historically, we have not had a successful seasonal buying process. But when fixed, provides us with another significant sales and gross profit opportunity. In the past, we have a lot of disjointed efforts without overall leadership and as a result, never allowed the buying supply chain and in-store merchandising to come together. We need to buy the right quantities, allocate it to the stores correctly, tie in the advertising and merchandise presentation plan and then make some money. As I said earlier, we had some success with this, this holiday season. As many of you know, these seasonal departments are planned and a lot of the merchandise purchased over a year in advance. We have a team in place, the process now developed and its execution is in full force for this calendar year. And you will start seeing the positive impact of these changes in our stores in our Easter and our upcoming summer seasonal merchandise.

Fifth is the refinement of our real estate strategy. While nearly all of our stores are profitable, as you have seen yourselves, many of our retail locations are just not acceptable. With our new real estate direction, we are confident we will open in much better locations, not only in this upcoming year, but in the future. In addition, as Jeff said, additional good news is the continuation of the high comp store sales result of the stores that we relocated in the last 12 months.

Sixth is continued efficiency and effectiveness of our supply chain distribution and transportation area. Over the last 6 months, we have transitioned from little control of our transportation to knowing within 2 hours when our truck will arrive at the store. Our next focus will be managing each aspect of our freight flow from our supplier right through to our store cash registers. And in addition, forecasting inbound freight received to our DCs with the plan of flowing the merchandise to the stores smoothly, so they don't get overrun by poorly scheduled freight shipments or incur excess freight costs like we have in the past.

Seventh, lastly, the implementation of ongoing 4-page circulars. In the past, we continued to increase the size of our circulars in an attempt to generate sales. But this approach merely resulted in very large purchases, heavy inventory and heavy clearance markdowns on that merchandise that did not sell through. This past holiday season, we successfully ran a number of smaller 4-page circulars on October, November and December and we were pleased with the results. We expect to continue this format throughout the upcoming year. We believe it can be very effective both in terms of sales growth, inventory, markdown control and improve gross margin.

The next phase, which we call Phase II of the turnaround, when completed sometime around September 1, will put us on the road to full recovery. This is a very, very big undertaking with 819 stores and will take the full force of the entire company. And while everything may not be perfect going into the fall, we expect to be in the best shape we have been in many years.

In summary, for the remainder of the fiscal year, we will be executing the final phase of a complicated turnaround, while at the same time establishing the true operating baseline for our company, taking out all the lumps and the one-time bumps and positioning ourselves for the new Tuesday Morning, which we will experience starting early in the fall of 2014.

So what do we want you to take away from this call? First, a renewed understanding that this is a very complex turnaround. There's no 90-day quick fix here. Everything was underdeveloped or broken. It is now being rebuilt one piece at a time. And with our current team in place, we believe we have the experience to do this as evidenced by the excellent progress we have made to date. This progress is reflected in our sales and the condition of our stores and the improvement of our operations. We are building this company to last.

Second, we had a pretty good second quarter. If you sort out all the sales takeaways and with little time for planning the holiday season, and we'd have very little time, a 3.1% comp was pretty solid in this environment, but also factoring in a 4% negative impact from discontinued product lines we drove a pretty good 7% comparable store sales increase on the ongoing core categories. I think this is great for a company that has comp sales increases in only 3 of the last 10 years.

Third, we made a lot of new friends this past holiday season as a result of our improved merchandise offering and our store operation. There were days when store traffic was up considerably versus last year and early January sales trends and customer counts are encouraging. This holiday season, there was a lot of good buzz about Tuesday Morning, both with customers and with our suppliers.

Fourth, although sales are starting off strong this month, our comparable store sales for the next 2 quarters may be occasionally affected as we face last year's period, a very aggressive merchandise clearance program, which we will not repeat this year. And while we expect continued improvements through the entire spring and summer season, our focus is looking straight ahead to the goal line, which sets us up for fall 2014.

Fifth, through our third and fourth quarter, we have some very, very heavy lifting to do on Phase II of the turnaround, which I just described to you. And while our transition may not initially lead to perfection, we expect to get it done and be well positioned as we go into the fall season of this year, the most important months of the year.

I will repeat what I said on each of our calls. Based on our focus on continuous improvement, which is that everything we do can always be improved, I believe we can and will produce consistent year-to-year growth on our financial results. We're very pleased with the progress we have made in such a very short period of time, and we feel that we have established a very aggressive set of priorities for Phase II of our turnaround. As a result of these efforts, we are confident in our ability to deliver consistent, profitable results.

