J. C. Penney (JCP) Q2 2014 Results - Earnings Call Transcript

Aug.14.14 | About: J.C. Penney (JCP)

J. C. Penney Company, Inc. (NYSE:JCP)

Q2 2014 Earnings Conference Call

August 14, 2014 4:30 pm ET

Executives

Kristin Hays - SVP, Investor Relations and Communications

Edward Record - EVP and CFO

Analysts

Neely Tamminga - Piper Jaffray

Matt Boss - JPMorgan

Oliver Chen - Citi

Paul Trussell - Deutsche Bank

David Glick - Buckingham Research

Will Frohnhoefer - BTIG

Steve Strycula - UBS

Bernard Sosnick - Gilford Securities

Dana Telsey - Telsey Advisory Group

Charles Grom - Sterne Agee

Jeff Stein - Northcoast Research

Carla Casella - Carla Casella

Operator

Good day, ladies and gentlemen, and welcome to the Second Quarter 2014 J. C. Penney Company Earnings Conference Call. My name is Kim, and I will be your operator for today. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. (Operator Instructions) As a remainder, this conference is being recorded for replay purposes. I would now like to turn the conference over to your host for today, Ms. Kristin Hays. Please proceed.

Kristin Hays

Good afternoon. Thank you, Kim. As a reminder, the earnings presentation this afternoon includes forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, which reflects the Company's current view of future events and financial performance.

The words expect, plan, anticipate, believe, and similar expressions identify forward-looking statements. Any such forward-looking statements are subject to risks and uncertainties, and the Company's future results of operations could differ materially from historical results or current expectations. For more details on these risks, please refer to the Company's Form 10-K and other SEC filings.

Please note that no portion of this presentation may be rebroadcast in any form without the prior written consent of J. C. Penney. For those listening after August 14, 2014, please note that this presentation will not be updated and it is possible that the information discussed will no longer be current.

I will now turn the call over to our CFO, Ed Record.

Edward Record

Thank you, Kristin, and good afternoon everyone. Normally our CEO, Mike Ullman, would be kicking off the call. However, I will be sharing our quarterly results today while Mike is recovering from a surgical procedure. We wish Mike all the best for his speedy recovery and a quick return to work. With that, I will now take you through the Company's financial results and also give you an update on the progress for turnaround.

We are pleased with our second quarter results. We continue to gain market share while significantly increasing our profitability, and believe we are on track to re-establish J. C. Penney as the leading moderate department store in America. In the second quarter, we saw improvement in almost all aspects of our business.

I would like to take a moment to give our associates the recognition they deserve for the crucial part they are playing in J. C. Penney's turnaround. They have a passion and a commitment that continues to produce new highs in customer satisfaction while driving customer loyalty and engagement. We are fortunate to have such a strong team in place.

Now let me take you through our second quarter results. Comparable store sales increased 6% for the quarter. We not only grew sales and gained market share in a highly competitive environment, we did so by selling merchandise much more profitably. This is our third consecutive quarter growth and reflects continued progress as evidenced by an improvement in our two-year and three-year stacked comp performance.

In total, sales increased 5.1% to $2.799 billion for the quarter compared to $2.663 billion in the same quarter last year. Total online sales through jcp.com continued to show meaningful growth this quarter with a 16.7% increase over last year.

While still negative for the quarter, store traffic continues to improve. In addition, .com traffic was up double digits for the quarter. Our store conversion, average transaction size and average unit retail for the quarter were all up versus last year. As previously mentioned, all regions of the country comped positively in the quarter driven by continued growth in our two largest businesses, women's and men's apparel.

In addition, the Sephora inside JCP business, which is now in the early 500 stores, continues to post strong sales growth. Our Sephora business was up over 25% in total and up over 11% in stores opened at least one full year. We also opened 13 Sephora inside JCPenney locations and expanded eight locations in existing stores this quarter. Importantly, sales were strong during the final weeks of the quarter, which represent the beginning of the critical back-to-school shopping season.

