Q4 2021 Joann Inc Earnings Call
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Ladies and gentlemen, todays conference is scheduled to begin shortly please continue to standby. Thank you for your patience.
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Good day, ladies and gentlemen, thank you for standing by welcome to Julien fourth quarter and full year fiscal 2022 earnings conference call. At this time all participants are in a listen only mode. After the speaker presentation, there will be a question and answer session.
To ask a question during the session you will need to press star one on your telephone. Please be advised that today's conference is being recorded if you require any further.
Please press Star Zero I would now like to hand, the conference over to your Speaker, Mr. Jay Chang head of Investor Relations. Please go ahead a J.
Thank you Sherry and good afternoon, I want to remind everyone that comments made today may include forward looking statements, which are subject to significant risks and uncertainties that could cause the companys actual results could differ materially from management's current expectations.
These statements speak as of today and the company undertakes no obligation to update or revise any forward looking statements to reflect subsequent events.
Information for future circumstances. Please.
Please review the cautionary statements and risk factors contained in the company's earnings press release, and our recent filings with the SEC during the call today management may refer to certain non-GAAP financial measures a reconciliation between GAAP and non-GAAP financial measures can be found in the company's earnings press release, which was filed today with the SEC and <unk>.
Due to the Investor Relations section of Chileans website at investors doctoral and Dot com.
On the call today from Julien, our Wade Miquelon, President and Chief Executive Officer.
<unk> Chief Financial Officer.
I'll now turn the call over to Wade Miquelon.
Good afternoon before I begin my prepared remarks, I wanted to personally acknowledge the horrifying situations in the Ukraine and related devastating human toll as an organization, we extend our deepest sympathies to the individuals and families who are affected by the tragic developments in Ukraine.
To that end Joanne is partnering with the Red Cross to provide direct assistance during the ongoing humanitarian crisis through this program, we will match all contributions.
Our team members dollar for dollar will continue to monitor the situation on behalf of our leadership team, we all of our financial and moral support.
Today, I thought I'd take a minute to reflect on our first year as a public company and highlight some key milestones that we've achieved a joanne.
Despite unprecedented and persistent supply chain and inflationary headwinds and challenging pandemic related sales comparisons from fiscal 2021 underlying growth in our core operations remained strong over the past year.
During fiscal 2022, Joanne delivered high single digit sales growth on a two year stack with double digit gross profit dollar growth.
We continue the expansion of our Omnichannel business, which has more than doubled based on a two year comparison, including the launch of new payment methods with coroner and Apple pay making it easier for customers to purchase with us.
We enjoyed a successful first year of our sort of our store refresh initiative. We completed 15 products the past year and are on track to ramp up that activity to about 40 locations next year.
We delivered record customer service scores across all channels. Despite a sport historic supply chain headwinds and labor shortages to include an industry best performance and curbside pickup where we consistently deliver to the customer in just two minutes.
We successfully rolled out our new Pos system to more than 300 locations modernizing our checking experience and setting us up for future innovation and expect that process will be completed across our store fleet in the current fiscal year.
Also I'd like to highlight the opening of our multipurpose distribution center in Columbus, Ohio.
This fulfillment center is truly unique and completed the first phase of the project and when completed later this year. The center will allow us to expand our omnichannel fulfillment capabilities, while also harnessed handling the seasonal flow of merchandise into our stores.
Addition, we believe that the opportunity improve line fill rates and reduce split shipments is a significant opportunity for joanne to improve our caution omnichannel profitability once fully operational.
Okay.
We expanded our doing good while doing good charitable giving platform raising over $3 million for our key partners Susan G. Komen nationwide children's hospital in St. Jude and we're on the way to record fundraising for four H in early fiscal year 'twenty three.
We took steps to improve our balance sheet through the sale leaseback of our Opelika, Alabama distribution facility and we refinanced both our long term and revolving credit facility at more favorable pricing terms.
We've also made several strategic announcements that should open new paths for value creation in the future, notably we ended the year announcing a 50 50 global joint venture with SPP or singer biking Fab. This new partnership will bring exciting products and services as it revolutionized the pattern access design and the cutting process for source everywhere.
The number one so as pinpoint into the most fun part of the process is just the beginning of this journey.
The digital launch remains on target for later this year and we'll have more to share as we get closer to that launch.
And during fiscal year 2022, we successfully launched our international E Commerce platform shipping now to over 50 countries in just six months into the launch.
Okay.
We continue to add new customers, who Joanna hit a high rate.
Through the end of fiscal year 2022, our known customer database grew by 42% over the three years and is now in excess of $77 million or <unk>.
<unk> profile continues to evolve with this new additions, becoming younger more diverse and demographics and the crafting of selling interest and also more digitally native in fact, 85% of the new customers acquired in fiscal year 2022 were acquired through digital channels. We believe this sets us up for future growth.
Yes.
Another highlight this past fiscal year was the performance of our top customer segments, those who are true category enthusiasts.
To grow sales with these customers by over two X versus our average the strongest two year comp and also positive comp on a one year basis as well.
We are particularly excited about our ability to grow both sales and share with these customers along with increasing gross margins at a higher rate than those interface as well.
<unk> been purchasing at the same rate, but now with higher average unit retail due to pullbacks, we've executed with promotions. These category enthusiasts recognize and appreciate our breadth of assortment and quality value and most of all and knowledgeable service we provide in our stores to continue to participate at a very high rate.