In closing, when we left our October earnings call, I suggested how you can measure us over the next 9 months or so. And I said this: better-looking stores delivering solid comp sales growth on the ongoing core categories; two, fresher, cleaner, faster turning inventory; and three, a much stronger financial position. These measures remain the key metrics as we enter the second half of the year. And overall, I believe that we are making great progress. But you know what they say, the proof is in the pudding. I look forward to sharing our progress on the next call. Thanks for joining the call today. The operator will now open the call to your questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of Mark Montagna from Avondale Partners.

Mark K. Montagna - Avondale Partners, LLC, Research Division

Just a question about traffic. I think your 7% traffic might have been the best in the industry and I'm just wondering what kind of feedback you may have gotten from customers that has caused them to go in your store? Is it word-of-mouth, is it Facebook? What might you be hearing?

R. Michael Rouleau

I honestly think it's probably word-of-mouth because a lot of people I talk to, friends of mine in Arizona, in Seattle said you know, I was in Tuesday Morning, maybe they know me, I don't know. But they're in the store, they said boy, the place has really been cleaned up. I also had, as I told you last time, I had 2 CEOs that were on the way to Walmart that stopped into our store in Roger City and they called me personally to say, god, I can't believe this is the best-looking store I've ever seen. So I really think it's word-of-mouth. I think we had our circulars -- were just a little bit more effective this Christmas. They were crisper, sharper and we gave good service. And so, all our store managers would tell us that people are really recognizing the changes that we made and really loving it. So that's about all I could tell you.

Mark K. Montagna - Avondale Partners, LLC, Research Division

Okay. And then I would imagine comps might have been hurt a little bit by store closures. Do you have any numbers to help us understand how much store closures might have hurt during the quarter?

Jeffrey N. Boyer

Mark, you're thinking about the weather closures and things?

Mark K. Montagna - Avondale Partners, LLC, Research Division

Yes.

Jeffrey N. Boyer

Always tough to get an exact number of that. Rough numbers, rough estimate, it's probably about 1% or so. I think weather affected us maybe about 1%.

Mark K. Montagna - Avondale Partners, LLC, Research Division

All right. And then what about -- trying to understand the cadence of comps. If you, like many other retailers saw a slowdown in December, probably driven by weather?

Jeffrey N. Boyer

Yes. We did. December was a little bit off of November. The pattern we had was actually October was our weakest month, November was our strongest month and we have a bit of a falloff in December. Some of that is due to our promotional plans and timing but we have -- we really run 1 or 2 limited kind of promotions per month, happen to fall a certain time of the month that kind of sways things. And November seemed to have a little bit more waiting in it from a promotional standpoint. And I think the later Thanksgiving gave us some more time in it. So we did a little bit weaker in October, some real strength in November and then it softened up a little bit in December with the weather and things, Mark.

Mark K. Montagna - Avondale Partners, LLC, Research Division

When you say promotions, you're not referring to like percentage off, you're talking about your monthly...

Jeffrey N. Boyer

Just our...

R. Michael Rouleau

Everyday low price and just kind of telling the customers some new offerings that have come in the store.

Jeffrey N. Boyer

The green card circular.

R. Michael Rouleau

Green card.

Mark K. Montagna - Avondale Partners, LLC, Research Division

Okay. All right. And then, can you remind us how much were those on -- how much was the ongoing core category comp up in the first quarter?

Jeffrey N. Boyer

That was up about 14%, 15%. The adjustment was about the same. If you think about it, Mark, we had a 9% comp and you add back another 4% or 5% or so. So you get about a 14% number in those categories.

Mark K. Montagna - Avondale Partners, LLC, Research Division

And then you mentioned higher store labor charges for November and December. Is that going to continue for the next 6 months?

Jeffrey N. Boyer

No, it's really a seasonal thing we did for Christmas. We looked at the scheduling and the freight flow and really thought the stores need it, and it was about $1 million. We put about $1 million in the store in the November-December time frame. Absolutely the right thing to do to support the stores. They're in much better shape from a merchandising standpoint and managing the freight.

Mark K. Montagna - Avondale Partners, LLC, Research Division

Okay. And when does that 5% drag disappear from eliminating ready-to-wear and footwear? Is that by the end of the fourth quarter?

Jeffrey N. Boyer

We'll start to cycle through it probably by the end of the fourth quarter, that's the biggest. We'll have it with us for Q3 and Q4 and then we think it will start to get to be quite a bit less as we get into our fiscal 2015, which starts in July.

