Q2 2019 Earnings Call
Good morning, My name is Carrie and I will be your conference operator today at this time, we'd like to welcome everyone to the Michael's company.
Second quarter earnings Conference call.
Oh I seven placed on mute prevent background noise, if you need assistance drawing the <unk>. The conference call. Please press start then zero and then operate also steel.
Please note this about it as being recorded.
Thank you and now I'd like to Shun the call over to your host Elaine Block Vice President of Investor Relations and treasure.
This lucky maybe getting the conference.
Thank you carry good morning, and thank you for joining US today early this morning, we released our financial results for the second quarter of fiscal 2019.
A copy of the press release and a few related slides are available in the Investor Relations section of our website at W.W.W. Dot Michael's Dot com.
Before we begin our discussion let me remind you that today's press release and the presentations made by our executive on this call may constitute forward looking statements and are made pursuant to and within the meaning of the safe Harbor provisions of the private Securities Litigation Reform Act of 1995 as amended.
While these statements address plans or events, which we expect will or may occur in the future.
The number of factors is set forth in R.S.C.C. filing send press releases could cause actual results to differ materially from our expectations.
We refer you to and specifically incorporate the cautionary and risk statements contained in today's press release and in our L.C.C. filings.
You are cautioned not to place undue reliance on these forward looking statements, which speak only as of today September 4th 2019.
We have no obligation to update or revise our forward looking statements, except as required by law and you should not expect us to do so.
On today's call, we will reference Noncat financial measures, including adjusted operating income adjusted net income and adjusted diluted earnings per share.
All adjusted for restructure charges, primarily related to the errand brothers and Pakistan store closures.
Severance charges related to the departure of our former C.E.O.
Right off of an investment in a liquidated business.
Losses on early extinguishment of debt refinancing costs.
Interest paid on our 2020 senior subordinated notes during a period between the issuance of our 2027 senior notes and the redemption of our 2020 senior subordinated notes.
In Texas adjustments related to the 2017 tax act as applicable.
A reconciliation of these measures to the corresponding got measures are detailed in today's earnings release.
We will began this morning with the prepared remarks from Mark Cosby, and I'm C.E.O. and Denise Polonus see about following our prepared remarks, we will open the call for questions.
Now I'd like to introduce Mark Cosby for some initial comments mark.
Thank you Elaine and good morning, everyone.
This morning, we reported results for the second quarter that were above the guidance range. We provided on her last earnings call.
Compher sales were positive 0.3% adjusted operating income was $75 million and adjusted diluted earnings per share was 19 cents.
In the last call I said, our number one goal is to improve our sales performance and we are pleased to see movement in that direction.
And this call I will talk about the actions we implemented drive improvement in the second quarter and then provide a look at our new long term strategy.
You will see that the priorities for 2019 that are embedded in our strategy has started to have an impact on our results and we'll play a bigger role in our expected second half performance.
Let's start with a review of our two two results in progress.
The foundation for all the actions we took to improve our second quarter results is based on our ship did become much more customer centric.
We listen to our customer and implement an action plan to improve our results.
The actions included promotion calendar process improvements.
Value perception enhancements expansion of our growth category initiative and enhancing our <unk> capabilities.
The enhancement in our promotion planning process focused on ensuring that our weekly promotions across all media work together to deliver our sales plans.
We put comprehensive plans together for every week, particularly focused on our big events.
An example was a very successful June lowest price of the season event, which featured a cohesive plan, including addressable T.V.E. mail digital social store presentations in store sinus.
Another example was their first semi annual clearance event in early July that included a comprehensive media program in a powerful store presentation that was a big success with our customers.
As mentioned on the last call, we identified an opportunity to improve our value perception based on our customer research.
We took a number of steps to address this value perception issue.
We eliminated the E.D.V. program and all U.S. stores, and we reduce the number of products excluded from coupons to make it easier and less frustrating for coop customers.
We also launched a new tool to help us manage the distribution of digital coupons, while maximizing the benefits of civilization and limiting coupon abuse.
And we adjusted our drive island and kept presentations to present, a stronger value impression.
These actions led to a reduction in customer complaints.
Improved our value perception rating and contributed to our improve sales trend.
We recognize the we have more work to do on the value perception front, we are heading in the right direction.
