J.C. Penney's (JCP) CEO Marvin Ellison on Q1 2018 Results - Earnings Call Transcript

May 17, 2018 4:14 PM ETOLD COPPER CO INC. (CPPRQ)12 Comments3 Likes
SA Transcripts profile picture
SA Transcripts

J. C. Penney Company, Inc. (NYSE:JCP) Q1 2018 Earnings Conference Call May 17, 2018 8:30 AM ET


Trent Kruse - IR

Marvin Ellison - Chairman and CEO

Jeff Davis - CFO

Joe McFarland - EVP and Chief Customer Officer

Therace Risch - EVP and Chief Information/Digital Officer


Lorraine Hutchinson - Bank of America

Mark Altschwager - Robert Baird

Matthew Boss - JPMorgan

Paul Lejuez - Citi

Richard Magnusen - B. Riley FBR

Kimberly Greenberger - Morgan Stanley

Paul Trussell - Deutsche Bank

Oliver Chen - Cowen

Chuck Grom - Gordon Haskett


Good day, ladies and gentlemen, and welcome to the Q1 2018 JCPenney Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will follow at that time. [Operator Instructions] As a reminder, today's conference call is being recorded.

I would like to introduce your host for today's conference, Trent Kruse. You may begin.

Trent Kruse

All right, thank you Kevin and good morning, everyone. As a reminder, the presentation this morning 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-Q and other SEC filings.

Please note that no portion of this presentation may be rebroadcast in any form without the prior written consent of JCPenney. For those listening after May 17, 2018, please note that this presentation will not be updated, and it is possible that the information discussed will no longer be current. Also, supplemental reference slides are available on our Investor Relations website. While management will not be speaking directly to these slides, these slides are meant to facilitate your review of the company's results and to be used as a reference document following the call.

Joining us on today's call are Marvin Ellison, Chairman and CEO of JCPenney; and Jeff Davis, our CFO. Following our prepared remarks, we look forward to taking your questions.

With that, I will now turn the call over to our Chairman and CEO, Marvin Ellison.

Marvin Ellison

Thank you, Trent. Good morning, everyone. We had a strong start to the first quarter with February and March comps ahead of our annual guidance range. However our April results were negatively impacted by unseasonable weather resulting in a sales comp increase of 0.2% for the quarter. Overall we're confident that our strategic plan is working and this is evidenced by the sales recovery we experienced in the final two weeks of April when the temperatures began to normalize.

The first quarter can be summarized in five key points. Number one; we saw continued strength in our Beauty segment lead by Sephora, Fine Jewelry and our Salon business; number two, we had great performance in our home refresh initiatives specifically appliances, furniture and mattress; number three, we expect to return to positive sales performance in Men's apparel; number four, we're pleased with the continued revenue growth in our omnichannel business; and finally unseasonably cool temperatures in early April negatively impacted overall apparel cost and gross margin.

In fact without the impact of weather we estimate our comp sales would have been a plus 1.5% for the quarter. Despite the short-term weather impact in April we are maintaining our annual guidance of flat to up 2%. We have an expectation that we will continue to benefit from our home refresh and beauty growth initiatives as well as the ongoing enhancements in apparel. In addition we are very encouraged that our May monthly performance exceeds the high end of our sales forecast.

Now let me discuss briefly gross margin. As you know it is critical for us to improve the performance of our apparel categories to not only deliver improved top line results but to deliver better margin performance and Jeff will discuss specific actions that we are taking to improve gross margin in the remaining three quarters of 2018. I'll take a little bit of time to add some color to our Q1 margin performance.

So for the quarter there were three major factors that negatively impacted our gross margin performance. First and most significant to our gross margin impact, occurred within our dotcom business. We experienced mixed supply chain and process issues and negatively impacted in the prior year's gross margin. All these issues have been identified and process improvements are underway.

Second, we executed store cleaners markdowns to address slow selling apparel categories. We're committed to running the business for the long run and not just the quarter. So having said that we took appropriate markdowns and pricing actions in the first quarter to address slow moving inventory and make room for new product. And third, our negative comp performance in Women's [specialty] apparel created gross margin pressure. We can correlate 100% of the negative comps in kids and women's apparel to unseasonally cool temperatures in early April.

Gross margin improvement is a major focus for the company and Jeff will outline specific strategic steps we are taking to improve performance for the balance of 2018 and in spite of the challenging margin performance we experienced, I'm pleased that we are maintaining our great expense reduction discipline which is evidenced by 270 basis points reduction in SG&A versus last year. It is also important to note that many of our key growth initiatives are sooner around lower margin rate businesses. However we see the importance of incremental profit dollars in these initiatives. And in the near term our ability to drive margin rate improvement falls largely on delivery consistent sales growth and higher margin categories including apparel, fine jewelry and salon while ensuring we drive operational efficiency in our dotcom business.

As we've discussed in the past we're placing a greater emphasis on apparel and in the quarter we drove improved sequential performance in many of our women's categories across total women's apparel. We're also encouraged with return of positive sales comps in our overall men's apparel business. Because apparels and activewear will become a larger piece of our business in upcoming quarters the improvements we've made in these categories bode well for the balance of 2018. Growth in our activewear area will be driven by enhancements and our partnership with Nike, Adidas Champion and Puma and we are very excited about the upcoming launch of our fanatics fan shops in 700 stores this summer.