Mark K. Montagna - Avondale Partners, LLC, Research Division

Okay. And then the relocated stores, how many have you done going back even more than 12 months? And then what's the plan going forward in terms of the rest of this year, the number for relos or remodels? And then for years going forward?

Jeffrey N. Boyer

Yes. The number for remodels for the rest of this year -- not for remodels, for relocations for the rest of this year I need to count these up in my head, it looks like 17 that we have for the rest of this year on relocations. For next year, we are looking to accelerate that, the number that we do in terms of relocation. We don't have a number for you right now, Mark. I'll tell you, it will be a multiple of that. It will likely be pushing into the 30s, 40s. If we can do more, fantastic. But we're definitely going to be doing quite a few more relocations. We really like the results we've seen.

Mark K. Montagna - Avondale Partners, LLC, Research Division

So with the relocation, the success, in the past I think you've talked about trying to be in B locations. Are you thinking about A locations?

Jeffrey N. Boyer

Pure, pure A locations, probably not. From a pure rent standpoint we don't have the productivity yet. But good solid B locations, we can afford those and we can be in those spots, so -- and there's plenty of those around, particularly with some of the challenges other retailers have been having. So we're finding good real estate opportunities.

Mark K. Montagna - Avondale Partners, LLC, Research Division

Okay, and then just last question. When you -- if you look at all the stores that you wish you could relocate tomorrow, what percent of the total would that be?

Jeffrey N. Boyer

We still -- we mentioned this on the last one -- we've done more work on it and our rough ballpark number from the last call is still holding up. And it is about a 40% number, overall. There's about 300 or so, 320 of our 800 stores that -- when we look at it they're in really good demographics, we really like the demographics that they're in. But they're really in either a poor center or a poor location or undersized. So we have a fair amount of stores that from a size standpoint or is actually the center that they're in, they're not in a B mall or B center or what could be a -- what is currently a good demographic for us. And so we think there's a lot of opportunity in that particular group.

Operator

Our next question comes from the line of Seth Sigman from Crédit Suisse.

Seth Sigman - Crédit Suisse AG, Research Division

If I could just follow up on that store relocation question. The 40% of the base that you would want to relocate, I mean, how many of those leases are flexible enough? They're up maybe in the next 1 to 2 years that you really could accelerate that plan?

Jeffrey N. Boyer

I don't have that number right on my fingertips, Seth, on it. We do have a lot of month-to-month leases and we have a lease that is coming up on it. On an annual basis, it probably -- I will tell you, it probably falls fairly consistently with our store base. So if we typically have 800 stores, we have 150 or so that come up every year, so you could have 40%. You could have 60% or so that are coming up. The real trick on this equation is actually finding then, the real estate location. So it's a bit of a filtering process. So I think the -- if we have 150 a year that come up for lease renewals, you would use a 40% number on that and you get what the potential is and the key is how many of those can you go and get done.

Seth Sigman - Crédit Suisse AG, Research Division

And as you look at the team, do you have the team in place to potentially accelerate that plan over the next 1 to 2 years as you just kind of implied before?

R. Michael Rouleau

I would say, absolutely yes. We brought in a gentlemen from the outside that was working with us many, many years ago. He's absolutely phenomenal in terms of putting together the processes to -- and he's got the whole team in place in terms of opening these new stores. So we're doing a little bit of work on the store layout itself now, which we just talked about a little bit. He's been out to our new stores, watching them and again, we're expanding the process so that I would say, we absolutely do have the team. We're confident in that team.

Seth Sigman - Crédit Suisse AG, Research Division

Okay. Great. Anything early you want to share about that store prototype that you guys are working on or do we have to wait?

R. Michael Rouleau

You got to wait, really. Because we're still working on it and it's just -- I mean, it's nothing -- it's more, honestly -- it's more really based on maybe a little fine-tuning and some fixturing and maybe the fine-tuning of some adjacencies in the store and by that toll. There's nothing dramatic. I mean, we are not looking at a new prototype to save the company here. We got a pretty good store right now, but we're looking for just to make it a little bit more sensible for the consumer to walk in. So don't expect any big, big prototypes that's going to save the company. We're not going that way.

Jeffrey N. Boyer

Looking at expanding some of our really strong categories, we had some strength in. Looking at some new categories that you're going to appreciate. We had apparel, that's hanging apparel. Hanging apparel in our stores was probably was opportunistically put in there from a revenue margin standpoint on it. It doesn't make sense long-term -- not really a sustainable business for us. So getting out that apparel business, we are expanding our shelving and categories into that space and moving out those racks and things that you -- those rounders and things that you just have seen, so some refinements in that arena.