For the first quarter, gross margin was 36% of sales compared to 29.6% in the same period last year, representing a year-over-year improvement of 640 basis points. Gross margin was positively impacted by an improvement in clearance sales performance. Clearance sales were less than 15% of the total sales for the quarter, in line with historical rate. In addition, the margin on clearance goods continues to normalize and significantly improved versus last quarter's results.

We are pleased with the improvement we have made in our gross margin. For the third quarter, we expect gross margin to be in line with our Q2 performance, approximately 650 basis points of improvement over Q3 of last year.

SG&A for the second quarter was $964 million. That's down $62 million or 6% from the same period last year. These savings were driven primarily by lower store expenses, net advertising and corporate overhead as well as improved credit income. We leveraged our SG&A by 410 basis points this quarter. Overall, total operating expenses were down $104 million or 8.8% versus last year, representing a 590 basis point improvement.

Our operating income improved $325 million for the quarter to a loss of $70 million compared to a loss of $395 million last year. EBITDA was a positive $90 million, a $342 million improvement from the same period last year. Year-to-date, our EBITDA is a positive $1 million compared to a loss of $602 million last year. We are extremely pleased we have delivered positive EBITDA for the first half of this year. Our second quarter earnings per share is a loss of $0.56, a 79% improvement versus the same quarter last year.

Moving on to the balance sheet; cash and cash equivalents at the end of the second quarter 2014 were $1.036 billion. Comparative inventory was $2.848 billion, a decrease of 9.7% over the same period last year. We ended the second quarter in a very clean inventory position and we feel very good about our inventory levels heading into the second half of the year.

Our suppliers' payables at quarter end were $984 million compared to $1.276 billion last year. This large decrease year-over-year is driven by the reduction in inventory as well as the payables-to-inventory ratio normalizing, as referenced last quarter. Other accounts payable and accrued expenses were $1.176 billion compared to $1.350 billion last year. This difference is primarily driven by a reduction in accrued capital expenditures versus the second quarter of 2013.

With the closing of our new credit facility, our short-term borrowings are now zero. $500 million of the $650 million previously outstanding shifted into the new term loan and the remaining $150 million was retired with cash on hand. Long-term debt was $5.323 billion compared to $4.850 billion last year. As mentioned above, this change is due to the addition of $500 million term loan under the new credit facility.

Moving on to cash flow; our operating cash flow for the first quarter was a source of $137 million compared to a $708 million use last year, an improvement of $845 million. Our capital expenditures totaled $61 million for the quarter, offset by the proceeds from the sale of non-core assets of $11 million. Cash flow from financing activities was a use of $229 million, reflecting the paydown of borrowings under the previous credit facility and fees associated with the new facility. This was offset by $500 million in new term loan proceeds. Overall, our cash and cash equivalents decreased $134 million in the quarter.

Free cash flow for the quarter was a positive $76 million, representing an over $1.2 billion improvement from the same period last year. This improvement was operationally driven by significant improvement in the profitability of our business and strong inventory management. We ended the quarter with over $1.9 billion in total liquidity.

Before discussing our outlook for the third quarter, I'd like to briefly update you on some of our key priorities moving forward, including merchandise, omnichannel and marketing. First regarding merchandise, overall we are moving back to a merchandising model marked by narrow and deep assortments. There are three pillars for our merchandising strategy; our offering powerful private brands, sought after national brands, and exclusive attractions that can only be found at JCPenney.

First, the restoration of key private brands has been fundamental to our turnaround. Brands like St. John's Bay, JF, J. Ferrar, Ambrielle and Xersion all continued to outperform. We believe private brands like these are key to JCPenney's growth. They not only give customers style at a price that fits their budget but at margins that are 300 to 600 basis points higher than other brands.