I'll now hand the call over to Jeff to discuss in more detail our first quarter financial results, as well as outline our updated guidance for 2018. I'll come back and close our prepared remarks with highlights of some of the key initiatives for the balance of 2018. Jeff?

Jeff Davis

Thank you Marvin, and good morning everyone. Before I begin I want to remind you that starting in the first quarter of fiscal 2018, we implemented and accounted for new FASB revenue recognition standards and changes to pension accounting and have changed the current year and prior year presentation of our financial statements. Please refer to the most recently filed 10K for a complete understanding of the accounting of financial statement presentation changes related to our adoption of these new accounting pronouncements.

Now let's turn to our first quarter financial results. For the first quarter total net sales decreased 4.3% versus last year, while comp sales increase 0.2%. As a reminder, the 450 basis point spread between total net sales and comp sales was primarily due to the 141 stores' closures in fiscal 2017, most of which were closed in late in the second quarter. The comp sales improvement for the quarter was driven by an increase in average unit retail and units per transaction. Geographically the Gulf Coast and Southeast were our better performing regions while the Midwest and Northeast where our most challenged regions.

Starting this quarter credit income is now included in total revenues. Recall credit income was previously reported as an offset to SG&A in prior periods. For the first quarter credit income was $87 million compared to $83 million the first quarter last year. Jewelry, Sephora, men's and salon comped positive in Q1. All divisions, except women's specialty comped positive for the combined February and March period. As Marvin mentioned in his opening remarks our comp sales results for the quarter were impacted by cooler than normal temperatures in April.

The quarter started off solid with comp sales for the combined February and March period above the high-end of our full year guidance of range. While April comps ended down in unexpected mid single-digit, we delivered significant positive comps in the last two weeks of the quarter and the weather began to normalize. Cost to goods sold for the first quarter was 66.3% of sales, an increase of 240 basis points compared to the same period last year. As Marvin mentioned earlier, gross margin is a major focus for the company.

So looking ahead to Q2 and the back half of the year the following gross margin initiatives gives us confidence that we can see improvement for the balance of the year. Continued execution of pricing analytics and markdown optimization, sufficient purchase and allocation of inventory based on sales volume versus square footage, an enhanced e-commerce channel to drive greater profitability through improved operational disciplines, and continued self-improvement across higher margin apparel categories, namely women's.

Moving now to expenses. SG&A expenses for the quarter were $826 million or 32% of sales compared to $938 million or 34.7% of sales for the same period last year. The reduction in expenses was primarily driven by optimizing controllable cost and more efficient marketing. In addition, as we discussed in our last call the remaining amortization of $30 million gain on the sale of leasehold interest last year was recorded as reduction of SG&A expenses.

Turning now to our adoption of new accounting standards, as I mentioned earlier, we implemented new FASB accounting pronouncements starting in the first quarter. The impact of full year adjusted earnings related to the new revenue recognition standards is expected to be approximately $7 million or $0.02 per share. In addition, given the new FASB standard associated with pension accounting we now include the current service cost component of pension expense and income in SG&A.

The net impact to full year adjusted earnings related to the adoption of this standard, the majority of which is related to the service component, costs component, is expected to total approximately $32 million or $0.10 per share. All other components of net periodic pension costs and income are now recorded in a separate line item below operating income. It is important to note service costs do not impact our operating cash flow and it is funded through the pension trust. The pension plan has a current funded status of approximately 102% and we do not expect to make any cash contributions for the foreseeable future.

Interest expense was $78 million this quarter versus $87 million last year. During the first quarter we completed the sale of our Milwaukee-Wisconsin distribution facility and recorded a gain of $12.5 million. In total, we recorded net real estate gains of approximately $17 million or $0.05 a share in the first quarter of this year compared to $117 million or $0.38 per share last year related to the sale of our Buena Park distribution facility in the first quarter last year.

Now let's turn to our capital structure, our liquidity position and our cap balance sheet. In February we used available cash on hand to retirement at maturity of $190 million of notes due February 15, 2018. During the quarter we also issued $400 million in senior secured second priority notes due 2025. We used the net proceeds from this transaction to successfully complete the tender offer for $375 million of aggregate principal amount of our outstanding unsecured 2019 and 2020 bonds. As a result we now only have $50 million of debt maturing in October of 2019 and $110 million maturing in June of 2020.

Our capital allocation priority remains to deleverage the balance sheet through debt retirement at maturity or proactive refinancing and to rebuild cash balances. We remain confident to fund near term maturities from free cash flow. As expected and given the $190 million in cash utilized early in the quarter to retire the February notes we drew against our credit facility during the quarter to fund a portion of our seasonal working capital needs. We ended the quarter with an outstanding balance of $351 million.

As such our liquidity position at the end of the first quarter was approximately $2 billion. Cash and cash equivalents at the end of the first quarter were $181 million which was $182 million less than the end of the first quarter last year. Our reduced cash position is primarily attributable to the February $190 million debt prepayment, in addition capital expenditures net of landlord allowances for the quarter were $103 million.

During the first quarter free cash flow was a use of cash of $421 million an increase of $128 million compared to last year's use of cash of $293 million. Inventory at the end of the first quarter was approximately $2.9 billion down 1.4% versus last year and up 2.6% on a comp store inventory basis. The increase in comp inventory is primarily related to four samples associated with additional clients and mattress showrooms and the expansion of the extended sizes and active assortment.