Seth Sigman - Crédit Suisse AG, Research Division

Okay. And Michael, you made a couple references to making a lot more friends in the last quarter or so and I mean, it makes a lot of sense. The word-of-mouth seems to be pretty good as you're making some improvements in the store. Is there a way that you guys can measure how much of the improvement is coming from customers that haven't been there a long time or just new customers that maybe haven't shopped in the past?

R. Michael Rouleau

Well, we can probably do that in the future, but we're kind of in the early stages of all our work here and we're so damn busy with so many things that I would -- and we're pretty confident about what we're doing. So I would probably rather get a little bit further along and see what we want to do then. We did do, about a year ago, just about when I got here to join the board, they did a pretty thorough research project with customers in different markets. And we've got the names of all those customers and so we have a good opportunity to go back with them and see if they really notice the difference. But now isn't the time to do that. I mean, we're making progress but we want to make a bigger difference.

Seth Sigman - Crédit Suisse AG, Research Division

Okay. And just one final one for me. The gross margin, I think they held up a little bit better than we expected, especially in light of the very promotional environment out there. Any more color on trends within that and how you're thinking about the opportunity as you move through the year?

Jeffrey N. Boyer

I think we were ultimately pleased with the gross margin performance. From a markdown standpoint, we made some real progress there. We talked a little bit more on the earlier call, on the first quarter call, about the IMU drag and then the markdown drag and those 2 things together gave us the term 90 basis points. In this particular quarter, we actually saw some better performance on the markdown level. I've started to see some of the efficiencies coming through on distribution and freight. So really, what happened was the IMU was still 150, 180 basis points down, so consistent with what we saw in the first quarter. And so that trend will likely continue and we'll cycle through that as we cycle through this year and it'll no longer be a drag once we get through this year. We're seeing the markdowns improve and so the markdowns -- actually, markdowns combined with our freight efficiencies and distribution efficiencies actually were favorable to offset some of that. So we're encouraged by that. We do have some periods going through the next couple of quarters. Michael mentioned a little bit about the aggressiveness and maybe the lumpiness of sales. We still have some of that and I think it is important to think about the baseline this year that this year's an important year to set the baseline. And you can see we're kind of hovering a little bit around that 35% gross margin range. We were at 34 and change. In the first quarter, we're 35 and change. In the second quarter, from what we look at from our IMU and our markdowns, the recent past isn't too bad indication of the near-term future.

Operator

Our next question comes from the line of Justin Ruiss from Sidoti.

Justin Ruiss - Sidoti & Company, LLC

Can you just give me, I mean, the numbers for the store openings and closings again, just to reiterate?

Jeffrey N. Boyer

We have them in the script here. I have to go back now. Let me find the one so I make sure I close the same one. [indiscernible] on Page 17, so here we go. This happens to be -- so during the second quarter, we opened 1 new store, closed 2 and relocated 1. We ended up with 819. And since the end of the second quarter of fiscal 2013, so lap an entire year, this is a year count, we've opened 4 stores, closed 28 and relocated 18 on that. And if you need more detail, I think there may be in some of our -- our Q may have a store count table in there as well. We just filed our Q so you should pull that up. But if you need more help, Justin, I can help you on that.

Justin Ruiss - Sidoti & Company, LLC

Sure, it's fine. And then just looking at like, the revitalization on the store fronts. I mean, if you could slap a percentage on that to show how many of the stores are kind in this new clean look versus how many you have left to go, where do you think that would be?

Jeffrey N. Boyer

We just have a limited number because the new stores -- we've only opened up a couple of new stores that look like that and it's...

R. Michael Rouleau

The story you're talking about how many store do we feel are cleaned up versus still looking pretty rough?

Justin Ruiss - Sidoti & Company, LLC

Pretty much.

R. Michael Rouleau

I would say it's a very high percent because we had people out all through the Christmas season doing a correction of error exercise. Our buyers were out all over the country. We found 2 districts that were maybe a little bit in need. We've helped them out now. So I would say we're well on our way, we're well on our way.

Justin Ruiss - Sidoti & Company, LLC

Gotcha.

R. Michael Rouleau

[indiscernible] percentage are cleaned up. Now, we've got a little bit more cleaning here to do. But I mean, they made every store or many of them -- most of them made a lot of progress.

