Tuesday Morning Corp. (NASDAQ:TUES) Q2 2016 Earnings Conference Call January 29, 2016 9:00 AM ET
Jennifer Sanders - Investor Relations
Steven Becker - Chief Executive Officer
Stacie Shirley - Executive Vice President, Chief Financial Officer and Treasurer
Melissa Phillips - President and Chief Operating Officer
Taylor LaBarr - Stifel
David Mann - Johnson Rice
Jeff Van Sinderen - B. Riley
Seth Sigman - Credit Suisse
Good day, ladies and gentlemen, and welcome to the Tuesday Morning Corporation second quarter 2016 results conference call. [Operator Instructions] I would now like to introduce your host for today's conference Ms. Jen Sanders. Ma'am, you may begin.
Thank you, operator, and good morning, everyone. I'd like to welcome you all to Tuesday Morning Corporation second quarter 2016 earnings conference call. Presenting on this call today are Steve Becker, Chief Executive officer; Stacie Shirley, Chief Financial Officer and Treasurer; and Melissa Phillips, President and Chief Operating 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 the 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 may 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 filings with the SEC.
Steve Becker will provide an overview of the results and strategy; followed by Stacie Shirley, who will discuss the financial results in more detail; and then Melissa Phillips will provide a key update on key merchandising and marketing initiatives, before we open the call up to questions. Steve?
Thank you, Jen, and thank you to everyone joining us this morning. I'm pleased to speak with you again on my first call as Tuesday Morning's CEO. I'm also very happy to have Stacie Shirley joining Melissa and me on the call today. Stacie officially started earlier this month and comes to Tuesday Morning with over 20 years of experience in finance, accounting and capital markets. We are very excited to have her on board.
Last quarter, I talked about the significant opportunity we have at Tuesday Morning to improve productivity and profitability. As you know, given the demonstrated success we have seen to date, we have accelerated the pace of certain components of our rebuilding efforts. We believe the completion of these efforts will allow us to emerge as a more profitable and competitive retailer.
These projects include a significant repositioning of our real estate portfolio, a continuing rebuild of our supply chain infrastructure and a variety of other initiatives aimed at improving our iconic treasure hunt shopping experience. We continue to make good progress on these initiatives.
Melissa will speak to our holiday results in more detail, but I'm very pleased with the performance of our teams and the results that we have delivered, highlighted by an 8.4% comp for fiscal Q2, which was driven by significant traffic increases in an overall retail environment that many have described as challenging.
As we have consistently said, this year will be one of investment, and you are seeing evidence of this in both our gross margin and to a greater extent in our SG&A expenses in Q2. A quick update on our key initiatives, before I hand it over to Stacie.
On the real estate side, we remain on track with our relocation efforts and we have continued to see excellent results from these stores. We continue to see a sales lift of approximately 50% on average in the first year of operations from our relocated stores, partially driven by better real estate and larger store footprint, which is also driving improved profitability at our relocated stores.
This is a proven strategy for our brand. And with a large and attractive pipeline of opportunities, we will continue to position our stores in areas that will better attract both new and existing customers.
While the economics of our real estate relocation strategy are compelling, there are associated costs. Along with these one-time transition expenses, these relocated stores also generally have higher rents associated with better real estate, but the improved sales productivity justifies the increased cost.
During the third quarter, we plan to relocate 11 stores, close an additional 18 stores, open two new stores and expand one store. We are rapidly moving out of our least productive real estate. In Q3 alone, we are planning to close 10 of our 20 least profitable locations.
The relatively short-lease terms on our historical portfolio has allowed us to move quickly. For fiscal 2016 alone, we currently expect to close or relocate a combined total of approximately 80 stores. While the vast majority of these stores are rolling off in the normal course of lease expiration, in the third quarter we will be closing two stores that will require us to take a charge, which Stacie will describe in more detail in a moment.