Our teams remain committed to effectively manage inventory levels without fact-finding customer availability. We recently appointed a new Senior Vice President of Planning and Allocation who come to us with a strong retail background in P&A. Under her leadership, we will enhance our focus to better assess the effectiveness of our inventory positions and make informed decisions on inventory productivity, and improve our planning and forecasting capabilities. Merchandise accounts payable was $933 million, up $40 million versus the first quarter last year. The increase was primarily due to the timing of receipts.

Turning now to fiscal 2018 guidance and the update to adjusted earnings per share, we announced earlier this morning. Starting this quarter, we implemented new FASB revenue recognition standards and changes to pension accounting. As such we're updating our full year guidance for fiscal 2018 to only include the previous mentioned $0.02 impact from the revenue recognition items and $0.10 impact from pension related costs to our adjusted earnings. Our new guidance is as follows. We expect comp store sales to remain in the range of flat to up 2% and adjusted earnings per share is now expected to be in the range of a negative $0.07 to a positive $0.13 per share.

Now moving to another key financial metrics and expectations for Q2 of 2018. Comp sales in the second quarter are expected to be in the middle of our annual guidance range. We expect second quarter cost of goods sold to decrease compared to last year. SG&A dollars in Q2 are expected to be down versus last year. In closing, we remain focused in 2018 on improving inventory turns to increase free cash flow and improve margins and delivering greater operating productivity.

With that, I'll now turn it back over to Marvin.

Marvin Ellison

Thank you, Jeff. We remain focused on executing our three-part strategic framework of private brands, omnichannel and increasing revenue per customer. We have key initiatives in place that give us confidence in our ability to achieve our 2018 financial objectives. First as we've already discussed a key focus this year is enhancing our apparel offerings to better align with customer preferences. We remain focused on categories that offer the greatest opportunity for growth particularly special sizes, activewear, dresses, contemporary and casual sportswear. Specific to special sizes we are pleased with the performance of our plus size Liz Claiborne brand and we are also very excited about our partnership with Shaquille O'Neal who is a definition of big and tall.

We believe that JCPenney can leverage our unique position in the marketplace to achieve $100 million growth opportunities in special size 2018. Our second key area is beauty, we have a significant opportunity to leverage our total beauty experience. One of our critical components of our beauty strategy is our continued best in class partnership with Sephora. After opening 70 new Sephora locations in 2017 and adding 27 more this year, Sephora inside JCPenney shops will operate in over 75% of our stores.

We're also excited about a series of new launches and brand expansions we have planned in Sephora for 2018. We will keep you updated on the timing and successes of these launches on future calls. Also in 2018, we plan to rebrand and remodel another 100 salons to salon by InStyle. As a reminder, when we remodel all salons the sales performance in these salons improve on average 400 basis points.

Additionally fine jewelry is a key component of our beauty strategy and our jewelry business comped positively in every quarter in 2017 and was the highest comping division in Q1. Our jewelry business is bringing a new and younger customer to JCPenney and we have aggressive plans for the balance of 2018.

And finally we recently partnered with Fitbit to introduce a line of health and wellness products into our assortment. We are in the early stages of this new partnership and look forward to expand the health and wellness areas of the JCPenney business. JCPenney is the only retail that can offer our customers a total beauty experience combining Sephora, salon and fine jewelry under the same roof.

And third, we are continuing our commitment to becoming a world-class omnichannel retailer and although we experienced some process challenges that impacted gross margin in Q1, we are pleased that today approximately 80% of our existing inventory is now eligible for free same day pickup. 100% of our brick and mortar store network is being utilized for online fulfillment and nearly 40% of our dotcom orders are picked up in a store and while in the store over one third of the customers make an additional purchase.

Through an enhanced collaboration across all digital functions we are merging our ecommerce operations with the latest innovation in IT to ensure that our omnichannel strategy enables JCPenney to be a high-performing fully integrated digital enterprise.

And finally, we continue to position JCPenney to take market share from ailing competitors. One area where we see significant share capture opportunity is in our home refresh categories. Over 70% of our customers are home owners and we have a large competitor in the space donating market share. This is arguably the most challenging and competitive retail market that we have seen in over 50 years. In over the past three years, we've taken significant steps to de-risk our business and improve our balance sheet, specifically reducing outstanding debt levels and proactively refinancing.

These financial improvements have stabilized our company and positioned JCPenney to take advantage of available market share opportunities as other retailers continue to struggle. To that point we have identified over 300 malls where we will aggressively pursue sales opportunities given to us by other retailers in 2018. And the vast majority of these malls are highly rated and will provide incredible market share opportunities as we continue to enhance our merchandise assortment which includes appliances, mattress, furniture and work wear. In addition we see opportunities to capture market share in baby gifts, footwear and our new toy category based on competitive dynamics.

In closing retail in the U.S. is a multitrillion dollar industry and we believe there can be multiple winners. Those retails who can offer their customers a value while providing the best in store and online experience will be winners. And as a company JCPenney plans to be one of those winners.

So Kevin with that we will open the line for questions.

Question-and-Answer Session


[Operator Instructions] Our first question comes from Lorraine Hutchinson with Bank of America.