I now want to touch on our fourth quarter operating performance. After a slow start to the quarter. We had an acceleration of our sales trends during black Friday and this momentum continued over the holiday period through the end of December . However, we did experience some incremental softness in January resulting primarily from a pullback in customer traffic as the omnicom variant spread.
We did see a greater shift to online during the month of January from ship to home demand to customers choosing more curbside pickup versus coming in store for their online order, but that was not enough to offset the retail traffic dip.
Estimated the combined impact of Omnicom, along with some significant weather storms, resulting in incremental store closures was between 100 200 basis points on our fourth quarter sales performance.
Recently, we've also experienced some additional pullback from the consumer following the recent geopolitical developments and the related sharply higher fuel costs and we'll expand on more of that later.
Okay.
Finally, as it relates to our fourth quarter I want to highlight the impact of excess ocean freight costs. As I mentioned, we were very pleased with our sales performance during the holiday period, which was a result of our proactive merchandize flow planning earlier in the year, we were clearly in a better in stock position on holiday versus some competitors, enabling us to take market share.
However, delivering that seasonal inventory on time really came at a cost to our operating and financial results in Q4, while we previously anticipated that excess freight costs in Q4 will be approximately two times higher compared to Q3. The impact was around three times higher on a sequential basis contributing factors to higher than expected freight costs in Q4 included significantly higher container rate.
Trans loading fees and additional expenses, including retention of demurrage fees the industry up stranded containers that was prolonged congestion at the west and East coast ports.
Any retailer would be remiss, if they did not acknowledge the uncertainty and stress in the current operating environment and Joanne is no different.
Over the past few weeks, we have seen a shift in behavior, among our noncore customers that Joanne as the war is exacerbated inflationary pressures and clearly created anxiety for all regarding the state of the world at large.
Our internal and third party data indicate discretionary spending in aggregate is under pressure due to elevated fuel prices higher energy costs and higher inflation across the board.
We are evaluating these macro forces will make relevant adjustments to our business as needed.
Heading into fiscal 'twenty 'twenty three we have always anticipated that sales comparisons will be unfavorable in Q1 due to a 15% comp last year.
Also expected comps would resume positive year over year growth beginning in our second quarter of fiscal 2023 going forward. Our outlook in Q1 is incredibly cautious incrementally cautious as we continue to monitor macro factors and the related consumer behavior on a near daily basis.
We're seeing accelerated growth as some critical reopening categories, such as special occasion for weddings problems and parties, but again. This is weighed against other categories that are under pressure from the macro forces outlined having said that we continue to believe that we are broadly holding or in some cases building market share and this is the key metric we are focused on to ensure actions our balance for the long term.
Overall I'm proud of the combined efforts of our teams and navigating through unprecedented supply chain challenges during the back half of fiscal 2022, even after absorbing nearly $60 million for higher year over year logistical costs. It should be noted that our gross profit dollars measured on a GAAP basis still grew by approximately 10% in fiscal year 2022.
On a two year stack.
And while we believe that these costs have reached an inflection point following our fourth quarter. At this time, we still have complete visibility on the financial impact for fiscal year 'twenty three in part because we are still not completed our annual ocean freight negotiations.
Well, we expect spillover effects from supply chain disruptions to impact us in the current fiscal year longer term. We believe that most of these costs will prove to be transitory and that margin comparisons will significantly improve as these eventually normalized creating a multiyear tailwind.
I previously mentioned that we have more to share in the months ahead in relation to other blue Ocean initiatives at Joanne today I'm excited to announce that we forged strategic partnership with JDM growth group, a premier wholesale and E. Commerce consulting company leadership of JDM includes members of the <unk> family, who had extensive background in the arts and crafts industry. This partnership will forge new avenues for Joanna the BW hold.
<unk> channel ranging from single sellers, all the way to multi chain retailers. In addition, the team will continue to pursue other channels to showcase our in house private brands launched as soon as next month.
Following our press release last week I'm also excited to highlight our recent acquisition of <unk> and for those not familiar with <unk> as a leader in innovation and digital textile printing and related solutions.
Partnership with leave up again in 2018 and this relationship expanded further following the subsequent round of financing led by Joanne since that time, we've tightened our proposition to create value and my company is fully together. We believe we can accelerate that journey. We've up is led by foot Davis and is truly a unique software company that empowers digital textile solutions for the consumer commercial.
Patients and hospitality markets. This will allow us to create the highest quality bespoke consumer and designer fabric and other offerings streamline our product development sourcing processes enable both digital and rotary mills to be more efficient the evolution of our relationship with <unk> is a great example of how we've only scratched the surface with our blue Ocean growth initiatives and there'll be more to share on other initiatives.
As the year unfolds.
There have been some recent developments regarding the class action litigation of which we are apart regarding the legality of section 301 tariffs with China that went into effect in 2018.
A three judge panel has hurt the case and has the ability to either dismissed the case overturned the tariffs, which could include back tariff refunds and penalties or move the case to a trial.
We understand that decision should be forthcoming in the coming weeks four months.
Further the ministration stenting required review of U S trade policy related to section 301 tariffs. The current tariffs are set to expire for years. After they were initially implemented unless the administration makes the case for their necessity moving forward.
Our forecast and projections continue to assume that 301 tariffs will continue into the foreseeable future, but that said, we would welcome any incremental tariff relief.
In closing we've enjoyed a number of successes in our first year back as a public company, we've dealt with unplanned and unprecedented business disruption head on from over 20000 store team members to our distribution members to those at our store support Center I want to thank you for your support for our ongoing efforts to keep our customers at the front and center of everything we do.
We remain focused and committed to being a friendly clever allied to our customers into each other and I am very excited about the journey ahead.