Our first major project reset of the year came in April with tools and technology in response to growing customer interest we added 25 feet to this high growth category.
This effectively double the space to support an expansion of widely recognized brands like cricket Caesar an oracle.
With the additional space, we can display more machines samples and recreated empower wall vinyl accessories.
These changes allowed us to expand our leadership in this important D.I.Y. category and we now offer the largest assortment of cricket product of any retail store.
This category Hope drive sales and the rollout helped create some excitement in the arts and crafts community.
We are both a strong partnership but the team at cricket included our exclusive launch of the Unfeasible, Inc product.
Your cricket C.E.O. also hosted many events that are stores that drew big crowds and created many large social media events.
The last big contributor to our sales improvement in Q2 was the success of R.E. Com business.
We have continued to focus on building R.E. com capabilities to drive sales well implementing initiatives to improve our profitability.
The ship earlier this year to bring our performance in house has helped us improve our fulfillment cost lower our shipping costs and leverage are fixed cost base.
In a rising by on line pick up and store or BOPUS penetration has also been a big win for R.E. com profitability.
We believe that the actions we took to improve our results in Q2 will continue to help us as we move into the second half of the year.
Now looking forward to the balance of 2019 in the future I am pleased to provide some insight into our updated long term growth strategy.
Layton queue for the board at our leadership team launched a comprehensive effort to define our growth strategy for 2020 and beyond.
We engaged external partners combined with internal resources to help us identify and prioritize customer segments and customer solutions to drive long term growth.
In June the brute the board approved our growth strategy and we are now using it as a road map for planning future growth.
As mentioned in the last call, we have defined our target customer as the core maker.
This is someone that is interested in D.I.Y. crafting, creating fine arts or is just injecting more creativity into their life.
This target customer definition was the result of significant customer research looking at attitudes behaviors and needs of our customers.
We divided them into different customer segments identifying key characteristics in spending then we conducted and another set of research to learn how the core maker shop with traditional quantitative surveys immersive interviews individual customers and focus groups.
This research has led us to believe that we can better focus on this core maker and increase our overall market share.
These core makers represent two thirds of all arts and crafts band and importantly indicate a strong desire to spend more on D.I.Y. projects.
Historically, we've seen stronger growth over time with these enthusiast customers than we have seen with our novice customers. We believe that focusing on these maker segments will drive drunk.
Our new purpose is we're here for the makers.
This purpose will guide our path to growth and help us ensure that we have our customers in mind, along with financial results when we make decisions.
We have defined three big building blocks that will drive our maker strategy build the business better leverage digital in data and re position in the business.
We have initiatives in place for the project teams to drive these building blocks.
The initiatives in support of building the business better and leverage leveraging digital and data are many of the 2019 priorities that we discussed in our last call.
We think of these initiatives as quick hits that we started well in advance of the Finalization of our strategic planning process and will deliver results in the second half of this year.
There are four big initiatives under the build the business better building blocks.
Build a store selling culture create a customer centric assortment.
Optimize pricing and promotions and maximize marketing productivity.
I will provide you with a brief summary of each of these initiatives starting with building a solid culture.
This initiative is designed to ship the store culture from task minded activities to focus on the customer and selling.
The stores will have scorecards with metrics to reinforce priorities that show, how they rank compared to other stores.
Creating some friendly competition.
They will define action plans to improved their score card results based on the best practices of our top performing stores and there will be consistent coaching in recognition programs in place to motivate and inspire progress.
This comprehensive program was roll out to every store leader by the end of August and we are expecting the program to improve our customer conversion and our baskets eyes in advance of the holiday season.
We have also launched our customer centric assortment of an issue with the goal of adding space decor maker categories with high growth potential.
We lost the program in three phases, starting with the previously discussed technology launch in May and expansion of crass storage in fine art in July and August .
The technology expansion continues to for awhile and should be a sales driver for us in Q3 as well.
In July we increase the selling space and craft stores to accommodate and expanded assortment with a more prominent display for the customer, including it craft car wall.
The response has been very positive and our customers are sharing online how they use these new cards to create solutions for their stories needs.
Wouldn't be marketed the new cards, we lean into the teachers with back to school ideas for keeping the classroom organize.
In August we completed the reset of art supplies, expanding our assortment of drawing and painting categories by adding over 20 feet to this way, including thousand new items in drawing and paint expanding several name brands such as Tombo sharpy it might crime.