Lorraine Hutchinson

Can you give us an update on your free cash flow guidance, are you reiterating that this morning? And then secondly if you could just talk about a little bit about the opportunity to reduce the levels of inventory in your stores and how much cash you think that could drive over the next few years?

Jeff Davis

So we're continuing to reiterate our free cash flow guidance for the year in the range of $200 million to $300 million. As it relates to the inventory we do believe that we have an ongoing opportunity to induce -- reduce our inventory levels. If you take a look at our weeks of supply on hand that's a definitely an opportunity for us. We have not provided any guidance as to what that amount would be over the course of the year. We are working very carefully and very diligently with the new individual that I'd mentioned in my prepared remarks to actually identify where those opportunities are and how we can execute them without affecting customer availability as we move forward.

Marvin Ellison

Lorraine this is Marvin. Just one additional point, regarding strategic inventory investments, men's apparel was the only positive comping apparel division for us in Q1 in spite some of the weather challenges we faced. Two reasons why they were able to accomplish that, were investments in the big and tall category and in work wear. Those two categories were more weather resistant than typical spring attire and enabled that division to deliver positive comp. So to Jeff's point we want to be prudent because our overage versus last year in comp stores were driven in large part by 100 stores where we set appliance displays where we expanded mattress aggressively and those were some of our best performing top line areas of the quarter. And so we want to balance being very, very smart and prudent on managing our working capital while continuing to drive sales.

Lorraine Hutchinson

Thank you and could you quantify the gross margin headwind you faced last year, as you were closing out the stores at the end of the quarter?

Marvin Ellison

From a quantification it's difficult to do it in a very sustained fashion because it was an ongoing process. As Jeff mentioned in his prepared comments the majority of stores actually closed towards the end of second quarter, so it was an [iterant] process that occurred in the first two quarters of the year. So it will be very difficult to kind pinpoint on the calendar and impact but it's obviously something that we're aware of and something that we're managing and something that we're going to continue to understand what our compares were versus last year.


Our next question comes from Mark Altschwager with Baird.

Mark Altschwager

Just first on the gross margin you identified three specific issues in the quarter, any chance if you could quantify the relative pressure from each of those?

Marvin Ellison

What I said in my prepared comments more is that issues in dotcom were the most significant from a year-over-year impact. Because of some of the supply chain process challenges that we face we made decisions on some holiday goods to just take pricing and liquidation actions. We did not want to carry the inventory into the upcoming quarter. We felt like as I mentioned that is important for us to run the business based on the full year, based on the long term and not make decisions that artificially make the quarter look better than the business dynamics present but the dotcom piece was a large one.

The good news is those issues were identified, process improvements are underway and you can easily describe it as a onetime event that we don't see facing the same pressure going into the balance of the year. But in addition to that because we had in our minds that we can quickly and easily quantify what are our internal data weather impacts to the business from an apparel perspective we took action to rate some of that inventory so we could have the proper space presentation for new business coming in and again that's another example of not running the business for the quarter but thinking about the whole year.

And so those were kind of two big things that impacted gross margin and the good news is, is that we don't see those things repeating themselves in Q2. I mentioned that our May month to date sales performance is strong. We note that because I think it's important for us to demonstrate that April trend was not predicated on any macro dynamic, it was predicated on the weather because the moment weather normalized through last week of April we delivered significantly strong performance and that strong performance is carried into the month of May.

Jeff Davis

Then one other point I would add to that is that with the first quarter the mix of apparel was actually down in our overall composition of our sales. As a result of that the margin associated with apparel is a higher margin and therefore also impacted us also from a overall basis.

Mark Altschwager

And then Jeff just to follow-up at start of the year you provided some guidance posts on gross margin, SG&A, credit income just other items that built into the EPS outlook. I know there is a lot of moving pieces now with the accounting changes. But maybe just specifically can gross margin still be up slightly for the year and any change to your expectations on credit for the full year based on your experience in Q1?

Jeff Davis

So as it relates to our margin we are expecting our margins to improve over the course of the year. What we've seen this first quarter the decline is going to have an impact for our overall for the year but our expectations as we get through Q2 as well as the balance of the back half that our margins will continue to improve based on the actions that we are taking. As it relates to credit income, our outlook for credit income has not changed. The improvement that we actually saw in the first quarter was as a result of some marketing funds that we had received but the outlook with respect to the performance and the overall portfolio and the risk actions that we believe that we will have to take with our partner will remain as we have given in earlier guidance.


Our next question comes from Matthew Boss with JP Morgan.

Matthew Boss

Can you help quantify the impact of the calendar shift on your 1Q comps. I guess any sense on magnitude of the improvement that you've seen in May? And then with the second quarter guided up one is there any way to rank the initiative that you see in place to drive back half improvements and maybe including any update on the progress to your partnership?

Marvin Ellison

Matt on the calendar shift it's marginal. I mean we can spend the rest of the call talking about shifted, non-shifted. But I think relative to our business is not material enough to gain the nuances of it. Relative to the growth areas for the balance of the year, we have quite a few days but still have a significant amount of confidence. Beauty is a significant part because it is weather resistant and also it provides a level of differentiation and brings an increased level of relevance to our stores. So we have 27 Sephora openings, 100 InStyle salons being renovated and we just have a very strong and vibrant jewelry business that's going to continue.