Second, our partnerships with leading national brands are also critically important to our customers and to the future of JCPenney. Brands like Nike, Carter's, Maidenform, IZOD, and Van Heusen are performing very well in our stores and on JCPenney.com. Third, exclusive attractions like Sephora, Liz Claiborne and Royal Velvet also continue to be important growth drivers for us.

Another growth opportunity for us going forward is the omnichannel experience and we are committed to being a retail leader in this area. JCPenney.com, which is a cornerstone of our strategy, continued to perform very well in the second quarter, as it has throughout most of the turnaround. Our .com growth is generated not only by increased traffic and average order value on jcp.com itself, but also from the growth of .com orders that originate in our stores.

Our associates know how to save the sale by helping customers find more sizes, styles or colors on jcp.com and the associates can place the order right at the POS on their handheld device. We just rebranded this effort as 'Find it, keep it' and our associates love saving the sale by helping customers find what they are looking for.

Lastly, we feel good about where we are in marketing. In this highly competitive environment, I'm happy to say we stuck to our planned promotional cadence and clearly the customer responded. The Company's [lipstick] (ph) campaign that helped to differentiate us from our competition, re-established our unique value proposition and deepened our connection with the customer. Our back-to-school marketing with the right balance of brand and promotional messaging has been effective in helping to drive the positive early performance I mentioned. You will hear more about these priorities during our October Analyst Meeting in New York.

Let me close with our outlook for the third quarter and full year. Our third quarter guidance is as follows; comparable store sales are expected to increase mid single-digits; gross margin is expected to be in line with our second quarter performance; and SG&A expenses are expected to be slightly above last year's levels.

And finally, our full year guidance is as follows; comparable store sales are expected to increase mid single-digits, gross margin is expected to improve significantly versus 2013; free cash flow is expected to be positive; liquidity is expected to be approximately $2.1 billion at year-end; capital expenditures are expected to be approximately $250 million; and depreciation and amortization are expected to be approximately $640 million.

With that, I'll be happy to open the call to take your questions. Operator?

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Neely Tamminga from Piper Jaffray. Please proceed.

Neely Tamminga - Piper Jaffray

Ed, congrats on a great progress here being made as well as we do wish Mike a speedy recovery as well. Just wanted to dig in a little bit on the comp guidance for Q3 and some of your comments around back-to-school. It sounds like you ended well for July, and that's obviously traditionally back-to-school. Did you end higher than that of the mid single digit comp guidance or you're giving the raw for Q3 that you're kind of factoring in the overall smoothing t might exist there, and I guess maybe if you could give us some color as to maybe how some of those traditional back-to-school categories may be performing in the final weeks of the quarter, that'd be helpful?

Edward Record

Sure. We're very pleased with our back-to-school performance. I would tell you week 26, which is the last week of the quarter, is the second-largest week of the spring season for us, second only to Easter, and we ended on double-digit comps. So we feel really good as we head into August about the back-to-school. As far as areas of the business, I could tell you, through the weeks that we track as back-to-school which are weeks 23 through 26 in second quarter, all areas that we track for back-to-school were positive. So all areas are performing well and we feel good about back-to-school.

Operator

Your next question comes from the line of Matt Boss from JPMorgan. Please proceed.

Matt Boss - JPMorgan

So it seems you stabilized the ship on the top line. As we look forward though, revenues $12 billion to $13 billion, still 30% below 2010. I guess my question, are you guys happy with the pace of recovery, what you're seeing, if you took a step back over the last year, and how should we think about – what's the best way to think about the sustainable revenue base today and going forward versus that $17 billion from 2011?

Edward Record

I think the answer to your first question, I think we do feel good about where we are. Obviously we wish the sales came back faster, yes, but I think once you break that habit of the customer where they go, you have to earn them back like every other customer. I think we have a little bit of tailwind in that but it's not as easy as just putting back the merchandise that you had and they're going to come back, I think we all realize that, and I think it continues to be a fight out there in a very competitive environment, but I think we're winning market share and I think our results show that.