Now, regarding our supply chain strategy. The decision to move to our broad and shallow strategy accelerated the need to rework our supply chain, with plans for our new West Coast distribution center, a key initiative. Over a year ago, the company embarked on this project, and last quarter I reiterated our continued focus on getting our new Phoenix DC opened in the first half of fiscal 2017. While we were behind our initial schedule, I am now pleased with the progress we are making.
Our teams are diligently working to ensure we remain on track to deliver on the timeline and within the projections that we previously laid out. With that said, our sales success this holiday season taxed our existing facilities to capacity and we incurred additional expenses in DC labor, trade and store labor to accommodate the increased volumes we were processing directly as a result of the broad and shallow strategy.
To put this in context, we shipped approximately 20% more units and truckloads out of our existing Dallas DC this quarter versus last year. We expect the completion of the Phoenix DC to significantly improve our ability to handle and transport goods more effectively.
Finally, with regards to talent, as I've said before, we have strong teams across key functional areas and will remain focused on ensuring we add the capabilities we need, as we improve the business. Along with Stacie's hire, we have also brought our new talent in our marketing group with Athena Spencer, who joined the team from The Home Depot's Home Decorators Collection division.
We are also pleased that Bill Montalto has joined the company, assisting me with certain projects, including the completion of the Phoenix DC and the ongoing work on the supply chain. Bill is a 40-year retail industry veteran with extensive operational experience and knowledge in all aspects of retailing. His most recent position prior to joining Tuesday Morning was as the COO of Sterling Jewelers.
And with that, I will turn it over to Stacie.
Thank you, Steve, and good morning, everyone. Let me begin by saying how pleased I am to be on the call with you today. Joining Tuesday Morning and becoming a part of the team during the business transformation that is underway is very exciting.
I will review the numbers for Q2, and then Melissa will provide further color on the marketing and merchandising initiatives that clearly resonated with the Tuesday Morning customers this holiday season.
In the second quarter, net sales were $319.9 million, an increase of 6.1% over Q2 last year, despite having 28 fewer stores. Comp store sales growth was 8.4% as compared to 7.6% in Q2 last year. This 8.4% comp was driven by an 8.5% increase in transactions, which was offset slightly by a 0.1% decrease in average ticket.
Relocated stores contributed 225 basis points to comp sales in the quarter. Melissa will provide some additional color on what drove these strong results in a minute.
Gross margin for the second quarter was 35.2% compared to last year's gross margin rate of 36.2%. The 100 basis point decline year-over-year was driven primarily due to an increase in markdowns, higher supply chain costs that Steve already mentioned, higher buying cost and slightly lower initial merchandise market driven by the mix of product sold, all of which were partially offset by favorability in other costs. A portion of the higher markdowns we saw this quarter came as we began to prepare the assortment for the accelerated markdown testing in certain categories that we mentioned on our last call.
Also this quarter, to take advantage of the key holiday selling season, we increased our inventory levels and improved our inventory flow, both of which support our broad and shallow strategy. While we believe this was the appropriate strategy to help drive sales, we did see an increase in cost related to supply chain and buying cost as expected.
SG&A expenses were $92.1 million for the second quarter, an increase of $7.3 million versus last year's expenses of $84.8 million. As a percent of net sales, SG&A was 28.8% versus 28.1% in the same period last year. The increase in SG&A expenses was driven primarily by the increase in our supply chain cost related to our new Phoenix distribution center as well as the increase in our advertising spend, as we tested new advertising mediums this quarter.
We also had higher store rent and depreciation expenses, due in part to our strategy to improve store real estate as well as higher store labor cost and higher corporate employee and recruiting expenses. All of these expenses were partially offset by favorable share-based compensation expense in the quarter as compared to the same period in the prior year, due to executive vacancies in the current quarter.
Our operating profit for the second quarter was $20.6 million compared to an operating profit of $24.2 million in the second quarter of fiscal 2015. The company reported net income of $18.9 million or $0.43 per share compared to last year's net income of $23.7 million or $0.54 per share for the quarter.