We mention active where we're opening 700 fanatics shops this summer. We are very excited about that because we are arguably behind in the act of we're [trading] and this gives us the ability to catch up with a really unique differentiated brand partnership with fanatics. We have great expectations for our home refresh business. We have 100 non-comp appliance showrooms, we have 300 non-comp mattress showrooms, and we have a new brand that we won't comp against [Frigidaire] the back half of the year.

We continue to see improvement in our toy business specifically with the competitive dynamics in the marketplace. We're not trying to be number one in market share in toys, but it's a great addition to the basket and we are seeing great attachment data when a customer buys toys how she goes to other parts of the store and buys other categories. Dotcom continues to grow positive and was excited about the operational changes we have made, the structural changes we have made and we think that business is going to only continue to be strong and incredibly important part of our portfolio.

And last but really most important is apparel, we spent an enormous amount of time over the past 18 months fixing our apparel assortment and making necessary changes. That is really reflective in how well men's apparel performed in spite of some weather challenges we saw in the Midwest and the northeastern parts of our geographic areas. And when we look at women's apparel, we can see specific indications that business is very healthy, when we have seasonable weather trends the same with kids.

And so apparel is the most significant initiative for us to grow positive comps and again without some of the challenges we're facing in the first quarter, we think that will happen. So all of these things give us a significant amount of confidence. That we will continue to meet or exceed our sales guidance for the balance of the year and we're going to continue to just execute along those lines.

Matthew Boss

And then just a follow-up on the expense front what's your estimates for underlying asset sales in this year? I think as we think about core SG&A, how much low hanging fruit do you believe remains with your controllable costs and as you think about the marketing side, do you think you're leaving any sales on the table as you continue to reduce marketing expense?

Marvin Ellison

So I will talk about the marketing side outlet, Jeff will talk about asset assumptions. For marketing, we talked about marketing efficiencies. Our impressions were actually up 13% for the quarter. So we don't see what we're doing in marketing as a detriment to show voice in detriment to driving traffic. If you combine our online and store traffic we had positive traffic because of omnichannel retailers you just can't look at traffic in the traditional way. So we believe that the changes we're making in marketing, shifting more 1-to-1 backing away from preprint, investing those dollars into digital, social and radio gives us the ability to be a lot more nimble. And so we feel confident that our marketing strategy is not only efficient but it's driving increased impression of the share and voice and that we are going to continue to modify and continue to tweak it but we don't have any concerns about that. I'll let Jeff take the rest of your question.

Jeff Davis

As it relate to our asset sales and gains associated with that, at the beginning of the fiscal year we had given guidance of $50 million to $60 million of gain that we would expect over the course of the year. In my prepared remarks I had outlined what we had actually achieved in the first quarter associated with the sale of the Milwaukee facility. As it relates to SG&A, we believe that we continue to have opportunities in SG&A specifically as if we take a look at our overhead costs.

But also this year so far as with any other quarter we had already taken some actions, as related to our operations above store level as well as a few areas here at home office. We continue to want to find ways to be very disciplined and continue to find ways to quite honestly reshape our expense curve as we take a look at our national footprint and we still believe that we have some opportunities across the business in order to achieve that.


Our next question comes from the line of Paul Lejuez with Citi.

Paul Lejuez

You talked about a strong March but just curious I think March could have been helped by Easter. So I'm curious if you can maybe talk about March ex-Easter shift, maybe March and April together around that Easter period? And then, as I know you said that sales were decent in February and March. Curious if you had already picked up the pace of markdowns at that point or if you look at the sales gross margin equation during the February and March period, as being a strong one? And then I guess related to that if the margin pressure was just in April what were the specific actions that we're taken from a markdown perspective and over what period to cause such a big impact to the quarter?

Marvin Ellison

Well specific to the months, when we look at February and March, shift and un-shifted the business was very strong. When we look at April to provide some color the first two weeks of April were negative 12 and a negative 24 comp and that's when the weather was really difficult for us of North, the last two weeks were plus 9.5 and a plus 10. So that gives you some perspective on the dynamics of the month of April. And so we have good analytics where we can look at trends of businesses based on weather, based on sell through, based on geographic locations and we feel pretty confident in our analysis on how weather impacted our specific company and also how it impacted apparel specifically.

And as we look at the month of May when you look at shifted and un-shifted we are above our forecasts and apparel is performing significantly strong specifically in women's apparel and so it gives us confidence that we may provide strategic decisions. Relative to the markdowns and relative to our gross margin we took actions throughout the quarter. There was no designated period when we did more or less. April really hurt us from a sales perspective.

But when we were looking at the decisions we had make specific to some of the goods that were challenged in the online area due to process and some supply chain budget issues. We took those actions obviously in the earlier part of the quarter to liquidate them out and just to take aggressive pricing action. That was the most significant impact to our gross margin reduction versus last year because we had to take aggressive steps to exit our product that was not very desirable based on the time frame of the year and we did not want to carry it into the balance of the quarter or carry it into the balance of Q2. And so those were the most aggressive steps that we took to address those issues and they had a dramatic impact on gross margin.

Paul Lejuez

Got you and just one follow up. Can you talk about your plans on lease to own the business timing of that and what's broke into your guidance for that business this year?

Marvin Ellison

There is really nothing in the guidance. We're testing it. The thing that we want to make sure that we understand is all we are providing a service to the customer. At the end of the day we want to make sure that we give a customer that may not have the financial wherewithal to purchase something like an appliance that they needed, the ability to do it that can fall within their financial means. And so that we are testing in a couple of different markets, a couple of different iterations. It's still early but we hope to have some clarity on what we can or cannot do as we get into the second half of the year.