Justin Ruiss - Sidoti & Company, LLC

Perfect. Then lastly, you had mentioned something about taking out the rest of the apparel that's going on in the stores. How quickly do you think that can happen and is that something you'll accelerate now?

R. Michael Rouleau

Probably take us through somewhere around June.

Justin Ruiss - Sidoti & Company, LLC

June.

R. Michael Rouleau

Well, we don't want to give everything away and the other thing is we've got to expand other categories to put in the store. So it's got to be kind of a smooth transition, otherwise we're going to have empty space all over the place, so...

Jeffrey N. Boyer

It's a little a balancing act.

R. Michael Rouleau

Yes, it's a balancing act.

Justin Ruiss - Sidoti & Company, LLC

Perfect.

Jeffrey N. Boyer

It will be out through -- by the time we get through the end of summer, July, August, we'll definitely be out then. You'll start to see it really shrunk down by the end of June. And it will probably start to really disappear in July and August so by the time it's September 1, we'll be in really good shape.

Operator

Our next question comes from the line of Wayne Archambo from Monarch Partners.

Wayne J. Archambo - Monarch Partners Asset Management, LLC

Could you share with us the average basket, what is the purchases and what that number was a year ago?

Jeffrey N. Boyer

The average basket is about $30 or so, and the year before it was probably about $1 or so more, $1.50 more. I'm going a bit from memory here. So our average basket is down a little bit, much like our average ticket is down. It pretty much goes in line with that.

Wayne J. Archambo - Monarch Partners Asset Management, LLC

And what do you attribute that to? Is that the direction you want to go in?

Jeffrey N. Boyer

Some of that is due to the fact that we had -- in the prior quarters, we were actually selling some fairly sizable items. We had some furniture items that were fairly sizable on it. We think actually, that the number will probably stabilize. Another thing, as we make this transition on our merchandise offering, that the number will stabilize as we get through this year and get into next year. We don't think that will go down anymore. We think it'll sit probably about where it's at. So it won't be an impact on our comp store sales, but it'll take us probably another couple of quarters before we see that average ticket get consistent and stabilize.

Wayne J. Archambo - Monarch Partners Asset Management, LLC

The relocations, you touched a bit of this on earlier questions, you're going to go to 17 to 30 to 40, could that number grow beyond that? It seems like the comps are so significant that I'd be trying to accelerate that as much as possible. I know it's more complicated than that, but as you pointed out earlier, is that a conservative number, the 30 to 40 or could that...

R. Michael Rouleau

You put your finger obviously, on one of the big opportunities. We're just -- let's say, we're in the rehearsal mode of doing this. And we've got to really practice and practice and practice with the stores we have this fall. And then we will -- once we get this practice and really have this thing down, really have wired and we have the organization in place with the experience and all the other parts of this, then I think we could take a look at that. Because honestly, you put your finger on one of the big opportunities of the company.

Jeffrey N. Boyer

It may be a step function on this lane where what it is, is say, we did 20 or so this year, we'll do 40 next year, we'll grow to 60. But it is something that we'll have to grow into a little bit, just to make sure we get the real estate right, we get the process right. There's a lot of process that goes into this as well as some merchandise flowing. So I think there is real potential, as you point out, and we want to go as fast as we can. We also want to make sure we do it right. So it will probably be going from 20 to 40 to 60, if I were to hazard a guess, what it might look like. If we can get more done, if we feel really confident, we definitely will do everything we can. It's not a capital constraint. there's not a big capital element to this. Mostly, it's locations, getting it done and getting the process done. So it's really largest under our control.

Wayne J. Archambo - Monarch Partners Asset Management, LLC

Are these stores that have gone from C locations to B locations or just within B locations?

Jeffrey N. Boyer

Actually, it's been a combination. I would tell you that actually, it's been both. Probably the most common factor is actually they have been increased in size. We've taken them from 6,000 or 8,000 square feet to 10,000 to 12,000 and we're seeing really, a radical increase in the overall sales when we get the growth in there as well. Now, we're not seeing a decline in the sales per square foot. So probably the biggest driver has just been taking undersized stores, whether it be in a B location going to B or whether being a B in a B, it's really the size factor that seems to be the biggest driver on it right now.

Wayne J. Archambo - Monarch Partners Asset Management, LLC

And has the merchandise mix changed in the relocated stores and anything that's different from your corporate mix?

R. Michael Rouleau

No. It really hasn't. So again, that's the exciting part of this.

Operator

Our next question comes from the line of Victoria Constantino [ph] from THB [ph].