Now, let me review our results for the six months period ended December 31, 2015. Net sales for the first six months were $522.2 million compared to $503.6 million for the first six months of fiscal 2015, despite having 28 fewer stores. Comp store sales growth was 6.5% as compared to last year's 9.1%. This 6.5% comp was driven by a 7.3% increase in transactions, which is offset slightly by a 0.8% decrease in average ticket.
Sales at the 35 stores relocated, during the past 12 months, increased approximately 55% on average for the first six months of fiscal 2016 as compared to the prior-year period, driven primarily by better real estate and a larger store footprint and contributed 216 basis points to the comp store sales increase of 6.5%.
Gross margin for the first six months of fiscal 2016 was 35.5% compared to last year's gross margin rate of 35.9%. The decrease in gross margin was driven by the same factors that impacted our Q2 results that I just reviewed.
SG&A expenses were $170.7 million for the first half of fiscal 2016, an increase of $8.2 million versus last year's expenses of $162.5 million. As a percent of net sales, SG&A was 32.7% versus 32.3% in the same period last year. Drivers of the increase in SG&A for the first half of the year are similar to those that I just laid out with regards to the increase in expenses for the quarter.
Our operating profit for the first six months of fiscal 2016 was $14.6 million compared to an operating profit of $18.5 million in the first six months of fiscal 2015. The company reported net income of $12.8 million or $0.29 per share for the first six months of fiscal '16 compared to last year's net income of $17.4 million or $0.40 per share for the six months.
Turning now to the balance sheet. Cash and cash equivalents were $35.3 million at December 31, 2015, compared to $54.8 million at the same time last year. There were no cash borrowings outstanding under our line of credit and availability on the line was $132.8 million as of December 31.
We ended the quarter with inventory up 11.7% to $232.8 million from $208.5 million a year ago. As Melissa will describe in more detail in a moment, this increase was a strategic decision to take earlier receipts, which bring merchandise as well as increase our pack and hold inventory.
Also, keep in mind, that last year we believe our inventory balances were lighter than we would have liked, so the increase is more elevated, given that compare. As you know, inventory is a point-in-time snapshot, and we believe our decisions with regards to our current balance will provide our spring and future assortments with fresh and exciting products and amazing deals.
Year-to-date, we have invested $20.9 million in capital expenditures, the majority of which is related to our new DC and investments in our real estate strategy for new stores relocations and remodels of existing stores as well as IT investments. We currently expect to spend in a range of $45 million to $50 million in fiscal '16, as we continue to be opportunistic with our real estate strategy and acceleration of our store relocation efforts.
During the second quarter of fiscal 2016, we opened eight new stores, closed one store, and relocated seven stores, and we ended the quarter with a store count of 764.
As you know, we do not provide formal guidance, but I do want to make some comments about the third quarter that I think will be helpful. We currently expect operating margins to decline in the fiscal third quarter, driven by SG&A deleverage, as we incur expenses related to the Phoenix DC and non-recurring charge associated with two store closures; expenses related to ongoing supply chain work, executive transitions and a variety of other areas related to our ongoing transformational initiatives, which are not expected to continue long-term, specifically with regards to the cost associated with our Phoenix distribution center.
Recall that we said we expect to incur approximately $6 million to $8 million of expenses in fiscal 2016. Year-to-date we've incurred less than one-third of those expected cost associated with the new DC, and we continue to anticipate the remainder of this spend to contribute to SG&A leverage in the second half of the year.
Secondly, as Steve described, in line with our strategy to improve our store base, in the third quarter we plan to close two stores, which we anticipate will require an approximate $1 million charge. As I just said, there are additional expenses in areas that include supply chain and executive transition among others that will burden our SG&A and in turn drive operating margin declines in the third quarter.
Now, with that, I'll turn the call over to Melissa, who will speak to our merchandising and marketing efforts and give further color on our holiday results.
Thank you, Stacie. And I'd like to echo Steve's comments and welcoming you to the team. Now, let me turn to our merchandising and marketing results for the quarter. As we talked about on prior calls, our product strategy for the season was focused on improving our seasonal inventory flow, creating impactful gift statements and providing a steady stream of newness throughout the quarter.