The third build the business better initiative is to optimize our pricing and promotions.
This initiative supports improving both our customer value perception and our profitability.
This pricing optimization work will also support the price element of our tariff mitigation effort.
In addition to the steps we have already taken to streamline and enhance our coupon strategy. We are taking a fresh look at our mix of promotions coupons and regular price to determine how we can simplify the customer experience.
We are creating new tools to help us evaluate the effectiveness of a discounted campaign and make sure. We are getting the expected return on investment.
A good example is the category assessment, then informed us that we would improve our sales in margin by moving from buy one get one free promotion to a buy one get 150 per cent offer.
Our goal is to take action on a larger scale as the your progress is to improve our value perception eliminate unproductive discounting and improve sales.
The file initiative under build the business better is to maximize our marketing productivity.
This initiative is focused on optimizing our existing marketing spend to more effectively reach our core maker customer into drive higher sales.
We implemented a new tool that we will use to assess the productivity of all of our marketing vehicles and enable us to shipped our spending to the highest productivity options.
This will mean shifting funds from less productive mass media options such as newspaper, it's more productive options, such as digital and addressable TV.
We are also working to optimize within each type of mark things been such as improving the productivity of our digital spending options in improving the efficiency of organic search results.
The second building block of our maker strategy is to leverage digital and data.
This building blocks is comprised of two initiatives enhanced C.R.M. and profitable growth.
The enhanced c. or reminisce should it is focused on increasing our customer engagement to personalization of all customer messaging.
The goal is to create category in inspiration focused content supporting more personalized and relevant communication across channels.
Beginning with E. mail, followed by web and digital marketing.
We have an extensive collection of customer data, including 75 million customer records 31 million active email addresses and 38 million customers you know rewards program.
Today, we can link more than 82% of our sales to a specific customer.
We have continued to test proprietary models built to help us predict customer purchases based on interactions with our Michael's dotcom, the Michael's add email in store purchase behavior.
We started leveraging this data in may to personalize emails to customers based on their spending history.
Earlier results have been very encouraging with opening click rates almost three times the rate of our typical mass E. mail.
Today around 1% of our emails are personalized and our goal is to move toward personalizing, 15% of our emails by the end of this year and much higher as we move into 2020.
We will then move toward personalizing, all of our customer messaging channels, including the website and digital messaging.
The benefit will be improving engagement with our customers in driving higher sales results.
As an extension of the C.I. Ram initiative, we will be enhancing our rewards program in 2020 to create a more meaningful loyalty program.
We will test components of this loyalty program later this year. So we are ready to launch the new program by the middle of next year.
The second liver leverage digital and data initiative is to create more profitable E. commerce growth.
The goal is to maintain a rapid sales growth momentum, while enhancing the profitability of our Ami channel options.
We have a number of initiatives in place to continue our growth momentum, including optimizing our digital spending enhancing our website capabilities in personalizing the website.
Customers.
Today, our site is the same for every customer that visits.
Later this year the site will be customized to each site visitor based on their spending history.
We also continue see strong customer enthusiasm for by on line pick up and store or BOPUS.
From a cost perspective, well hope is is very attractive way to fulfill an e. commerce order as it does not include shipping costs.
And to to help us accounted for 44% of online sales and nearly two thirds of on line orders.
We continue to use technology to bills <unk> BOPUS orders and this quarter, we rolled out near real term time inventory tracking to improve BOPUS fulfillment percentages.
In addition to our focus on driving Omni channel sales. We are also focused on improving the profitability of this important growth channel.
We have initiatives in place to improve the gross margin fulfillment and shipping costs for all the ways that we distribute products to our customers.
We believe expanding our Ami channel presence is a critical piece of our long term growth opportunity.
We are actively working on plans that will improve our cost structure, while enhancing the customer experience to drive longer term profitable growth.
The third and final building blocks of our maker strategy is to reposition the business.
This building block is focused on initiatives that will not help us in 2019, but will set us up for growth in 2020 and beyond.
This building block today is comprised of three initiatives that are in development. It Michael's community a maker centered store experience and make her centered categories.
Let's take a quick look at these three growth initiatives.
Our extensive research over the last few months has shown us how important community is to our maker customers.