Unknown Analyst

If you can -- maybe I missed out, but can you remind us what percentage of your inventory is currently fresh and new and what has been left for clearance?

R. Michael Rouleau

80% is under 6 months now.

Jeffrey N. Boyer

Right.

R. Michael Rouleau

Versus about 2/3 or 60% last -- 67% last year.

Unknown Analyst

And that includes the apparel -- excludes the apparel that you're trying to...

R. Michael Rouleau

Yes, it does.

Unknown Analyst

What other -- I mean, are there any other categories left that you're thinking of exiting or that's pretty much it?

R. Michael Rouleau

No, not really. We might modify some, make some a little bit smaller and some a little larger, et cetera. So there could be some minor modifications but it's nothing that's going to lead to excess or heavy markdowns.

Unknown Analyst

When you talk about like anything in adjacent categories, should we think about Furniture or like Home Decor, are you going to stay into that kind of range of merchandise or you think...

R. Michael Rouleau

We pretty much concluded on the categories that we're going to expand, and for competitive reasons, I don't really want to say what they are. They certainly won't be women's apparel. But they will be extensions of the Home Decor business that our customers have really come to expect at the company. So it will be very logical.

Operator

[Operator Instructions] Our next question comes from the line of Bill Wolf from BW Capital Partners.

William Wolf

I think you had roughly 30% of your leases up this year. I'm just curious what impact those renewal negotiations are having on overall cost of the real estate you managed?

Jeffrey N. Boyer

It's really not seen a major increase in our rent overall with those leases coming up. Where we do decide to go into better locations or more square footage, we are seeing the rent go up because of that. That's the biggest, probably, driver behind any rent increase, is our decision to go into better locations or larger space.

William Wolf

But what's the delta in terms of per square foot rental increase that you're seeing in those new locations?

Jeffrey N. Boyer

Our average rent per square foot is probably about $10 on an average basis. We're probably in some of these locations, willing to go up to $15, $18 a square foot. So they're sizable in terms of the increases but we're seeing such large -- such sizable sales increase on them that the return is good on the investment. Now if we don't go and if we just renew most or many of our leases that are up, we can opt into renewal position for a year or some time period. Oftentimes, those have very modest increases or no increases whatsoever. The existing portfolio doesn't vary much. Most of it has to do with new real estate activities that we're doing.

William Wolf

So you're not seeing the landlords in your B locations pushing rent because they have -- the economy is stronger and there's other opportunities to rent those locations?

Jeffrey N. Boyer

We have seen some of that. There are some that we have seen, and in some cases, we will walk away from a lease on it. If somebody is asking $25, $30, $35, we just -- we don't have the sales productivity in our model right now to afford that kind of...

R. Michael Rouleau

We did walk away from one recently.

Jeffrey N. Boyer

We'll walk away from some if they're just too pricey for us. So there is some of that going. So as one of the other gentlemen was asking about the retail relocation or relocation of our retail stores, it is an important part of it, which is making sure you can find those right locations and still get affordable rents. So that's a part of the challenge that we have.

William Wolf

On the comp store numbers, can you break out comp stores for existing locations without the relos and then the comps on the relos and the differentiation of the 2?

Jeffrey N. Boyer

Yes. We will -- we've had a conversation with some of the analysts about doing that. Right now, it's not a big, big number. It is about 50 basis points. We are getting a little bit of a lift in our comps because of the relos. We don't have that many relos to drive the numbers. It's a large percentage growth but not many of them. At some point, when that numbers starts to be sizable, we'll probably start to give you much like we give you transaction and average ticket, we'll probably give you a component of how much the real estate component of relocations are assisting. But at this point, it's pretty small.

William Wolf

Okay. And what about on the comp stores, the number of days that you're open in each quarter. Like in the first quarter, you were open 5 more days than the prior year, which helped drive comp sales. Could you give those metrics each quarter when you announce comp sales?

Jeffrey N. Boyer

No.

William Wolf

So it's an apples-to-apples comparison?

Jeffrey N. Boyer

Yes, we're getting into a situation where we're really open the same number of days. We did have a situation in the first quarter where because of our inventory count process, we were closed on that and then we're open more days. We're going to have a...

William Wolf

So in this year, you were open more days than the prior year?

Jeffrey N. Boyer

Yes. In Q1, that was the case. In Q2, it's the same 90-, 91-day pattern. In Q3, we'll probably pick up a couple of days on it. We were closed for a couple of days for inventory last year. And this year, with our cycle accounting, we were able to be open -- more fully open really, throughout the entire time period. So we'll pick up a couple of days in Q3 for us. But once we cycle through this year really, actually it's going to be apples-to-apples. We'll be open 91, 92 days a quarter.