With the hard work that our buying teams did earlier this year in preparation for the season, we were able to drive strong execution on all of these strategies and provide our customers with a steady flow of great product at compelling values. In addition to the improved product assortments, we also saw some encouraging results from our marketing efforts during the quarter.
On our print media, we improved performance with a stronger mix of product, improved circulation planning and better look and feel. As you'll remember, we also had a shift in our print spend out of Q1 and into Q2, which allowed us to hold our circulation equivalent to last year and layer-in one additional print event in the month of December.
In addition to our print media, we are in the early innings of touching various other strategies to drive customer brand awareness and acquisitions. For the holiday season, we tested radio in a subset of markets and digital advertising in markets across the country. We were pleased with the customer response on both, and now with Athena on board, she and I will work closely together on continuing to test and evolve our overall marketing mix.
Moving to inventory. As Stacie described, we ended the quarter up 11.7% over last year's inventory levels. This increase is primarily driven by three factors. First, as our seasonal business continues to be successful, we are investing more dollars into fueling its growth. Last year, we tested in a limited number of stores, bringing in early receipts for our back half seasonal businesses. Based on the success of this test, we expanded the test to include a larger part of the chain.
The second component to the increase is the growth in our pack and hold merchandise. Last year, at this time, we did not have the capability to allow the buyers to take full advantage of great deals in the market and hold it for future seasons. With the current retail environment, we are seeing a good amount of opportunistic products and are now in a place to capitalize on these deals.
The third factor for inventory growth is based on where we ended inventory in December last year. We did come out of December feeling like our inventory levels were too low. As we continue to improve our processes and tools around inventory flow, we corrected that this year and feel good about the content of the inventory, as we head into spring.
In summary, I am very proud of how the teams executed this holiday season. As we have all heard, this was a highly promotional, very competitive holiday season and our comp performance was delivered of this out-material promotional activity.
Our team is focused on delivering on the core strengths of Tuesday Morning, creating exciting treasure hunt shopping experience with high-quality product and brands at unbelievable values. That said, our teams are not complaisant, they are pushing hard every day to drive continuous improvement.
Looking ahead, we will continue to test, analyze and learn across our marketing and merchandising areas. Over the next few months, expect to also see improvements with our in-store experience, as we continue to evolve our store prototype with our relocated and new stores.
On the supply chain side, we are working on multiple projects to drive efficiency in our broad and shallow model. The Phoenix DC will be a major part of this strategy to both improve our flow, but to also drive transportation efficiency on both the product coming into our DCs as well as the product going out to our stores.
In addition to Phoenix, we're also working on other projects related to improving and driving efficiency in our freight flow. Even though there is a lot of work still to do, the opportunity and the potential for the Tuesday Morning brand is immense. We have strong experienced people in place across the organization and we are all laser focused on positioning this business for long-term success.
Now, I'll turn it back over to Steve for some closing comments.
Thank you, Melissa. In summary, we're very pleased with our topline results for the key holiday season and believe that we have even more room to grow sales and profitability in the future, as we realize the benefits from our relocated stores, our merchandising and infrastructure initiatives and our marketing strategies. However, this year will be one of significant investment, as you have seen from our results to date and as Stacie outlined for the third quarter.
We continue to expect our profitability to be burdened by temporary expense headwinds, largely associated with the Phoenix DC, but also a significant consulting cost related to our ongoing supply chain work, recruitment and severance costs related to the executive transitions and a variety of other items that we do not expect to persist over the long-term. These investments are critical to realizing the potential that exist for Tuesday morning, and will help position the company for sustained success.
I'm proud of our leadership team and especially pleased with the team we are building, and I could not be more excited about the future opportunities for Tuesday morning.
Operator, we're now ready for questions.
[Operator instructions] And our first question comes from Taylor LaBarr of Stifel.
I just wanted to ask about a couple of gross margin line items though. I'm wondering if you could give us a sense, how much of the margin pressure you think resulted from, I guess, in overstressed supply chain, frictional cost or maybe would have been there, if your DC capacity were already higher? And then, a second question on markdowns. Did the markdowns you tested have the elasticity that you thought to drive sales? You obviously had a nice topline. How much of that was driven do you think by those markdowns?