Our next question comes from Jeff Van Sinderen with B. Riley and FBR.

Richard Magnusen

Hello this is Richard Magnusen in for Jeff Van Sinderen. Thank you for taking my call. We know that you've been increasing penetration in some of the athletic and exclusive brands, but can you provide more detail on how you are evolving the women's assortment and any changes we can expect for back-to-school season in the fall time frame this year? And also we know that you have also been involved into omnichannel structures can you give us an idea about what we kind of change we can expect to see for omnichannel for back-to-school and holiday this year? And then lastly, are you seeing any impacts from the Bon-Ton liquidation?

Marvin Ellison

I will take the Bon-Ton piece, I have our Chief Customer officer, Joe McFarland here and I will let Joe talk a little bit about women's apparel going into back to school and we have Therace Risch our Head of IT and Digital and I will let Therace just talk a little bit about some of the structural organization of changes and some of the things we are doing to drive really the key part of our omni business, which is mobile.

As it relates to Bon-Ton we've not seen any material impact to our business with the Bon-Ton closings. Just to give you some context, we have 97 malls that we share with Bon-Tons. That number was 107, but over the course of the last couple of years they closed stores. As they liquidate we have seen no material impact to the business. We believe that's in part because those stores had very low inventory levels before the liquidation started. So there's not a lot of product to speak of that's driving traffic and that we think we're will cannibalize our businesses.

Obviously we're keeping a very close eye on that and we're going to follow it with intent detail. But as we look at our competitor Sears conversely we share over 350 malls with Sears and we had a 100 Sears stores close in malls we shared over the course of the last call it three years. So we have a really good understanding of the impact to our business when a Sears closes and the net effect is positive and it was positive even before we were strategically introducing categories like appliances and categories like mattress and categories like work wear.

So as we've introduced those specific categories when we see a Sears close is a greater significant benefit to our business in the whole end to end process. So it's a dynamic market place, we are paying very close attention to it and we're prepared to make sure that we can gain market share where it makes sense. I'll let Joe talk a little bit about women's apparel for back-to-school and what's coming, I'll let Therace talk a little bit about mobile and some of the other steps we have taken to continue to drive digital. So I'll let Joe take it first.

Joe McFarland

So from a women's apparel standpoint we continue to be very pleased with the work that Jodie and her team are doing in women's apparel. So specific categories beginning with active we continue to see great growth in our active brands. We will be leaning more heavily into Nike as we move forward, the expansion of Adidas and the other active brands and also our own private label Xersion brand. And so we continue to see a great progress for the quarter. Our women's active business grew double digits. Breaking it down into the more traditional customer, we are very pleased with the sequential improvements we see in our modern wear things like Worthington, things like a.n.a.

And so we will continue our refined approach to the mix to what the customer is responding to. In addition our Liz Claiborne brand we saw a great success in Q1. We have continued plans to continue to lean into the Liz Claiborne brand and continue to improve the overall women's. And then finally from a women's plus, the work that team continues to execute in the all plus size businesses across the entire store we are pleased with what we're seeing there.

Marvin Ellison

Okay. Therace.

Therace Risch

We've made significant investments in our ecommerce technology platform over the last 18 months including as Marvin called our mobile platform. This has been very important to set the stage for what we're starting to work on now which is creating a very much inspiring experience on the website. This is going to enable us to drive sales for apparel and fine jewelry which will improve our overall ecommerce profitability and we are also doing quite a bit of work to better connect the stores experience with the ecommerce experience. So that will work more seamless for our customers. So I'm excited that our technology platform is largely in place and that we can shift to a better customer experience going forward.

Richard Magnusen

And then I have one last question, can you give any more details on the new facility in Hesperia that you announced a couple of days ago and maybe exactly what size of a region it will service?

Trent Kruse

I will take that one, this is Trent. No details, I mean that's a replacement of our existing facility in Buena Park. It will do -- it will service what that facility was servicing frankly. So no meaningful updates. We decided to have a brand new facility launching great technology in place and will certainly enhance our capabilities on the West Coast.


Our next question comes from the line of Kimberly Greenberger with Morgan Stanley.

Kimberly Greenberger

Marvin I wasn't really sure I understood what happened with the ecommerce business, I think you talked about some issues during the first quarter. Would you mind just elaborating on that and then talk about the [six] that you got in place now? And then in the call out for the strongest categories here in Q1, you didn't mention appliances, can you just talk about the appliance performance in the quarter and any additional rollouts of appliance for the shop-in-shops as we get throughout the year?

Marvin Ellison

Okay. Kimberly for appliances first we delivered 15% comp in appliances for the quarter. It exceeded our internal forecasts and we are very pleased with that business. We're in the process of evaluating how we can make that business work with a smaller footprint because we have stores that are just square footage constrained. And so as we can figure out through test and pilots how to create a smaller footprint that we can possibly put in a smaller square footage stores, we will see the possibilities of improving or expanding the number of locations that we have.

We're pleased with our performance thus far and our best performing stores tend to be stores that share a mall with Sears, which gives us confidence that we can compete head to head very well. Relative to gross margin and ecommerce, we have to take pricing actions and clearance actions to liquidate dotcom holiday inventory. This was due to some supply chain process issues that prevented holiday product from properly flowing through the dotcom distribution centers in a timely way so that we could get it shipped to consumers.