William Wolf

Your comp store sales are a little bit overstated this year because of the not being apples-to-apples on the day count.

Jeffrey N. Boyer

Yes. I think we did the math on the first quarter and if you look on a year-to-date basis, 5 days and a slow summer period over 180 days is not very material.

William Wolf

Well, it's 2.5% or something?

Jeffrey N. Boyer

I don't think it's that much but...

William Wolf

It is, that's the math.

Jeffrey N. Boyer

Well, the volume days are pretty limited and I don't believe it was a full 5 days.

R. Michael Rouleau

I think the important thing to note here is the fact that we have pretty good numbers in these relocated stores, as we just told you about. A lot of these -- most of these relocated stores were open before we even got the show on the road here with anything. So what excites us is the fact that when we go in the fall and all the clothing is gone and the new expanded categories are in there and et cetera, et cetera, et cetera, that is the real Tuesday Morning. And we're really excited about the comps we had at 50, but we haven't really done too much different except maybe relocate to a little bit better location. So there appears like maybe there's a lot of opportunity there also.

William Wolf

Well, Tuesday Morning historically is at pretty bad locations. So I would imagine that a new location can help a good bit.

Jeffrey N. Boyer

Yes.

William Wolf

On the gross margin issue, you looked at your real competition that you're up against, whether it's a Big Lots or it's a T.J. Maxx, the Ross Stores, the closeout guys. Their gross margins are, frankly, at or lower than where you are. How do you anticipate ever getting above 35% gross margins? Because you're all buying the same stuff from the same place in China and...

R. Michael Rouleau

Not really. I think if you go into HomeGoods, for example, I mean, HomeGoods is a very nice store, they're very...

William Wolf

A beautiful store, yes.

R. Michael Rouleau

They're almost like a Target store, even almost getting better now. And because of their size, they do a lot of programming of merchandise. So while they look like they're buying tons of closeouts, I'm not sure they really in fact are. They're more...

William Wolf

No, they're doing engineered closeouts in China, that's exactly right.

R. Michael Rouleau

And we buy -- I mean, we but still a lot of closeouts. We could buy smaller quantities because we're a small chain, et cetera and we're renewing our acquaintances with a lot of these vendors that we then kind of not proactive with in the past. So we're more in the closeout business. But what's happened in our company here is that we would bring in, for whatever reason, maybe trying to make a profit or something, we would bring in products that are very high priced and we would buy too much and then we would mark it down on the first markdown, mark it down the second markdown, mark it down on a third markdown, mark it down on a fourth markdown and then throw it away. Well, we just got -- we can do better than that. So what we're doing now is getting -- buying way less, we have our new merchandise strategy, et cetera and we expect to have a substantial reduction in our markdowns. So therefore, we can go priced in a little bit better right from the get-go and give the consumers better values. And you'll see a little reduction in our IMU these days and frankly, that's got to do with sharper pricing, which I talked about on the call.

William Wolf

But you guys already have your whole closeout team so you're not buying closeouts in the old-fashioned way of buying closeouts, you're doing more engineered stuff and you're just spending a little on trying to sell it at a uniform price across the lot as opposed to buying stuff at $0.10 and sell it at $0.60 and $0.50 like a true closeout guy would do in the old-fashioned sense of the closeout?

R. Michael Rouleau

Well, I can't say that because I can just tell you, we just bought one yesterday and were offer these -- we go every -- we go with liquidators, great Americans, so forth and so forth. There's a fellow up in Minneapolis that I'm associated with, Irwin Jacobs, you probably heard of the name. He's called us, we just placed some purchase orders with him today. So we are pretty active in the closeout market today.

William Wolf

That's good. One last thing. On the turns, how do you get your turns much better than 2.5 when you only have 1 distribution center in Dallas?

R. Michael Rouleau

Well I'll tell you what it is. We buy too much and we just -- I don't know how high is up but we just buy too much of every single item and it just sits in the stores and we might buy 6, 7, 8, 9 months of supply, that's why we don't get any turns and that's why our stores look stale. So we now have kind of a different philosophy here in that every purchase order that we place today, we talk about how many units per store did we actually buy. And we're tracking that and we're not buying a year's supply of items anymore. We're trying to buy a 30-, 60-, 90-day supply so the stores are continuously looking fresh. So we feel we got a really handle on that now, that's why our turnover is improving and that's why we expect it to approve more in the future.