I think as we move forward, when we get to the October Analyst Day, I think we're going to lay out some of the ways that we expect to continue this sales growth as we move forward. We know that we can't run in the flat to 2% comp range, we need to stay in the mid-single range as we move forward to get back to where we were and we have plans to do that.

Matt Boss - JPMorgan

Great. And then on the balance sheet, payables and inventory management clearly large drivers of free cash this year, but as we think forward, I mean do you guys see the story as free cash flow positive on a go forward basis, and if so, what would be the priority of cash – what would be the cash priorities going forward?

Edward Record

So clearly being cash flow positive is a big hurdle that we're striving towards this year and expect to get there. As you pointed out, we are throwing off working capital this year. So we need to make up that working capital, get back next year with operational improvements, and we're working on a game plan to achieve that for next year. We expect CapEx to be in the $250 million to $300 million range in next year and probably the year after as we move forward. And within that though, again at our Analyst Day, we'll lay out some of the initiatives that we expect to spend that money on. Obviously I talked about some today around omnichannel, continues to be a big opportunity for us but also big investment, and we have some other merchandising initiatives that we plan on rolling out next year that we think can really add to both the top line and bottom line of the Company.

Operator

Your next question comes from the line of Oliver Chen from Citigroup. Please proceed.

Oliver Chen - Citi

Congratulations on an awesome quarter and start to the season. Regarding the traffic and the opportunity for traffic, what do you see as the biggest drivers in terms of driving that line item within the comp, and also if you could speak to the product side for Q4, how would you prioritize where the biggest opportunities are on a year-over-year basis?

Edward Record

Okay. Taking your last part first, I clearly think we have opportunity. If you go back to when Mike showed back up I think a little over a year ago, 15 months ago or so, clearly we had very new people in their chairs and frankly we were making changes after he showed up to put newer people in those chairs. They went on and bought to get back into stock for last year and I think that's why you see the inventories down as much as you do because frankly we were overbought at the end of Q1 and Q2 last year as we were heading into the fall season.

But also the merchandise we bought going into fall was not necessarily home runs across the board, and you saw that in the clearance we had and the margin impact we saw in Q1 this year. We feel good about the opportunity as we go into next year. I think all businesses, particularly women's apparel and men's apparel are firing on all cylinders right now and when they're leading the Company, that's always good.

But we think there are a couple of businesses that we saw opportunities in, particularly around kids. Frankly kids has had a very tough spring and we expect that to turn around as the new management team came in early this spring and their first impact is really fourth quarter. So we think there is opportunity there. Obviously the home store was nowhere near where we wanted it to be last year. We think we've got a lot of initiatives in place to drive that this year. And we have opportunities around footwear and handbags as well that we think we've got a new management team in there going after right now.

So that in addition to the private brands that we continue to drive and see the penetration increasing in private brands, we feel good about the fourth quarter. And I'm sorry, what was your first part of the question?

Oliver Chen - Citi

The other question is about traffic and the opportunity for you to begin upside to traffic over time.

Edward Record

I've spent a fair amount of time looking at our traffic history, and the best I can tell is, traffic is an issue I think in the industry and I think you heard Macy's and Kohl's talk about it, talk about transactions which equates to traffic. I think we're in a little different position because I think if you look at it, our sales dropped more than the traffic dropped last year. And so, as we she traffic more normalize, we're seeing conversion go up. So while traffic is negative, conversion is positive.

And when you look at basically average dollar spent by a customer in the door, is how I'm looking at it, we're getting back to decent levels, we're not quite back to 2011 levels yet but we continue see that improve. So, I think we're going to see our traffic as a comparable to 2013 improve as we go through Q3 and Q4, just because of the anomaly last year.

That said, we need to obviously continue to drive people in the door. I think as we talked about, one of the exclusives at JCPenney's, that pillar of our merchandising strategy is really there to drive people in. We continue to roll Sephora. Sephora being up 25% in total over '11 comp continues to drive more and more footsteps in the door. We believe we have opportunities in response to driving more footsteps in the door. So we're looking at those exclusive brands and categories as really being able to drive people in the door.