These customers want to share and learn with our maker customers.
We saw this come to life with the roll out of our tools and technology product. We said in early may what our customers were sharing in social media attending events in coming to our stores to take classes.
We are focusing on ways to build a community with our customers in stores and online.
This will include work to take our existing successful community classroom to the next level and work to create an online community for make her customers.
We have also started work to create a maker centered store experience.
This initiative will include the development of a store designed specifically to meet the needs of our maker customer.
The store design will feature an easier shopping experience a curated assortment and enhanced service experience full omni channel capabilities and it will bring the community experience to life.
We will build this new concept in a lab environment. This year and then open up you stores next year. The goal will be to learn from these exponents stores and expand the best practices in a low cost way across the system.
The third component of repositioning the business is our maker centered category initiative.
This initiative is focused on innovating, our sort meant and presentation targeting our maker customers.
The work will lead to the development of the assortment for our new maker centered store.
The work will also form the basis for a new category management process that will leverage customer feedback to optimize our key product categories for our maker customer across all of our stores.
This focus on the maker will translate into making shifts and some core assortments categories, such as art tools and technology and jewelry will become more important to us.
We will also modified categories to meet the needs of our makers and example can be found in jewelry.
When we were focused on bringing the knob listened to the store we carried more finished jewelry and fashion watchers in the assortment.
With the D.I.Y. jewelry maker in mind, we will now be more focused on giving her the best assortment of jewelry pieces. So she can assemble what she wants.
We will not be abandoning categories, just making sure the mixed within the category is right.
Seasonal products come to mind as a question.
But this category is very important to the core maker is they like to decorate for events.
This makers centered category initiative will be a big component of our future growth plans.
In closing we are laser focused on driving sales and improving profitability. We are pleased with the actions. We have implemented have led to improve results and cute too.
Our 2019 <unk> priorities comprised of our build the business better in our leverage digital and data initiatives are showing positive results and should set us up for continued improvement in the second half of this year.
We also believe that are we are here for the maker purpose and strong focus on the customer well positioned Michael's for stronger growth in 2020 and beyond.
Now I'd like to turn the call over to Denise Denise.
Thank you Mark as Mark said at the beginning of his comments were pleased with our Q2 results.
We were returned it to positive comparable store sales posting a 0.3% com.
Grew adjusted operating income, 5.8% versus last year and grew adjusted E.P.S., 26.7% versus last year.
Second quarter net sales were $1.3 billion compared to $1.5 billion last year.
The decrease in net sales for the quarter was primarily due to the closure of our package hand stores in the fourth quarter of fiscal 2018 and was partially offset our 0.3% increase in comparable store sales.
And sales from the operation of 11, net new Michael's stores during the quarter.
Into to the company opened up for new Michael stores closed to Michael stores and relocated one at Michael's store.
0.3% increase and comparable store sales was driven by an increase in average ticket.
Partially offset by decrease in customer transactions.
Sales from Michael's Dot com or strong again, this quarter Durham by increase traffic and higher conversion rates with 44% of E. commerce sales and 62% of the commerce orders fulfilled to our buy online pick up in store or BOPUS initiative.
From a category perspective tools and technology crafts storage and our supplies or our strongest categories. This quarter, while traditional paper crafting supplies and kids crafts were more challenged.
Gross profit dollars for the quarter or $367 million compared to $373 million last year.
As a percentage of sales are gross profit rate for the quarter was 35.5% versus 35.4% last year, an increase of about 10 basis points.
Well the increase in gross margin was small there were several factors that mostly offset each other.
Including benefits from our ongoing pricing in sourcing initiative and improved occupancy costs leverage.
The increase from these factors was offset by the impact of tariffs on inventory, we purchased from China.
Increase in promotional activity and a change in sales next.
Of the elimination of R.E.D.D. program and return to a high low strategy for certain items in our store as well as our first ever seen semi annual clearance of that contributed to the increase in promotional activity.
Total store rent expense for the quarter was $98 million versus $101 million last year.
The decrease in store rent expense was due to the package hands store closures, partially offset by the impact of a net 11 additional Michael stores.
For the quarter as Jean expense.
Eating store preopening costs, and restructure charges was $296 million or 28.6% of sales compared with $299 million or 28.4% of sales last year.