William Wolf

Are you going to be able to do all that with just 1 facility in Dallas or you're going to have open up a facility and new stores in the west coast?

R. Michael Rouleau

I think now, we got a lot of improvement coming with exactly what we've got to work with now.

Jeffrey N. Boyer

Any more questions operator? We'll take 1 more.

Operator

Our final question comes from the line of Mark Montagna from Avondale Partners.

Mark K. Montagna - Avondale Partners, LLC, Research Division

A question for you on last year, third quarter. You had some -- you're blowing out a lot of inventory. Could you tell us how much that might have helped comps last year and then how much that might have hurt gross margin, if it actually hurt it at all?

Jeffrey N. Boyer

Yes. I can for the gross margin question, probably first. The way the retail method works on this is when you take those big markdowns, you take that charge but your margin is kind of maintained. So you've taken the hit on the cost side, you have lowered your retail levels but your margin doesn't really get impacted because you kind of swallowed it all with a big markdown. And it was part of that $42 million reserve the company took in Q2 of fiscal '13. So margins really weren't impacted but you did get the sales benefit, so that's a little bit of the lumps and bumps that Michael and I talk about at times. Probably from a volume standpoint, we estimate it's probably worth about 5%. There's probably -- much like it's been running about 4% on this it's probably a bit of an uptick as we are at this time period because it's a high -- you own the most -- the products with the freshness and the cleanness you're getting out of so you had a little higher sales volume. So we can look at that sales volume and do the backwards math and say it represented about 5% of our sales. So it's a little bit higher number in Q3 than we've been running with these core categories and that will -- it'll start to fade away as we get into Q4 and it should not be an issue to get to next year, but you're thinking about it right, Mark, in that we do have our -- we have our internal challenges here on a sales because of some of these exit businesses. It will expand a little bit in Q3.

R. Michael Rouleau

Mark, I think that's why we -- if we really kind of keep our eyes on the go forward categories, that's probably where you keep your eye until next fall and then the new categories will be in there, and then they'll blend together and then we're off to the races. But it's probably maybe that's the right number to look at, I don't know.

Mark K. Montagna - Avondale Partners, LLC, Research Division

Well, it seems like if you can actually comp positive, that would be pretty incredible because if you're losing out on 5% of sales that were clearance markdowns last year, 5% from discontinued ready-to-wear and footwear and then this discontinued apparel, I don't know, maybe that's 5 -- what percent is that? That's 5%, you're going up against a 15% comp headwind right there.

Jeffrey N. Boyer

I think you're doubling up. You're doubling up. It's about 5% for all the discontinued products and things that we have is about 5%. The discontinued apparel that we did this year we'll actually be selling through in a weird way, actually, the little of a good guy as you clear through that on it. But the big challenge is actually the fact that last year, you had a lot of inventory that they marked down and cleared through. And when you look at that and you do the backwards math on it and you ask the question -- I can't give you the math, it's about a 5% drag on that, that we're going to have.

Mark K. Montagna - Avondale Partners, LLC, Research Division

Okay. And then if you go out to Q4, you were talking about gross margin. Is there any chance gross margin can actually be flat by Q4?

Jeffrey N. Boyer

From your lips, I'm optimistic that we'll maybe turn the corner there with a combination of the IMU cycles around, the markdowns are better and the freight is better. But it's going to be close, Mark.

Mark K. Montagna - Avondale Partners, LLC, Research Division

Okay. But that's sequentially better than third quarter and second quarter, but it sounds like third quarter gross margin might be...

Jeffrey N. Boyer

Third quarter gross margin is going to be -- again, we're talking about the lumps and bumps. If you look at last year's gross margin rate, and I want to say with the adjustments, it's 37%. We've been running about 35%. If you look at the fourth quarter last year, it came back down to 34 and change on that. We're going to run 35-ish percent gross margin. And so we have a little bit of variability in the comparisons year-over-year on some of the lumps we mostly talk about.

Mark K. Montagna - Avondale Partners, LLC, Research Division

If you complete Phase II, can we start to look out to finally seeing you earn a profit in non-Q2, so Q1, 3 and 4?

Jeffrey N. Boyer

I haven't done the quarters yet for '15 but I would think that in a number of those quarters, we would be profitable.

I think that's it. Operator. It's our last call so I think we can close it off. Thank you, everybody, for calling in and listening to us. We look forward to talking to you in about 90 days.

Operator

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program and you may all disconnect. Everyone, have a great day.

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