And then obviously omnichannel, getting them whether they are in the door or shopping online, right now we do 30% of our online business as pickup in store. We think there's an opportunity to improve that as we improve online by going to be able pick up same day in-store, which is what we're working on, frankly in pilot, parts of that are in pilot right now. So we think there's opportunities to continue to drive traffic in multiple ways.

Oliver Chen - Citi

Thanks a lot, that's helpful. Just a quick follow-up. So for the gross margin line, your guidance, is the main driver there the merch margin improving on a year-over-year basis?

Edward Record

Yes.

Oliver Chen - Citi

Thank you, best regards. Best of luck for the season.

Operator

Your next question comes from the line of Paul Trussell from Deutsche Bank. Please proceed.

Paul Trussell - Deutsche Bank

Just to follow-up there on gross margin that Oliver asked about, first of all kudos on a substantial improvement year-over-year and also sequentially, but noticing that the third quarter guidance gross margins are indicated to be in line with 2Q, and I'm just wondering, do you still see room or the ability to close the gap between your current gross margin performance and your historical peak which for the third quarter was over 40%? I'm just wondering why there wouldn't be further sequential improvement going into 3Q.

Edward Record

That's a good question. So I'm not sure how far back you're going to get the historical peak over 40, but clearly there is room to go above 36%. And I would tell you, one of the things that's baked into our guidance and one of the things that we're seeing is, our regular price selling margins continued to improve pretty dramatically over last year's levels and almost back to historical levels. Private brands isn't quite there yet but it's seeing dramatic improvement and we feel we'll get there pretty quickly.

One of the issues we have is the clearance, the margin on clearance continues to improve and improved dramatically over Q1 but is not back to historical levels yet, and as we get into Q3, as we get to the end of the spring lifecycle and liquidating that product, we don't expect to be able to run the margins on that clearance that we did historically. Part of that reason is our average unit cost has been higher. Now they've done a lot of work going in the fall and we expect – and we will see average unit cost reductions closer, almost in line with historical levels, but that won't impact clearance because it's already bought, that will improve our Q1 clearance margins but not our fourth quarter.

Now we do expect to see continued improvement in the regular price selling in Q3 but we also think it's going to be a competitive environment out there, so we're a little cautious in the guidance we gave because we know again it remains competitive and we're going to need to be competitive to drive the customers back into the store.

Paul Trussell - Deutsche Bank

Understood, understood. And then turning to expenses, so if we look at SG&A, dollars were down significantly again here in the second quarter and in the press release you mentioned lower store expenses, advertising, corporate overhead and credit income, yet again turning towards third quarter guidance, you're now indicating that expenses will be higher year-over-year of those line items. What's changing sequentially that you're no longer receiving the expense benefits?

Edward Record

That's a good question and it's something I've been asking as well. But clearly some of the things, advertising was a significant driver of that savings in Q2, and what we're seeing in Q3 is that we're making investments in advertising. So while it won't be up to last year, it will be flat, but in Q2 it was down to last year which led to some of that benefit. In addition to that, there is some bigger deltas in bonus and some other things that we're seeing that are changing versus historical levels. For example there was no incentive comp accrual at all in Q3 last year, obviously at least right now we're planning to have one. So those are some of the issues that we're dealing with.

Even from a credit standpoint, we're doing very well on credit, we continue to see penetration increase. Revenue was up in Q1 and Q2, but because of some timing issues on how we recognized it last year, we think it's going to be down in Q3 and we get that back in Q4 and we'll be up for the year but there are some anomalies in Q3 that are causing some expense pressure as we move forward.

Operator

Your next question comes from the line of David Glick from Buckingham. Please proceed.