The good news is we have store fulfillment capabilities. So we didn't lose sales because the moment the order was made and identified the system audited and picked and pulled it from a store location closest to the customer's zip code which was great for sales but it -- master issue that we were not effectively leveraging the supply chain capabilities to get the product in the band, meaning in the DC to be picked and pulled. So it's something that has been identified. We have put structure processing teams in place and this will not occur again, but it impacted the business.

And when we came to the realization that we had inventory that was not properly executed in the supply chain, we took action on it because as I mentioned, I t Jeff noted as well we want to make sure that we make a prudent decision for the business for the long-term and not carry that inventory into the next quarter, so we took really aggressive steps to exit it and those steps were the most significant impact to our gross margin.

Kimberly Greenberger

That's very helpful thank you so much. And then Jeff I just had a follow up on SG&A. Could you just describe the reduction of leasing expense associated with remaining amortization again on sale of a lease hold interest last year? Is that finished? What is that item exactly and is this the only quarter when you should see an impact -- when we should see an impact from that?

Jeff Davis

So you may recall that last year we had sold the Paramus New Jersey facility which we are actually closing this fiscal year. And in that transaction, we realized the $50 million gain, $20 million of the $50 million was recognized last year and $30 million of it was recognized this year. Given the fact that we were actually leasing back that property from the landlord for a certain period of time, we had to offset the gain against the lease expense and SG&A and is an accounting sort of standard we had to comply with. It is now complete. We would not have any more amortization associated with that transaction.


Our next question comes from Paul Trussell with Deutsche Bank.

Paul Trussell

Last year in the second quarter I think it's fair to say that was a dynamic time for the company, you had a number of store closings and liquidation sales on going. So just asking for maybe a little bit more hand holding on how we should think about the amount of recovery possible or expected in the merchandise margins for 2Q? And also you outlined already I believe expectation for SG&A dollars to be down in 2Q, can you talk about any potential magnitude and what the drivers of that cost reduction are?

Marvin Ellison

Jeff mentioned that we expect gross margin to improve year-over-year in Q2, and we expect SG&A to be down. SG&A decline is driven in large parts by continued efficiencies in the business, and we were really pleased with our performance in SG&A over the last couple of years. When we started on this path I mean we were significantly higher than what I believe we should be and we've gotten that number down to a more respective of range but we are going to continue to work on it. We think we still have structural opportunities with organizational layers that we need to address. We have opportunities to continue to invest in technology that will minimize the amount of ineffective tax that we are taking on in the store.

Joe McFarland's team is working really hard to find ways to invest technology, reduce tax and improve service and we've seen that occur over the last 12 months and we think there is still room for improvement. But there is no one that's a silver bullet, it's a combination of a lot of things very similar to what we are able to deliver in Q1. Relative to gross margin, Jeff outlined some of the key things that we are working on and we will continue to work on. Things like continuing to have more dynamic pricing and leveraging data from a pricing standpoint, continuing to understand which promotions are accretive from a customer response as well as top and bottom line, ensuring that we look at continue to lean into our markdown optimization which we are having some really nice success on.

A lot of work in the supply chain as I mentioned, Therace and her team have made tremendous strides to remove some of the impediments that were really negatively impacting the company on a profit perspective. In the explanation I've just provided with Kimberly regarding the issue within the holiday supply chain and process related issues with dotcom, it's not going to repeat itself. I'm glad we identified it and now we understand how we cannot allow it to occur again.

So it's going to be improved and we see an improvement in gross margin for the balance of the year and so we're going to leave it at that without getting into a ton of specifics because we want to make sure that we are going to be committed to just executing the plan that Jeff laid out and there are other things we are continuing to work on to hopefully give some upsides to sales and to profit.

Paul Trussell

Thank you. And you know maybe bigger picture. You know one of the pillars of your strategic framework is increasing revenue per customer, can you just give us an update on how your tracking on that front and what are some of the more specific initiatives in order to drive that initiative?

Marvin Ellison

What I will tell you is that we have been very pleased with all of our strategic initiatives, revenue per customer is defined as you are a core JCPenney customer and you shop us but you don't shop us across the entire store. So as we think about revenue per customer is about introducing things for our existing customers that they are unaware that are available at JCPenney. You will be surprised the number of customers still don't know that we have Sephora shops in 75% of our stores. And so you will notice more marketing along those lines and the specific of our marketing within the social media channels. We launched appliances and mattress and furniture simply because the data informed us that 70% of our customers where home owners, yet they were buying their furniture, mattresses and appliances in other locations. So that's an indication.

When we did our sales search analysis going online to determine what customers were searching for on JCPenney.com that we didn't sell the number one category was toys and so getting into that business is not again to be a market share leader but to have another category that increases revenue and increases basket size when a customer is in shopping. And we have -- we're behind as relates to active wear. Joe laid out some of the things we're doing in women's, but across the store, you know 700 fanatics shops are going to help us to take the customers that really want to have a broader form of activewear and give it to them, that's something we've haven't done in the past.

And the last component of revenue per customer is our special size business. You know we've done a lot of analysis on our customer demographic, and we understand that special sizes is something that they desire. And so our partnership with Shaquille O'Neal is to take our market share lead in men's big and tall and leading to even more. We talked about the performance about Liz Claiborne plus size women's business, that business is a non-comp business for the first half of the year and we're seeing terrific results.