The decrease in as she an expense was primarily due to a 6 million dollar decrease in expenses related to the closure of the pack a tan stores.
Timing shift in our performance based compensation and the timing shift a marketing expenses to later in the year.
Additionally, in the second quarter of 2019, we reporters or restructure charge of $3.9 million related to the closure of all of our Pakistan's stores during the fourth quarter of fiscal 2018.
As a reminder, in the second quarter of fiscal 2018 recorded 3.2 million gain related to the settlement a lease obligations associated with the closure of substantially all of our Arab brothers stores during the first quarter of fiscal 2018.
[noise] gap operating income was $71 million compared to 74 million in the second quarter of fiscal 2018.
Excluding the restructure charges adjusted operating income for Q2, a fiscal 2019 was $75 million compared to adjusted operating income of $71 million in the prior year, an increase of 5.8%.
[noise] for the quarter interest expense was $40 million about $3 million higher than the second quarter last year.
This increases primarily due to high higher libel rates associated with our variable rate term loan.
The higher interest rate on our 2027 senior notes.
Double interest when both the 2027 senior notes and 2020 senior subordinate nodes were outstanding for 21 days.
The increases partially offset with lower settlement payments associated with our interest rate swaps.
In July 2019, we D. redeemed or 510 million dollar senior subordinated notes do in 2020 with cash on hand, and proceeds from the issuance of $500 million in senior unsecured nodes that mature and 2027 and bear an interest rate of 8%.
Also I'm pleased to announce that we've also just completed and amend didn't extend on our asset backed revolver to move the maturity from May 2021 August of 2024.
Our nearest her maturity is now in 2023, four r. term one.
Effective tax rate was 18.9 per cent compared to 24% in the second quarter last year.
The effective tax rate in Q2 of this year includes a tax benefit associated with a state income tax settlement.
Partially offset by investing of restricted shares and the expiration of certain vested stock options.
On that basis, net income was $25 million or 16 cents per diluted share.
Compared to $27 million or 15 cents per diluted share in the second quarter of fiscal 2018.
Excluding the restructure charge associated with the closing of the Pac 10 stores and the refinancing costs of our debt, including double interest while both our old senior subordinated nodes and the new senior notes were outstanding for 21 days.
Adjusted net income was $30 million or 19 cents per diluted share compared to $26 million or 15 cents per diluted share in Q2, a fiscal 2018.
And increase of 26.7%.
During the quarter, we purchased 3 million shares in the open market for $25 million as part of our previously announced share repurchase program.
As of today are total authorization remaining for future repurchases is approximately $373 million.
As a reminder, our share repurchase program does not have an expiration date and the timing and number of repurchased transactions under the program will depend on market conditions.
Corporate considerations dead agreement and regulatory requirements.
In light of the current trading price of our common stock and are available capital resources and requirements. We currently view additional share repurchases as an attractive use of cash we intend to continue to monitor or repurchase program and execute share repurchases opportunistically subjective considerations referenced above.
Any such repurchases would without additional activity with respect to our stock.
Increase the ownership percentages of all remaining shareholders, including our sponsors Bain capital and Blackstone.
As a result feature repurchases May result, and the sponsors holding in the aggregate more than 50% of our outstanding common stock.
Total merchandise inventory at the end of the quarter decreased 1.8% to $1.26 billion compared to $1.28 billion last year.
The decent decrease in inventory was primarily due to the Pac 10 store closures, partially offset by additional inventory associated with the operation of 11 additional Michael stores.
Average inventory per Michael's store, including inventory for E. commerce inventory and distribution centers and inventory in transit was 2.5% higher than the end of Q. to last year.
Inclusive an approximate 170 basis point drag from duties associated with Liz three tariffs.
As well as increased inventory in transit this year as we pulled some items forward for delivery to avoid incremental terrorists.
We ended Q2 with more than 800 million in liquidity, including $131 million in cash on our balance sheet and $686 million available under our revolver.
Total debt at the end of the quarter was $2.7 billion, our total debt to adjusted EBITDA on a trailing 12 month basis was 3.3 times.
And our trailing 12 month interest coverage was 4.1 times.
Capital expenditures for the quarter were $32 million, reflecting investments in technology projects, including investments to support E. commerce, and our don't platforms and investments in new and relocated stores.
For the full year, we continue to expect it to invest approximately 135 million in capital expenditures.