But more to come in fiscal 'twenty, three and beyond and with that I will turn the call over to Matt for a more detailed review of our financials Matt.
As we've mentioned over the past several quarters fiscal 2022 was an important transition year for Joanne as a newly public company.
I'll cover some key highlights of our fourth quarter and full year results and provide some additional color about the outlook for fiscal 2023.
We reported net income of $13 6 million in the fourth quarter with diluted earnings per share of 32.
Our adjusted diluted EPS was $1 16 in the fourth quarter compared to $1 65 last year.
Adjusted EBITDA was $88 9 million for the quarter compared to $106 1 million last year and to $80 6 million in fiscal 2020, a 10% increase on that two year basis.
Net sales were $735 million, reflecting a decrease in total comparable sales of 12, 4% to last year's fourth quarter on a two year stack comparable stores comparable sales increased by 6% in the fourth quarter.
While we while we will not normally call out the cadence of our monthly sales we've experienced much more volatility in our business lately due to a variety of external economic shocks and disruptions. So I'll provide a bit more color on this current quarter.
For further context, our two year comp was just under 1% for the month of November reflecting a slow start to the quarter, followed by a sharp acceleration through black Friday.
We finished December very strong with a two year comp of 10, 4% for the month, giving us optimism for the quarter overall coming out of the Christmas holiday.
However, based on the combined impact of weather a surge in COVID-19 cases, and some later arriving spring inventory at the end of the quarter, our sales momentum stalled in the two year comp decelerated to 6% for the month of January.
Our omnichannel business continued to be a significant growth driver for Joanne.
On the channel penetration represented 14% of our fourth quarter sales refract, reflecting growth of approximately 125% compared to two years ago.
We have been focused on our growth and gross margin dollars on a two year basis as we reset our baseline performance over this past fiscal year.
Our GAAP basis gross profit declined by 1% in the fourth quarter on a two year basis, driven by expected, but escalating increases and excess freight and related supply chain costs.
We fully absorbed around $42 million year over year of higher Ocean freight cost in Q4 of which $35 3 million was included as an adjustment to gross profit on a non-GAAP basis as we believe those amounts represent a transitory impact to our operating results driven by market conditions springing from the COVID-19.
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After accounting for the impact of excess import supply chain costs adjusted gross profit increased by approximately 10% based on a two year comparison in Q4.
Adjusted gross margin rate improved by 170 basis points on a two year basis and by 190 basis points over the fourth quarter last year, as we continue to deleverage sourcing opportunities and optimize promotional discounts.
While we took proactive and aggressive measures to ensure we were in stock on our seasonal inventory. These efforts were in part frustrated by ongoing severe congestion in key U S ports that we deliver product through.
That congestion did delay a portion of our Christmas and spring deliveries impacting early holiday sales in November and spring in the spring season category sales in January.
It also drove higher handling costs and fees to move goods through these ports than we were expecting or that we communicated earlier.
Excess import freight costs in Q4 were roughly $11 million higher compared to what we contemplated as of our third quarter earnings call.
Our fourth quarter, selling general and administrative expenses totaled $278 4 million a decrease of 11, 3% compared to the same period last year and an increase of nine 4% on a two year basis.
A significant source of variability relative to last year was a reduction in direct store expenses related to COVID-19, as well as lower incentive compensation expenses.
Relative to the fourth quarter of fiscal 2020, or two years ago, our expenses increased at a slightly higher pace than the 6% comp sales growth due to increases in domestic distribution center cost to handle later, arriving goods increases in strategic and technology development costs and higher incentive.
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Pre opening and closing costs were $2 1 million during the quarter $1 6 million higher than last year as a result of increased store refresh activity.
During Q4, we also refinanced our ABL credit facility, which will lower our borrowing cost based on more favorable pricing terms.
This follows the previous refinancing of our term loan during FY <unk> during fiscal 2022, which allowed us to extend debt maturities also under more favorable pricing terms.
I'll now provide some high level comments on our financial performance for the full year.
In fiscal 2022, net sales increased by seven 9% to $2 4 billion and comparable sales grew by eight 3% for the year. We also absorbed nearly $60 million year over year of additional ocean freight and related supply chain costs of which $46 6 million was excluded.
From our adjusted EBITDA and adjusted gross margin non-GAAP measures.
Despite the unprecedented and historic supply chain disruptions for the full year, our gross profit dollars on a GAAP basis still increased by 10% over the past two years.
Gross margin rate increased by approximately 90 basis points to 52% in fiscal 2022 compared to fiscal 2020.
Adjusted for excess Ocean freight unrelated supply chain cost gross margin rate improved by 280 basis points from two years ago, our fiscal 2020 to 52, 1%.
For the full year adjusted EBITDA was 245, $242 5 million, an increase of 58% on a two year basis compared to fiscal 2020.
Yeah.
Moving to the balance sheet and cash flow metrics cash and cash equivalents were $22 $5 million and net long term debt was $778 6 million as of January 29 2022.
Capital expenditures expenditures in fiscal 2022 were $59 1 million or $54 1 million after accounting for $5 million in landlord contributions toward our store refresh projects.
We ended the fourth quarter with inventory of $658 6 million, an increase of $102 7 million or approximately 18% over the prior year.
While we did expect to see increases in inventory due to depleted stock levels at the end of our prior fiscal year. Much of this increase was driven by excess ocean freight cost, which represents $46 million of our inventory balance at year end.
Earlier this year, our board of directors authorized a share buyback program of $20 million to address dilutive impact of share awards granted when we were a private company.