David Glick - Buckingham Research

Ed, welcome, trial by fire on the call today, hope Mike feels better. On working capital, can you help us quantify the benefit that you expect to see for the years so we can get a better sense of how inventories are falling for the balance of the year? Obviously down a lot in Q2. Just curious where you see inventory levels versus last year as the year unfolds and how big a benefit are we talking to, $300 million or $400 million benefit from working capital in the cash flow this year?

Edward Record

Sure. Obviously we expect to see inventories down at the end of Q3, at the end of Q4. It does moderate. So Q3 will be down somewhere in the 8% to 9% range and Q4 will be down in 6% to 7% range. When you do the math on that, we expect working capital to throw off between $250 million and $300 million in cash for the year.

Operator

Your next question comes from the line of Will Frohnhoefer from BTIG. Please proceed.

Will Frohnhoefer - BTIG

Just wanted to clarify debt on the bank lines here. So we had change in the structure of that bank facility over the course of the quarter. You had mentioned, I want to clarify this one point, $9 billion of liquidity right now in total?

Edward Record

Yes.

Will Frohnhoefer - BTIG

Okay. So do we have numbers that can be broken out regarding letters of credit versus straight drawability under the facility?

Edward Record

We will have to get you that information, I don't have in front of us. Letters of credit are obviously reducing our availability, they're not significant, it's I think they are under $100 million but I don't have the details in front of me.

Will Frohnhoefer - BTIG

Okay. So the overall sequential increase in the total indebtedness is based mostly to that structural change then?

Edward Record

Yes. So we added $500 million to the line, which particularly as we get into Q3 at our peak borrowing period, we have all that availability available to us at year-end. As the inventories come back down at year-end, we don't have the inventory to support all of the line but we expect it to provide about another $100 million of liquidity at the end of the year.

Will Frohnhoefer - BTIG

Okay, that's helpful. And then another question I had was, you gave some pretty good color regarding situation with kids and overall growth in apparel and also the internal growth in private label, how that boost margins, I'm wondering obviously one of the biggest sticking points for you guys over the past year and a half or so has been the home department. I'm wondering if you're starting to see the kind of say revenue generation per square foot in that fairly sizable portion of the store that you are looking to see, is that improving, do you have any kind of internal metrics you can report on that front?

Edward Record

I would tell you, it's improving. Home was up over double digits in the store piece, was up over 25% improvement over the prior year. So we continue to see the productivity improving. I don't have the sales per square foot or gross margin per square foot for the home store in front of me. I would tell you, it's not where we need it to be, there's still improvement versus 2011, and we're working through game plan on how to continue that top line growth and profitability growth to get that back to where it needs to be.

Will Frohnhoefer - BTIG

Okay, and is home store basically a portion of say the amount of clearance that you're doing?

Edward Record

Home had a significant amount of clearance, particularly in furniture, but clearance in total is dramatically down versus last year. Obviously we see the benefit in margin and we still drove nice top line growth, but I would tell you it was a drag on sales. I mean total clearance sales was down over $125 million year-over-year. So we're seeing it as a drag to sales but we think it's the right thing to do to get the business healthy and get the margins where we need to be. And it's not like we're getting back to zero clearance, we're getting back to historical levels. So we feel good about where we're heading into the third quarter and we expect clearance will be a drag as well in third quarter, but again, it's getting back to historical levels and we think that's where we need to be to get the profitability back up.

Will Frohnhoefer - BTIG

Great, that's solid color. Thanks and best to Mike.

Operator

Your next question comes from the line of Michael Binetti from UBS. Please proceed.

Steve Strycula - UBS

This is Steve filling in for Michael. First of all, great quarter guys, very impressive quarter on quarter improvement. I guess my question would be a little bit of a clarification, just a follow-up. Did you guys say that the home section was up about 25 percentage points year-over-year?

Edward Record

For in-store, yes.

Steve Strycula - UBS

Okay, so it was about 200 basis point contributor to comp, just to kind of like frame it a little bit?

Edward Record

Give or take.