Without as context, let me walk you through our guidance for the third quarter and the full year.
As a reminder, or guns excludes the impact of any remaining restructure costs associated with the closing of our packet hand stores any additional costs associated with the departure of our former CEO .
The one time right off of our Darby smart investments and any one time costs associated with debt refinancing.
For fiscal 2019, we now expect total sales will be between $5.16 billion and $5.19 billion.
This reflects our expectation that full year comp sales will be approximately flat and our plans to relocate 13, Michael stores and open 16, net new Michael stores inclusive of up to 12 pack a tan stores, we are pretty branding as Michael stores.
Well, we're pleased with our comps hills performance in the second quarter, we're cautious regarding the consumer environment in the second half of the year and the potential negative impact of six fewer shopping days between Thanksgiving and Christmas.
Additionally, the timing of the openings for three new stores has shifted out of 2019 and into 2020, and we added one more sore closure for 2019.
Adjusted operating income for the year is expected to be between $625 million and $645 million. This guidance now reflects the impact of lower estimated sales in the second half of the year, mostly offset by our second quarter performance and incremental costs savings that we have identified since the first quarter of the year.
Let me take a moment to comment more broadly unlisted for terrorists clearly the situation remains fluid and if list for China tariffs are fully implemented we estimate the applicable direct import product costs subject to these duties are between 400 million and $500 million.
Given the pace, we turn our inventory any material impact from the list for terrorists would not be recognized until 2020.
We're continuing to aggressively work our tariff mitigation plan.
Our focus on broad based cost controls our annual sourcing saving its efforts that have generated approximately $40 million a benefit in 2019.
Early success shifting sourcing out of China currency news progress with vendor negotiations and price increases taken so far bode well for a bit negate ability to mitigate list for terrorists.
With all this work underway. It is too early to quantify exactly what portion we would expect to mitigate in 2020.
We expect gross margin to be slightly down versus gap gross margin and 2018.
As discussed on the last call. We do expect to see continued benefits from our ongoing pricing in sourcing initiatives and better management of promotions offset by pressure from transportation headwinds terrorists the leverage of occupancy costs, given our comp guidance and continued strong e. commerce growth.
We continue expect to leverage as Jean expense versus gap as Gina expense and 2018, driven primarily by the favorable impact of Anniversaring to restructure charges and 2018.
16 million of investment spending in 2018 and incremental costs savings identified over the last quarter.
Partially offset by modest pressure from higher I.T. expense, reflecting our investments and a move to more hosting arrangements.
We expect interest expense will be approximately $153 million, reflecting the expectation of no additional rate increases this year.
Our earnings outlook assumes and effective tax rate of between 23% and 24% for the full year.
These assumptions translate to an adjusted diluted E.P.S. range of $2.31 to $2.42 for fiscal 2019.
On approximately 156 million diluted weighted average shares for the full year.
Our fiscal 2019 capital expenditure plan is to invest approximately $135 million to support longer term growth, including technology investments new stores and relocation.
Turning to key three we expect calm solar cells will be flat to up 1%.
We plan to open 13, new stores close one store and relocate five stores in the quarter.
The 13, new stores are two Michael's stores, and 11 package hands locations that where we'd be rebranded as Michael source.
11 of these have already opened and the last one will open at the very end of the quarter for a total of 12 pack at hand stores converting to the Michael's brand.
For comparison purposes, and the third quarter last year, we opened five net new stores and relocated for stores.
Of note for comparison into your stack purposes are comp in the third quarter of 2018 was positively impacted by 270 bit by the shift to the high volume week, the week of our Christmas tree that into the third quarter do the 53rd week in the twenties in we can 2017.
Hi, while you me the last week of the quarter remains in the third quarter in 2019.
We expect adjusted operating income for the third quarter will be between $133 million and $142 million. This guidance includes expectation that gross margin rate, an S.G.N.A. rate will be flatish versus gap rates in Q3 2018.
Archie three guidance for adjusted diluted earnings per share is 46 cents to 51 651 cents, assuming a deleted weighted average share account of 155 million.
In closing, we made significant progress on our sales and profit performance in Q2 as our customer responded positively to the changes we made coming into the quarter, including value enhancements and the expansion of key categories. While we're early in the journey. We are excited and optimistic about the potential of our 2019 initiatives and our longer term strategic priorities to continue to drive profitable growth.