During the fourth quarter, we repurchased 910120 shares of our common stock at a total cost of $9 2 million.
And with previously reported share repurchases for the full year, we repurchased $1 889.
$50 50 shares at a total cost of the full $20 million provided under our board authorization.
At the end of fiscal 2022, our trailing 12 months credit facility adjusted EBITDA was $251 $3 million, resulting in a leverage ratio for net debt less cash to adjusted EBITDA of three one times.
Our longer term leverage target of approximately 2.0 times remains unchanged and we.
And once we see relief from the current level of excess import freight costs and other temporary inflationary pressures, we expect to drive toward that level over the following 18 to 24 months.
Our quarterly dividend of <unk> <unk> per share was paid on December 29 to shareholders of record as of December 15th 2021.
Our board of directors recently authorized a quarterly dividend increase of 10% to <unk> 11 per share to be paid on April eight to shareholders of record as of March 25 2022.
Before I provide some comments about our outlook for fiscal 2023 I wanted to highlight the current operating environment and the challenges it creates from a visibility standpoint.
On a positive note we are seeing a resurgence in several categories tied to larger social gatherings and charitable giving that had been depressed throughout the pandemic.
However, following an initial consumer pullback primarily related to a spike in Covid cases. During January we are continuing to see softer sales. So far this first quarter.
Given our tougher comparisons this quarter, we entered the year expecting our first quarter comparable sales trend to be negative in the low mid to single low to mid single digit percentage range.
Since the start of the conflict in Ukraine, three weeks ago and related surge in energy and other commodity prices on top of already worsening inflation, we have seen that trend declining by approximately 5%.
Data, we used to read overall competitive and general consumer discretionary spending trends indicate to us. This is a general pullback in our space and that we continue to build on our market share.
As communicated earlier, we entered this fiscal year with the expectation that we would begin to see trends at our sustainable growth model of 2% to 4% comparable sales growth as early as our upcoming second quarter.
While we remain confident in our growth strategies current external pressures, including geopolitical unrest escalating inflationary pressures on both our business and our customers as well as ongoing supply chain disruptions, including recent COVID-19 related shutdowns in China, we are managing the business to a more conservative outlook until we have more certainty around the links.
Severity of these external headwinds.
For those same reasons, we are not currently providing specific sales and earnings guidance for fiscal 2023.
I can provide the following general perspective on the more material aspects to our operations and financial outlook.
We are experiencing increased costs for many of our products, particularly those that have petroleum input costs, such as polymers and fleece fabrics.
We have specific pricing actions that have already been taken and others that will be executed over the next few quarters that we expect will enable modest growth in adjusted gross margin rate.
That growth in adjusted gross margin rate is expected to be offset by what we see is prolonged but still temporary excessive international supply chain cost.
As Youll recall these excess costs did not begin to impact us until the third quarter of this past fiscal year.
Based on our read of the Ocean freight market and expectations at U S. Ports, we will continue to be congested, we see these excess costs affecting our results for all four quarters of this year before normalizing gives.
Given additional time to plan, we are taking steps to add to our ocean carrier capacity and flexibility to deliver over the most efficient routes.
While we currently expect the excess freight impact reported this past fourth quarter to be the peak of this headwind. We are currently in negotiation of our annual contracts that will commence. This June so we will have a better visibility to win to that when we announce our first quarter results.
We continue to manage pressures on labor and other inflationary headwinds impacting SG&A expenses, we will have some one time year over year increases to support investments in our store refresh program, our new point of sale system and other technology enhancements as well as our blue Ocean initiatives, but otherwise expect expenses to grow below levels of journey.
<unk> inflation.
For fiscal 2023 capital expenditures net of landlord contributions will be approximately $70 million to $75 million.
Primarily to fund our new point of sale system rollout completion of our multipurpose distribution center near Columbus, Ohio, and Grand opened 40 store refresh projects of which over half will be relocation of smaller stores to our larger prototype model.
Pre opening and closing expenses for those projects are expected to be in the range of $15 million to $17 million.
Depreciation and amortization is expected to be between 81 and $83 million a.
A slight increase to this past year driven by the capital events investments I just mentioned.
We have reduced our planned number of store refresh projects for this year from our earlier provided range of 50 to 60 due to current challenges and availability and cost of obtaining construction labor fixtures and related supplies. We expect these costs to normalize over the coming year, as well and anticipate accelerating to that higher run rate.
A project completion once they do.
We estimate annual interest expense of $47 million to $50 million, which allows for an increase in variable interest rates currently being contemplated by the federal reserve.
We expect to have an effective tax rate on a GAAP basis in line with what we experienced in fiscal 2022 of approximately 18%.
In summary, while we are managing through more broad and persistent headwinds. We also have demonstrated the ability to garner new customers and market share. During this past year that will support our future growth I also share weights enthusiasm about our new blue Ocean initiatives and related strategic partnerships that we've recently announced and other opportunities that.
We continue to nurture and we will announce as they mature.
With that we'd be happy to take your questions.
Thank you as a reminder to ask a question.
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These standby, while we compile the Q&A roster.
Our first question will come from Dan <unk> with Bank of America. Please go ahead.
Great. Thank you. So you mentioned that your core enthusiast customer comp positively in the fourth quarter can you just talk about what percentage of sales. They represent and then how many of your newer customers that you gained during COVID-19 has essentially disengaged from the category or have shopped with you.
Yes, I mean, our top 3 million, we've always said about 30% and then our kind of our next part of our tours of three 6 million, which.