Steve Strycula - UBS

Okay, great. And then just a little bit of color on the same-store sales component, I believe you said that the average basket in the store was up year-over-year and conversion was also positive. Can you give us a little bit better feel for which of the two was a greater driver just so we understand the dynamics of how the customers are influencing same-store sales?

Edward Record

Sure. So units per transaction were basically flat, AUR and conversion were up mid single-digits each, give or take.

Operator

Your next question comes from the line of Bernard Sosnick from Gilford Securities. Please proceed.

Bernard Sosnick - Gilford Securities

Could you give us a little bit of color with regard to the kids department performance in the spring, why it was so poor, the state in which private brands have been built up and why it's looking better now?

Edward Record

Sure. I think there are two big factors. One is that when we made the change in kids last year, beginning of this year, really the team that was in there was not good from a sourcing standpoint or driving private label. We were really missing the mark on the private brands in kids. The one home run that was in kids was Disney. Disney continues to perform very well for us and is a bright spot.

But in the other areas, private brands, the design that was coming in, as you probably know, working in private brands you're at least six months, probably nine months out from receipt that it wasn't where we needed it to be or where we wanted to be, the value wasn't really in the product. So, they started working through that, day one beginning of this year, so we expect to see Q3 some of that impact and really to be in a decent place by the time we get to holiday in where we want to be in kids.

We have seen it improve, it's actually like I said, all areas were positive through back-to-school, so it is running positive comps and that's good to see and it's made market improvement since Q1, just not quite where we need to be right now, but it's definitely on its way.

Bernard Sosnick - Gilford Securities

And could I enquire about Arizona and your positioning with jeans for the back-to-school season?

Edward Record

It's clearly a tough down-cycle, Arizona is doing okay but not great given that it's predominantly bottoms and denim. Other areas outside denim are making up for it but still not overcoming the denim loss, but areas like Arizona and Athletic are blowing the doors off it, all the Athletic is doing well, across the store nationally and private brands.

Operator

Your next question comes from the line of Dana Telsey from Telsey Advisory Group. Please proceed.

Dana Telsey - Telsey Advisory Group

Congratulations on the improvement. Any more color on the gross margin and the complexion underneath, merchandise margin and what you're seeing there in terms of product cost and also clearance versus any direct price? And are there any updates on the home performance and how that's doing, is it doing differently at all regionally? And just lastly, how is traffic and was there any difference in traffic as you went through the quarter?

Edward Record

Sure. So the first, gross margin, merchandise margins continue to improve. The improvement we're seeing in the gross margin line, we're seeing in the gross profit which is the merchandise margin. The merchants continue to do a nice job of fixing the business and driving profitable sales. As we said, we saw a lot of improvement in Q1 but a lot of it was masked by the very high penetration of clearance and the very low profit we had on clearance. We fixed the penetration piece in Q2. We fixed some of the profit piece but not all of it. We expect to see those continue in Q3, although we won't be back to historical rates from a clearance profitability in Q3.

As far as home, I don't have home by region of the country in front of me but it's been performing just across the board. Bedding continues to be really strong, deck home is strong, window treatment is strong. So we continue to see strength across the board there from the category standpoint and feel good about home. Even in the months up against the relaunch, it comped positively. So we feel good about home.

And then lastly traffic, traffic kind of went with our sales. Sales were good to begin the quarter and good at the end of the quarter and softer in the middle, and traffic reflected that as we went through.

Dana Telsey - Telsey Advisory Group

Thank you. Please wish Mike a speedy recovery.

Operator

Your next question comes from the line of Charles Grom from Sterne Agee. Please proceed.

Charles Grom - Sterne Agee

Please give my best to Mike as well. I [have a couple on slate] (ph), but I didn't hear you quantify what traffic was. Did you guys speak to it, what the exact number was?

Edward Record

We did not, we just said it was negative but improved from Q1.

Charles Grom - Sterne Agee

Okay. And then obviously the margins benefited from clearance. Just wondering if they also benefited from an improvement in the mix of private brands and if you could quantify what the mix was this quarter and what you think the benefit was to the margin line in the quarter.