So I'll answer them individually. So on the gross margin, as Stacie walked through, I mean the primary drivers for the gross margin decline, it really was the increase in markdowns related to the markdown test, and I'll talk about that in a minute.
We also saw a small shift in IMU just based on the product mix that sold in the quarter. And then we talked about, a big part of it was also the supply chain and buying cost from the broad and shallow strategy.
As we go forward on gross margin, we don't look at this quarter's year-over-year decline as the new normal. We expect that the gross margin will be more normalized, as we move through fiscal '16. Even though we feel the gross margin will be more normalized, we do expect SG&A deleverage, but the gross margin should normalize.
On the markdown acceleration test, so we're only testing a couple of categories. So as it relates to the impact to comp, it was immaterial just based on the fact that it's just a few categories that we're testing.
But for those test that you did, did you get result that you intended?
It's early. I mean, I think, we are pleased with where the test is headed, but it's still early to talk through that.
And our next question comes from David Mann of Johnson Rice.
First question on, can you just give us a sense on how the comps trended by month through the quarter? And any sense on how that trend continued into January?
We just don't comment on the trend there.
Then in terms of real estate, can you give us a sense on the pipeline, in terms of how many relocation should we expect in the second half? And then also for those relocations that are already in their second year, how are they performing in the second year?
So I think for the total year, we're going to do 80 closures and relocations, and we've given you the number for the first half and we given you the number for the third quarter. So I think you can back into the total there. I will caution you that that does move around, as opportunities come up, sometimes things will slip a month forward, sometimes they'll slip a month back.
I would say that, generally speaking, we're really pleased with the opportunities there. I mean, to some extent there is a flywheel effect. So you open a new store or relocate a store in a territory we haven't done it before, and often the real estate community kind of wakes up to the fact that this is not the strategy that Tuesday Morning had employed historically. And as a result, you begin to see a lot more opportunities. And I would say that I think that as this has progressed over the last couple of years, the pipeline has gotten significantly better.
I personally have spent time with some of the real estate community, I've met with developers who have a pretty considerable footprint, and they are very receptive to kind of the new Tuesday Morning look and feel. And so we're enthusiastic about it. And I would say that there nothing materially has changed in terms of the performance of the stores from relo perspective.
And then, as we get an initial glimpse into fiscal '17, would you expect an acceleration in the number of relocations?
Look, I would say that we're really happy with the economics and to the extent that the opportunities are out there, and to extent that we can handle them internally, which we believe we staffed up to do. We'll take advantage of that. At this point in time, we're not giving guidance on that. But we have stepped it up in the course of last six months. And again, if the opportunity you said is there, we'll take advantage of it. But just like every other aspect of our business, we try to be opportunistic.
And our next question comes from Jeff Van Sinderen of B. Riley.
Jeff Van Sinderen
And just kind of a follow-up on the gross margin. Just wondering, I think you said you expected them to be normalized going forward. Just wondering on occupancy, I think, you said occupancy, there was some deleverage there. Just wondering, if that should normalize as part of gross margin? Should we expect occupancy to be running kind of flattish or should we get leverage? And then, I guess maybe what level of comp do you need to start to leverage?
Let me clarify the question. Are you talking about the rent line, is that what you're asking about?
Jeff Van Sinderen
I think, at this point it would be too early to say that. I mean, as we said, there is a lot more than we have to do, as it relates to the stores. And so as we've experienced so far and some of these where we're getting better real estate, we're certainly seeing in some cases a higher rent, but along with that we're seeing improved productivity and sale. So you're going to be leveraging off of that sales. And the rent piece of it is actually in SG&A, not in gross margin.
Jeff Van Sinderen
And then maybe if you can just touch a little bit more on inventory, obviously, that's a little bit of a moving target. But where should we be thinking about inventory at the end of Q3, obviously, subject to sales. But should we be looking for a similar magnitude of increase or should we be thinking that it's going to be a lower magnitude of increase, what you saw at the end of Q2?