That rounds out just slightly below 50, that's all been strong and actually through the quarter. It was all reasonably strong I think it's really that.
Kind of the last three weeks, what Matt was saying that that far down in database.
Has it been less engaged since the war really.
And.
Its across all categories from that customer more or less it's just really a traffic issue for I think someone who's got some anxiety about inflation and anxiety about what's happening in the world. We've seen it before with natural disasters is same kind of pattern in the short term so it's not new to us but.
But it's really been the last few weeks we've seen that.
Right.
Our top customers have been growing at a faster rate than our lower customers, which is if you had to pick one that's what you would want to see.
Alright, great.
And then I just wanted to clarify a statement that was made about it.
Okay.
As soon as the first quarter being down low to mid single digits now.
It'd be about 5% more so are you now.
Expecting about down high single digits to low double digits I just wanted to make sure I interpreted that correctly.
I'd say, where it's kind of day by day right, even if I say youll see is much stronger today than a data perhaps back to what we've been talking about so it's hard to say, but I would say that thats probably if this current trend continues that's probably reasonable.
Okay, Alright. Thank you again, what we're cycling of 15.
Last year. So you have to also keep that in mind I think as you model.
Yes.
Thank you. Our next question will come from Steven Forbes with Guggenheim. Please go ahead.
Even though.
Maybe just to start with the 40 projects that are planned for 2022 liter Mackie.
Probably a little more detail about how you would classify them between the three types of projects that we discussed during the IPO.
Our process and any color sort of on the cadence of those projects.
Yes, I can take on the tape this Matt.
As I mentioned in my prepared comments.
Slightly over half of those are relocations so.
We will have 23 of those that are currently plan.
And then we will have about another.
And these <unk>.
Scale and scope on these do more of a little bit over time, but in general we'll have about five to 10.
A more higher end Remodels and then the balance of those will be.
The work that are primarily to.
Reestablished the most efficient macro layouts for the stores, so lower touch a bit lower cost.
Remodels cadence as we've mentioned before because we're kind of coming out of.
Having to shut a lot of these products down for the pandemic is going to be a bit back weighted so well over half the projects for this year will be grand opening in July or later.
Across the whole portfolio of our projects when you put them together in aggregate we are actually.
Outperforming our pro forma both in sales and the profit contribution, but what we're also seeing right now in the short term as some of our projects and markets we're seeing contractors.
Trying to take significant increases we're seeing on some of the things like fixtures significant delays. So as we've redone the plan from about $55 to $40.
We have been able to prioritize the ones that makes sense and where we're not going to have.
Kind of the short term inflation burdening, what we think is the appropriate long term investments more or less and a lot more certainty around delivering them on time right.
And then just a quick follow up at a high level. If we think about gross margin obviously.
It would be elevated freight cost.
The associated impact, but any any sort of.
Changes to call out within me sort of other line items within gross product margin shrink.
Clearance and are there any sort of changes both positive or negative that are that are worth noting.
I think we had the same general positive trends on shrink and clearance.
Our clearance inventory as a percentage of the total continues to be very well managed and low we are starting to cycle. Some of the improvements we made on those so I would say that we expect them to be positive contributors to our year over year gross margin, but probably not as.
Strong as they were this past year. If you do look over our margins over time I think we've made extraordinary progress considering the inflation, we've absorbed the considering the ocean freight.
Transportation issues and considering tariffs.
I think we feel pretty good about this environment that we can keep driving margin to make sure. We can absorb those but having said that gross profit dollar is really our first and foremost focus driving that in this environment. When it's very very hard and expensive to get products.
I'm sure that we're putting that in front of the radar makes even more sense.
Thank you.
Thank you. Our next question will come from Paul Cooney with Barclays. Please go ahead.
Hi, everybody. Thanks Bill.
Multi part on the excess freight and then a follow up.
First.
As you pointed out you expected at the double and Triple what drove the variance what drove it higher for what you would expected in December.
What do you expect it to be for Q1 next year.
And then can you just remind us how this flows through to your inventory and how it impacts gross margin into next year and then we'll follow up after.
Sure I'll try and make sure I capture all of that.
Call me on it if I don't.
So the first piece on what drove the incremental from our earlier expectation for the fourth quarter nearly 100% of that.
Was.
Cost, we incur due to congestion at the port so to the extent, we have container stock imports at a certain period of time under our contracts, we incur fees for that and at a certain point in time those become pretty material.
I think this is something with more time to plan, where you would be able to manage much better next year, but we definitely ran into some some costs that we incurred around the fact that we had product container stop there some additional handling costs as well, but those fees were also a significant piece of that I'm sure everybody is dealing with this but this is Paul.
The issue Thats been outlined by the administration, which is.
Even whether it's not our fault or not if it has been stuck there.
We have to pay either directly or indirectly through our carriers to be able to get those released.
And so again I think this is an issue that will get better overtime.
It really hasn't been seen before but I think it's much more widespread than us.
On the first quarter expected impact.
I would say, we're not in position to give a very specific number on that but basically what we said is the $35 million.
We experienced of that in the fourth quarter. We do think is the peak quarter. So you will see it come down from there, but I think it'll be it'll be approaching that number, but certainly don't expect it to be.
100% equal to that because of the P&L will have a lot of the flow through from the prior quarters, but our cash spending this quarter on that will have to be pretty good because our volume is lower our contracts that we have a pretty good and a much higher percent of our Congress will be honored this quarter, because it's a lower quarter in aggregate so.
There is a.