Now I'd like to open the call to take your questions operator.
We will now begin the question and answer session to ask a question you May Press Star then one on your Touchtone phone.
If you're using a speaker phone please pick up your handset before pressing the key.
To withdraw your question. Please press start then too.
Please limit yourself to one question with one follow up question. If you have additional questions. You may re entered the question queue.
At this time, we will pause momentarily to assemble our roster.
The first question will come from Steve Forbes with Guggenheim Securities.
Good morning.
I wanted to.
Hey, I I wanted to focus on the customer segmentation initiatives right. I think you said in a prepared remarks that the core maker as you to find it.
Represents one third of industry sales, but can you discuss where you're penetration rate is today with that customer base.
And maybe expand on what those customers writer, telling you about the current value proposition inclusive of the rewards program.
Hey, Steve is one point of clarification, the segmentation and the focus actually represents two thirds of the arts and crafts industry spend so just for that before I think mark will go into a little bit more detail or the color on on the segmentation.
So we did an extensive survey.
Touching 13000 different customers.
Ranging from surveys to in depth interviews.
And came from that with the perspective that you heard on the call today that the focus on this quarter maker customer is our biggest opportunity.
And our opportunity comes around the ability to leverage our expertise against this maker customer and differentiate overtime. So I kind of walked you through all the different leverage points that we have with the customer.
That as Denise just said that customers in our stores today.
A lot.
And we also believe that we have an opportunity to gain more share from them.
Overtime.
And there are customers that are in that segmentation, they're not in our stores as often as we'd like and we believe we have an opportunity to gain more share from that perspective, as well averaging all the tools that I mentioned don't call.
Yeah, I think I think that was the point I was trying to ask if you think about your sort of active members today or you're you're active customers.
How many would fall into that bucket and what percentage of sales would they represent.
So Steve I think we've talked historically when we're using the old definition of of kind of the core versus the enthusiast cussed didn't studious customer versus the novice customer you know at the time, we talked about that enthusiast customer you are being the larger base of spend in terms of who shopped in our in our costs in our business today versus that casual customer much of that enthusiast customer remains what we would now consider the core maker customer.
The next question will come from Christopher Horvers of J.P. Morgan.
Thanks, Good morning, everybody.
So a couple of questions.
You know the the focus on the novice really started in 13 and one of the key parts of that was the expansion a seasonal.
And then everyday value program. So you know that expansion. The seasonal was one reason why you can do better in the fourth quarter versus other parts of the year such as two q. So in terms of thinking about you know the long term calm potential business.
What do you think the market growth rate is for that core maker customer Michael's is averaged a 1% combo to pass 19 years.
And then the second related question is how do you expect to navigate the fourth quarter I I know that you mentioned that you know the makers engaged and seasonal as well, but you are implying that comp acceleration. So are you shifting marketing. The four q. are you expanding the assortment around seasonal how do you make sure that novice customer is not only engage but growing as well.
I can speak to the overall perspective, and then these companies can add anything she wants to one color around the numeric side, but is I mentioned in the comment the the <unk>. The research that we've done on the core maker indicates that they are very interested in seasonal products.
So we don't really see a change we set up this f. I may program. Several years ago that continues to be very successful for us in terms of how we position our seasonal product that will continue to be a big focus in everything that we do.
You mentioned mix of advertising, we have ship did some of our marketing support into the fourth quarter to continue to support the seasonal product, but but also because we think that the spending in the fourth quarter will be more productive than where we had it in the front half of the year. So I wouldn't infer big changes when we talk about.
The focus on this core customer versus this novice customer I wouldn't expect big category shifts, it's it's more about.
Taking the existing categories in fine tuning them. So that we have the right product within the category as opposed to thinking about big ships in terms of how we sort the store.
Category Wise.
And the only thing I'd I'd Aggie you only thing that I would add is is when you think about the things that we've been working on early in the year, they will ramp and produce more benefit for us in the third and the fourth quarter. So Mark commented on R.C. around progress and what we hope to be doing by the end of the year should be a good contributor will also have full quarter benefit of the assortment resets that we did in tools and technology and fine arts and crafts storage, but when you combine that with a healthy seasonal business. You know supports what we've effectively said for the second half of the year is a flat to plus one call.