Not to mention our kids plus business, Boys Husky, Girls Plus. So all those businesses fall under the umbrella of revenue per customer because they are customer shopping JCPenney, they wanted those categories and we didn't sell them. So that initiative is working well for us and we're going to continue to execute better and continue to research our customers and supply what else they are looking for that we can possible add to our assortment.


Our next question comes from Oliver Chen with Cowen.

Oliver Chen

I thank you very much. We had a question about women's apparel and creation and navigation in store. I'm just regarding the inventory levels and what you're thinking about the speed and the ability to touch read and react as well as making sure your customer can navigate well? Thank you.

Marvin Ellison

Oliver we have implemented a speed calendar and this impacts women's apparel more so than any other merchandising category. We have reduced the time from developed designs to sales more by 40%. We have certain categories in women's apparel that we are updating on a monthly basis and that's something that we've never done before. So we literally have a fast lane in the supply chain for women's apparel and this is primarily focused on tops, because we know that the ratio of tops to bottoms is something that we want to continue to get better at. And so when we think about that, when we think about our brands and our customer demographic that is one area that we have a high grade of optimism that's going to allow us to get this business to a positive comp.

And although we know we are impacted by weather in the first quarter, in women's apparel, the business did perform better than it did in Q4 and we are just going to continuously this business get better and better and part of it is newness freshness and the ability to create excitement on the floor with just more relevant and more recent updates to the business. And I'll let Joe just add a couple of more comments on that.

Joe McFarland

Over from the read and react standpoint we've spent a lot of time with the team and -- to bring about the new fashions sets that we've landed both in the month of March and in the month of April and then for this month in May. From the March set we were very pleased with the increase sell through compared to last year. The increase in the sell through and the same thing with the new set of fashion that landed on our floor for April set as well as our May set, I'm very, very pleased with the improvements that we are making, the creation of the design team, the merchandising team, our private brands team and really have this pulling together and coming to life on the floor and coupled with our new advertising campaign really like the earlier results that we are seeing.

Oliver Chen

And just a few quick ones. Regarding pricing are you feeling good about the consumer reception of pricing and simplification in terms of being competitive on the right key items and balancing how you communicate that message? And the last thing was about store based, I would just love your thoughts as you continue to innovate across omnichannel and think about format and service levels and the right levels of the CapEx and balancing lower productivity versus higher productivity stores, what is your latest framework and thinking about the physical plus to digital?

Marvin Ellison

So I think those two. On pricing we continue to focus on simplification. We think that in a high/low environment we have come to the conclusion that our customers prefer personals. It helps them to understand the value proposition. But there is work that we can do and that we are testing in making that a more simplistic math equation for customers. But we also have found some benefit in being everyday priced and it works by category at certain price points, worked really well when there is just a standard price and others worked better when there is personal. But that is something that Therace and her team are really working with the stores on to make sure that we have more continuity between online and in-store.

But we are making great progress. We have come a significant a ways from when we started this over year and a half ago. Relative to the store base I mean we talked a lot about omnichannel and I think the number is somewhere around 80% plus of all our ecommerce purchases touch a physical store and so stores are important and stores will help us to reduce the delivery and fulfillment costs over time. Having said that we know that we have to continue to invest the right level of CapEx.

That's one of the reasons why we are still investing in Sephora, fanatics shops , appliance show rooms, men's big and tall, women's plus, all of these required us to elevate the store presentation and that's what we're doing. And we're evaluating our fleet making sure that we're not going to run stores that are not productive or not adding value to the enterprise and that's an ongoing process.


Our last question comes from Chuck Grom from Gordon Haskett.

Chuck Grom

Couple of housekeeping things to attend. First on the $30 million gain, Jeff, is the assumption of the 50 to 60 asset real estate deals is separate from that or is it combined?

Jeff Davis

It is separate.

Chuck Grom

And then on the service costs, geographically on your P&L is that going to flow through as a contra pension income or is it going to come through on the SG&A line?

Jeff Davis

The service costs components flows through the SG&A.

Chuck Grom

And then just here in 2Q, that will seems like April got significantly better, if I recall back on 2Q of last year May was your toughest compare of the year. So I guess more of if you kind of look at the 1% guide as being conservative or realistic and how should we frame out the progression of apparel in the second quarter?

Marvin Ellison

Chuck what we're trying to do is we're trying to under promise and over deliver specifically on the revenue side. The key to our second quarter in the balance value is apparel and what I can say is we are very pleased with our apparel performance in the last two weeks of April and the month of May and that is going to be the lynchpin for our business and there is an enormous amount of work. So the short answer is we look at it as an under promise hoping to over deliver and we think we're going to be driven by improved apparel performance and we are saying that and that gives us confidence and that gives us encouragement that we are headed in the right direction.


And ladies and gentleman this does conclude the Q&A portion of today conference call and it also concludes the conference. You may all disconnect and have a wonderful day.

Recommended For You

Comments (12)

To ensure this doesn’t happen in the future, please enable Javascript and cookies in your browser.
Is this happening to you frequently? Please report it on our feedback forum.
If you have an ad-blocker enabled you may be blocked from proceeding. Please disable your ad-blocker and refresh.