Receipts in the cash flow versus P&L timing mismatch here, which is kind of your last piece of your question how.
How does it flow through our inventory and then to our P&L basically this works is we're paying.
Excess cost for moving the container and then if we're incurring any additional fees and cost either trans load or.
To the extent what unfortunately, we do have some containers stuck in ports that were paying fees related to those.
That all we're able to attach that to specific purchase orders for our inventory.
And we attach those cost to that inventory.
That's what represents a $46 million, we had at the end of the fourth quarter as those products sell we release those costs through our gross margin.
And that the adjustments you'll see two our adjusted EBITDA to get from GAAP basis to adjusted gross.
Gross margin.
And then obviously on a GAAP basis, it's fully fully expensed, but yeah. It's basically we're able to identify those freight costs to specific inventory and until that inventory sells it sits on our balance sheet once that inventory sells through run through our gross margin.
Okay.
My second one is on the section 301 tariffs can you remind us how much of your product mix is impacted by that.
Second.
How would you think about a reversal in tariffs would you maintain prices would you pass on some of that price to the consumer to take share.
And what would the potential timing b to your financials from from if that.
Reverses.
Yeah. Good question, So just remind people in 2018, we.
We had the tariff through when Larry Love. It in two phases that was about $85 million to $90 million a year of tariff costs.
Let me against Us and I don't know the exact percentage I want to say, it's in the mid to high <unk> or something in total.
But nevertheless, we've been able to mitigate about half of that overtime.
If they if they were.
Revealed one way or another.
Of that $45 million, I think more or less half of that was directly paid by us which would be something which would be pretty forthcoming. The other component was passed on by people that beta.
Directly in the raise it with us and that would have to be a process of going back to negotiate for the future.
We will see if that happens or not.
If they are going to be legal.
The best case scenario is we would get a repayment for.
Substantial money.
More than $80 million plus interest I think will be the number.
There is also a scenario where nothing happens so so we'll see.
But I think like I said in terms of the media benefit we probably will get close.
Close to half of what we currently haven't mitigated before we start to work supplier by supplier to see what we can do there.
Emphasize again, although we covered this in his remarks.
Our current expectation.
How we're managing the business from a cost perspective and pricing, we're not expecting any relief on tariffs at the moment.
Alright, Thank you best of luck.
Thank you.
Thank you. Our next question will come from Peter Keith with Piper Sandler. Please go ahead.
Hi, good afternoon, and thanks, everyone.
You've seen pretty good gross margin lift through 2021 as you've talked about there's just been a lower promotional environment. You haven't had it takes many markdowns.
What are you now seeing just kick off the year as sales.
And the industry have weekend promotion starting to pick back up at all.
I haven't seen that and the other thing I'd say, that's very interesting is we have actually taken some pricing.
Unfavorable skus, but we've also had holdout markets and we've really not seen any difference in unit flow, whereas had pricing or no pricing. So there's little pullback. We had is really more of a traffic issue across the board with this particular customer.
But not really a meaningful behavior change with the balance of customers and that's kind of another way, we're able to triangulate.
What I would call more of a.
And inflation in <unk>.
War shock really versus an overall pricing issue.
Okay.
And then.
So just wanted to just break apart.
The freight.
Freight costs and the component that stripped out so just mathematically I think you said that the freight costs were $42 million higher and you've stripped out.
$35 million, so does that leave a balance of about $7 million that isn't included in your adjusted gross margin.
Yes for the quarter, Yes, Thats correct. Okay. So so for is that a fair way to think about the freight pressure on an adjusted gross margin basis going forward about maybe about 100 basis points of <unk>.
Pressure for for Q1 Q2 has seen some cost continue.
Yeah.
I hesitate to give a range because some of this does depend.
Relative sell through of products that are impacted by this in and mix. So.
I think in a general scale youre, probably in the ballpark, but again.
Hesitate to give more specific guidance than that.
Okay I'm.
Sorry, one last question just on this topic when we look at that.
100 basis points that is flowing through adjusted Azure contracts readjust in June I.
I think most people would agree with everyone's contracts will go up.
But theyre just be less spot market pricing.
Should we expect on an adjusted basis that Youll continue to have freight pressure through the year as your your contract rate probably will move higher mid year.
Yes, I mean, what you said is I think right.
Because people will have hopefully more contracted not only because it made a contract and more of it because more is honored.
So you are less on the spot market from everything we're seeing.
On a year to year basis of what you actually get including all the ancillary fees should be better this year than last year.
But thats kind of the new normal will set in the year after that and what that new normal what we believe is kind of what we're calling our non adjusted.
From all the benchmarking work and what we're seeing in the indicators I think thats, probably the current best thinking at this time.
Okay, I don't know that answer right, but youre exactly right about the contract rates being higher but less on the spot, which you know some of our spire last year. It was pemex are sort of contracts.
So.
Okay.
That helps a lot. Thank you very much.
Thank you. Our next question will come from Daniel Hopkins with William Blair. Please go ahead.
Good afternoon.
Just I.
I guess one maybe.
If you could refresh our memory.
One question that we get from a number of investors can you just kind of a general approach.
Yeah.
Are they kind of the rationale for the adjusted numbers.
Specifically as it relates to elevated freight costs.
Are there ways in which these factors are a lot bigger for you than for most companies, but just the question. We're getting is basically like why why are these investments.
Especially given.
But theres so little visibility for the time being on when what the trajectory is going forward just curious if theres any.
If you could kind of just refresh our memory.
Thought process behind the adjustments I think everyone understands that if the environment gets better the cost structure will improve but just help us understand that a little bit.