So the way we manage our inventory is with the opportunistic buying model that we have is we manage the inventory based on the sales trend and the opportunities in the market. So to foreshadow what that will be over the next quarter is difficult, based on the model that we have. So we will buy the receipts and manage the inventory appropriately to the sales trend and the environment that's out there.
And the one last one if I could squeeze it in. Just on the DC in Phoenix, some of the work that you're doing there, is it the same kind of challenges that you've been experiencing or is there something new there? Just wondering, if there is any update you can give on what you're sort of dealing over there?
We obviously have had since the last call and prior to that, and all hands on deck effort, Bill Montalto had been working doing some consulting work for us and joined us full time. We have brought in the right consultants and we haven't updated our guidance there. But I would say that we've been working hard on it and we feel good about where we are.
And our next question comes from Seth Sigman of Credit Suisse.
I wanted to just circle back on the acceleration and sales in the quarter, it was nice to see that. Do you have a sense of how much of that was industry-driven versus company-driven? And specifically, wondering if you could quantify perhaps the impact from the marketing initiatives and how much of that shift may have helped the second quarter relative to the first quarter? And maybe just more broadly, like, how are you thinking about marketing spend, which has historically been a relatively low percentage sales for you. Just based on the response that you may have seen, any updated thoughts on that?
So on that comp performance, as we talked about on prior calls, on Q2 last year, that there was definitely business that we left on the table for last year's Q2, and we were very, very focused on making sure that we got that business back. And that was the big contributor to the comp for the quarter.
On the marketing side, even though we did invest marketing spend in the test, the test were in a small subset of our store base. So it wasn't a big material driver to the comp. On a go-forward basis, we don't give the marketing spend numbers. But I would tell you, as we're looking at it, we are in a test and learn mode. So as we move through the rest of the year, we will be spending the marketing in that manner, which is really just what the spirit of testing and learning and evolving as we move forward. So no major shifts there.
And I may have missed this, but just given the strength that you had in the fourth quarter or the holiday quarter, could you give any indication of trends in January so far?
No, we're not giving any indication.
And just one final question. Just as you think about the store base, I think in the past you guys have talked about 40% to 50% of the store base of optimal for variety of reasons. As we look at the two store closures in the next quarter and the charge related to that. Can you just give us a sense of, of that 50% you've talked about in the past, how many of those actually have leases that are coming up within the next one or two years? And how many you think you may actually have to pay to get out of, just as we think about the cash flow implications?
Well, first of all, let me make a couple of points there. We made a lot of progress over the last three years in cleaning this up. At this point in time, less than 2% of our stores are four wall negative on an EBITDA basis. I think, and literally in this quarter that we're in right now, we're closing five of our worst performing stores, so really, really moving through that quickly.
As you know, our historical lease term was five years, we have plenty of leases that are beyond five years, but we have an ability without paying dead rent or taking charges to roll through our leases pretty quickly. And so I think what you're seeing in this quarter, the two that we are taking a charge on, I'm sorry, in the upcoming quarter, that's really all we're going to need to do in that. In that case I don't envision having to do that again. And the vast majority of what we look at comes up in the ordinary course. Anything else there?
Well, and if I could just follow-up then on the store location strategy. So you talked about the 50% lift that you're getting on those relocated stores. You now had significant amount that are back within the base, right after that one year anniversary. When you look at the comp performance of, let's say, your core business, excluding the recently relocated stores, can you give us a sense of just the variability in performance between non-relocated stores and recently relocated stores?
I don't think we've given that, I'm not sure. I think we might be willing to discuss it. But we haven't given that in the past. So let us circle back with you on that one.
Thank you. And I am showing no further questions at this time. I would now like to turn the call back over to Mr. Steve Becker for closing remark.
End of Q&A
Well, thank you all for joining us today. We look forward to speaking with you again in April and updating you on our progress. Thank you and have a good day.
Ladies and gentlemen, thank you for participating in today's conference. This concludes today's program. You may all disconnect. Everyone have a great day.
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