Edward Record

Yes, they did improve, both from private brands being a larger percent, although we're still below our 50% goal, we're inching closer. They had also improved because the margins of the private brands improved as well. We're now – Q1 they were negative to national brands, we're now about flat to the national brands in margin in private brands. And as I mentioned earlier with the reduction in average cost going forward, we expect private brands margins to pull ahead of national brands as we move forward.

Charles Grom - Sterne Agee

Okay, great. And then just my last question, just looking at the P&L, you had a $53 million real estate another benefit and then in the statements in the back you had about $43 million of that looked like it was from a joint venture. Can you just remind me where that's coming from? Didn't look like you had a benefit last year, I was wondering why you had a benefit this yr.

Edward Record

It's really the joint venture we set up on what we researched as a fringe land here, the land around our corporate headquarters. We sold a track of that land to Toyota for give or take – it wasn't all the $53 million, there was some gains on some – [on the car] (ph) batteries in there as well. So that line controls all of it.

Charles Grom - Sterne Agee

Okay, and that goes into your assumption to have positive free cash flow at the end of the year?

Edward Record

Yes.

Charles Grom - Sterne Agee

Yes, okay. Thanks and good job on this call.

Operator

Your next question comes from the line of Jeff Stein from Northcoast Research. Please proceed.

Jeff Stein - Northcoast Research

Credit card penetration, can you talk a little bit about where it was at the end of the quarter compared to prior year, and also maybe talk a little bit about new credit card holders versus perhaps some reactivations you've seen over the last 12 months, customers that kind of abandoned you and have now come back?

Edward Record

So credit penetration continues to in-shop. At the end of the spring season we were up about 160 basis points over the prior year. I don't have information on reactivations for credit. I will tell you we're continuing to see, we track known customers in the stores, we continue to see known customers improve dramatically year-over-year. I think known customers are up over 25% in Q2 versus the year before. So we continue to see customers coming back into the store and reengaging with us.

Jeff Stein - Northcoast Research

Perfect. And final question, on SG&A in the second quarter, where in the stores have you been cutting back on your payrolls, is it on the selling floor or is it in areas that are kind of transparent to the customer and how should we think about that over the balance of the year?

Edward Record

Honestly I can't tell you if it's all not on the selling floor, but I would tell you that we're doing a lot around the back office to make it transparent to the customer and we are running customer service scores as high as we ever have. So we feel good that it is transparent to the customer in the reductions we've made. We expect to continue to be efficient as we move throughout the fall season.

Operator

Our final question will come from the line of Carla Casella from JPMorgan. Please proceed.

Carla Casella - Carla Casella

I have a couple of housekeeping and then another product question, but you mentioned the ABL facility, where does the borrowing base stand as of today at this quarter?

Edward Record

I don't have in front of me. I don't believe we're maxed out at the end of today but I don't know.

Carla Casella - Carla Casella

Okay. And then did you get the [supposed] (ph) growth where you are in terms of gross selling square feet now that you've closed stores and kind of if you've finished the store closing for the year or how many you have for the remainder?

Edward Record

All of the 32 stores we said would close have closed. I don't have the square footage but it will be in the Q.

Carla Casella - Carla Casella

Okay, great. And then on the home side, how much of your home – when you're looking at stores versus online, what percentage of the business is home, did it skew much differently?

Edward Record

Stores versus .com, dramatically over penetrate index is on home, so it's in the 30% to 40% range is home. The stores is obviously much less, 105 to 15% range.

Operator

Ladies and gentlemen, that concludes our question-and-answer session. I will now turn the call back to Ed Record for closing remarks.

Edward Record

Thank you everyone for joining us on the call today. As you can tell, we are excited about our results in the first half of this year and look forward to seeing you all at our Analyst Day in October. Bye.

Operator

Ladies and gentlemen, that concludes today's conference. Thank you for your participation. You may now disconnect and have a great day.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!