I recognize that there is different ways to view. This so not make anybody wrong or is it a different way I think the way we view it as a couple of things one is that.
It's a very very big number to the degree that we are directly or indirectly importing 90% of what we do in a huge percent of that.
From where the lanes are most pressed and then you know the average item that we sell is $4. So when you look at.
If we were importing.
Luxury launches or movies or something but this wouldn't be an issue, but when you have bulky things or cost a couple of Bucks yourself, a four box its a big percentage of that so if you combine that with the fact that.
We don't want to do is we don't want to over price for something which we believe you know in a year or so is going to normalize.
That's going to be a situation that's not great for the long term and we also want to make sure that when we're setting our objectives were.
We're not lowering our threshold for the future at a much lower base because we're assuming these are permanent when they are not permanent then we're spending that away or eating that away for value creation. So so that's really the philosophy is that there are very big they are very material.
These two will normalize and we want to make sure that we're running the business model in a way that will create value for the long term without.
Making tactical destructive short term shifts along the way.
Yes, I think it's maybe the question's a little bit about whether these should be formal adjustments and the numbers are just started discussion points around.
Areas of cost pressure, but I hear what youre, saying.
Hopefully that we're trying to be as transparent as we can on the number and then.
I'll, let them at least they know what the aggregate number is.
Sure, Okay and then.
In terms of sales picture it sounds like things have weakened quarter to date.
That's before lapping stimulus from last year is that inclusive.
The benefit and the comparison last year in March.
We're modeling that and a little bit we don't exactly know how much benefactor, we are a stimulus.
Not a lot, but I will tell you that what we kind of call.
Our technology sales.
We are modeling what that spike was last year. Some of that was because you have innovation and you had a lot of huge offers last year and some of that could be everyone getting a benefactor, but that's where we usually get it as a big machine sales high ticket. So I think we are factoring that in.
But like I said, what you could see as of the day when the warhead a certain kind of customer was just frozen for whatever reason.
And we have seen that before.
And then we see that customer ultimately normalize and come back but.
I think the biggest piece, we're seeing right now is just that.
Shocked that that customer has.
I'm sure I'm sure.
I am sorry go ahead.
Oh, I'm, sorry, I didn't mean to cut you off and some of the data that we get in terms of you know across all discretionary and other spend it seems to me that the consumer has a similar patterns in many other areas. So.
I think it's something that a lot of others are probably seeing them I guess.
Okay.
And then I guess lastly can you can you give any color on kind of category performance either traditional showing versus some of the newer arts and crafts businesses that are bigger underdeveloped and is there any way to kind of talk about that before the recent slowdown in what youre seeing more recently.
Yes, we don't get for competitive reasons too into the weeds on this but I can't say the themes.
For one it's very consistent with.
The teams we've expressed earlier.
We continue to be pleased with our ability to grow.
Our arts and crafts business at a rapid rate than our overall growth, which again, we've got more opportunity to take share in that range. So.
That's good for US I think the other thing is we're very pleased with where seasonal came in in the fourth quarter given the challenges on getting a lot of that product and country.
Even with those challenges we had very solid performance on our seasonal business over the last quarter and on the selling side.
As we've come through the quarter.
Come through what I would call Omicron, you really saw an omni crown hit kind of the end of December you saw kind of again the same traffic shot.
But we're actually within selling as Matt said before our special occasion, which is tied to it as an example tide reopening events Proms weddings all of that is really starting to.
Explode, which is good that has been our theory on the reopening. So we have a few other businesses like that too, but it's just a certain percentage consumer segment across.
The broader business that I think is kind of sitting in front of the television set and wondering what the future holds.
Got it okay.
Thanks Best of luck. Thank you.
Thank you.
Thank you. Our next question will come from Cristina Fernandez with Telsey Advisory Group. Please go ahead.
Okay. Thank you. Thank you for taking my question I wanted to ask on the inventory can you expand about.
You know the quality of the inventory you have on tap.
And perhaps how much is on hand versus in trends and how do you feel about the ability to get.
Inventory for the key seasonal periods here.
First half of the year.
Yes, so I describe it.
In my earlier comments about half of that growth on a year over year basis is really these excess freight costs. If you look at the balance we did have.
Roughly double the amount.
Transit that we would normally have at the end of the year as you can imagine we.
We had a lot of inventory trapped in the ports and some.
Coming on the water.
A bit slower than we expected most of that being spring receipts.
In fabric fashion receipts that are spurring based products or spring based prints.
We're doing the good job of getting those through our distribution network. The other favorable thing we have in the first half of the year is our seasonal and fashion.
Selling period is substantially longer than Halloween and Christmas would be typically about twice as long and maybe even a little more than that.
So we have more time to sell through those goods. So overall I think we feel like we're in a very good position again, some early selling we typically do in those categories did have a little bit of a headwind on our January sales.
And we are.
Probably lagging about two to three weeks late on a lot of our receipts, but again compared to like Halloween being.
Less than a two month selling season typically these are spring seasons tend to they.
They are much longer time to sell through those products.
Thank you for that color.
My second question is I wanted to see if you could talk about you have a number of initiatives there new whether it be the.
Acquisition.
The one you announced today with J D.
In aggregate this one and also internationally commerce, which was launched last year.
When can we start seeing more.
Terminal contribution from this once maybe some color there about how should this contribute to the course of 2022.
Yes, I think you're going to see that all of these and other ones. We're working on should.
Start to matter in the second half of the year and really matter by the end of the year.
So this fiscal year that we're in as we kind of go along with it we will probably give you more color in some of these and what the size of the prize we think is or the momentum, but I would say it's probably.
No.
You start to get some meaningful benefit in the last quarter and then next year should be.
Thing that were.
What we believe to be able to kind of add some meaningful stacks year on year on top of our base business.
Thank you. Our next question will come from Laura Champine with loop capital. Please go ahead.
Thanks for taking my question so on the <unk>.
Increased freight costs it sounds like some you kept in in some you adjusted out the vast majority of you adjusted out.
How do you determine what get suggested out and what you leave in in terms of freight inflation, yes, I can walk through at a high level. The one thing Laura I'd probably point you to is if you look at the MD&A section of our 10-K when that comes out tomorrow as well as.
The adjusted EBITDA reconciliation in the press release that just went out we've actually added a lot more disclosure around how we arrive at that number but generally what.
The way. It works is it's our contracted rates plus a normal amount of spot market that we would normally need to procure over and above our contracted rates and that additional it typically.
Anywhere from like 15% to 20% of our volume at typically about a 15% premium to our contract rates. Obviously as you are aware and everyone is aware.
What we're seeing in the spot market was well well above that typical 10% to 15% premium.
And the other issue is our contracts weren't being honored so you were throwing a lot more of that volume into those very high priced spot market, but thats, how we arrive at it but.
Again, we've added a couple of paragraphs to our disclosures to be very specific about exactly how that numbers around that.
Other thing.
Tens of millions of dollars of cost that have never been incurred before because of these.
Congestion at ports, which is this.
Trans loading offloading as well as the demurrage and retention.
Most of that.
As one time or will go away.
But it's a byproduct of having <unk>.
90 ships floating off the coast.
And needing to do special things to pull the product out and pay a special penalties you've never been before so that piece is clearly one time.
I hope that.
Mostly goes away this fiscal year.
And certainly the ports and clear up it will but.
But that's the piece again, that's in that number on top of just the ocean Breeze itself.
Got it.
If I think about the adjustments longer term the expectation is if that normalizes then we will see that line disappear in say 2023.
Is my question and also would that be about this when will we see the tech development costs.
Disappear from the adjustments.
I don't know if those you'll we'll ever see those disappear fully we've historically had them even as a private company.
A reconciling item I would say there are higher right now than we have historically been because we're engaged in this very significant project to upgrade our point of sale systems.
So I would say they are elevated from where we normally are but any any software development and.
Program Rollouts, we do come with some cost.
That you're basically paying double maintenance on the software system that you're developing while you are still running the legacy system. We've historically included that as an as an add back for adjusted EBITDA and would anticipate doing so in the future, but but agreed.
Level, we have in <unk>.
Our adjusted EBITDA reconciliation currently is higher than.
We've historically been higher than I would expect to see in the future.
Got it thank you.
Thank you. Our next question will come from Zack <unk> with Wells Fargo. Please go ahead.
Hey, this is David Lance on for Zach Thanks for taking the questions I guess first on the adjusted gross margin expanding 190 basis points with about 480 basis points of that coming from the excess freight I was just curious if you could walk through.
The puts and takes to that line item in size some of the other impacts in the quarter.
Yes. So you are saying if I'm just looking at the adjusted gross margin so kind of ignore the excess freight at that point, yes, I would say.
Primarily still.
Promotional optimization is the lion's share of that.
We did continue to have.
Variable very favorable results in terms of our.
Shrank and ability to control clearance, but if I was looking at kind of waiting that.
Well below a quarter of the benefit really the lion's share continues to be.
Promotions and pricing.
A little bit you have a little bit of ore sourcing as well.
But I think even the end of this quarter, we started to see some inflationary pressures. So I would say those were also a bit muted. It's really really the main event in that regard as our as our pricing and promotion.
Okay.
Got it and then with its with inflation accelerating have you seen customers pushing back to price increases or differing category purchases and then historically.
Is there a specific level of inflation that you've seen that customers are willing to take before there's any impact to volume.
Yes, so far again, so we took a series of price increases and we had holdout markets and so we're able to see the behavior across the different markets.
And really we haven't really seen any meaningful unit decline there. So it's pretty good what really has been more of the issue is a certain customer just being frozen and then losing that traffic.
We believe that we can price, where we need to.
To stay with inflation although.
We're doing our best.
To work with our suppliers to prevent that.
Typically in our business over long periods of time, if you see it.
If we get into an environment, that's let's call it recessionary.
What we actually start to see at some point is that people stop making large purchases trips.
New car Novo whatever and then they actually kind of doubled down and things like what we do to give them kind of mental pieces Allison because were a $30 basket.
So.
So we actually feel that we can ride through this.
What we're trying to do though is not get too far over our ski tips in terms of pricing and.
And not take pricing for things that like I said like the ocean freight that we think are not normal.
Just because we do have momentum with the customer we had built market share.
And.
With the new customers, we have coming in we believe there is a lot more to gain if we just kind of stay the course.
Thanks.
I'm showing no further questions in the queue at this time I would now like to turn the call back over to management for any closing remarks.
Well look I want to thank you all for your generous listening today and a lot of great questions. Thanks for all the joint team members in all states all of our stakeholders, who share our mission our purpose our passion for our customer.
I know theres a lot of moving parts out there, but we continue to make great progress with Joanne and I really believe the best days are yet to come and so thank you again and happy St Patrick's day and be safe.
Ladies and gentlemen, this concludes today's conference call. Thank you for your participation you may now disconnect.
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Okay.
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Yes.
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