Got it.
Then in terms of the the guide it seems like you know at least relative the street the the fourth quarters coming down and then at the same time, you actually expanded operating come into queue for the first time since.
Four q. 17, so, but you're implying operating come I think down for the third and fourth quarter. So just trying to understand.
What <unk> what was unique to two Q., where you could expand operating income and not do so in the back half and what was this shift and was there any shift in terms of how're you were thinking about the fourth quarter.
No I I think if I, if I step back one yeah, we really think about the second half as an entire period of time that we're managing I think it's important to note that just simply because of the shift of this high volume week with our Christmas tree sales that happened.
Moving that into the third quarter last year. It stays in the third quarter of this year. So we in terms of the top line performance.
Always expected I think a bit more robust three q. performance and a little lighter for Q. performance simply because of the loss of the shopping days between Thanksgiving and Christmas. So that was always our ingoing perspective, you know in general when you think about what happened on the operating income side you on the operating income side in the third quarter you know we delivered.
Slightly positive gross margin.
That starts to show the impact of all the goodness of our sourcing and pricing work that we're doing.
We also got a little extra benefit from <unk>, posting a better comp and having less occupancy do you leverage that would happen in the quarter.
We did see negatives from sales mix and of course tariffs. When you think about the third and fourth quarters of the year. You know we expected that sells mix impact will continue we also expect that tariff impact will continue along with all the positives that I mentioned as well. So there's nothing out size that shifts between the second quarter and the back half of the year in terms of our view of margins and it's just puts and takes on the margin for the items within that but still expect $40 million in sourcing goodness from the year from all the work that we do every year around our sourcing program.
Still expect goodness from R.C.R.M. initiatives, and what will able to be able to do with discount management.
The next question will come from it's immune got Min Morgan Stanley .
Thanks, Good morning.
I don't know if I missed this but can you tell us in Q2, how much some of the clearance and promotions I guess I would think it was clearance specifically drove the second quarter comp.
And then related to it.
If if we assume that the business you know should calm positively over time, let's just say one is for 1% to 2%.
Can you give us a sense of of of what we could expect from the gross margin line, you mentioned goodness from pricing and sourcing.
Realize there's a return to high low, but what what's the level of gross margin is it flat isn't up slightly that we could expect if the business does generate that can system top growth.
Yeah, Yeah. So on the first topic the clearance event that we ran in the second quarter contributed about 15 basis points to call. So while it was a big marketing event for us that got a lot of folks into the store.
The actual impact of that in terms of clearance sales was very small it was much more of a marketing handle that really had a reason for people to shop. When that's a very common theme from other retailers of getting people into the store.
More broadly speaking on the question of gross margin Yeah, we talked about for the full year, we expect it to be slightly down versus gap gross margin last year.
For all of those reasons that I described on the call kind of playing out on the ups and downs regarding that yeah. We we expect it to be generally flatish in the third quarter.
We were posted slightly positive in the second quarter. So that's how we're we're kind of netting out right. Now you know too early to tell with 2020 I think we've got a lot of great plans in place to continue our sourcing benefit continue our discount management work and all of those you know will will kind of bring to bear to continue to to drive the gross margin number.
And then my follow up it's not related to 2020, it would be more you know the next 12 to 18 to 24 months.
You've talked a lot about her mark talked a lot about initiatives to reposition the business.
Does does the business have enough costs to take out that that can be so funded or or do you have to you know go through and and but.
Excuse me an investment phase in order to to to you know to make these investments.
You know overall, we don't we don't see the need for any outsize incremental investment and to to go after what we're talking about we've set on the capital side and we expect to be 2% to 3% of sales. We've generally been in the middle of that range, we'd still expect to be you know within the range of 2% to 3% and then on the expense side. You know, we're really looking at the places where we de prioritize some other things we'd we'd been doing in the business to fund.
The work that we want to do to drive the initiative.
So nothing out size that we can see on the near term horizon.
It's really more a matter of prioritization and D. prioritizing things that maybe have less of an impact. So the three that we talked about community. The store experience these maker centered categories.
All of them will be tested.
We'll learn from them, what kind of sales striving power they have and.
Any investment that we do into those things will be warranted based on the returns that they deliver.
And if we have to spend money against them or hopefully we do spend money against them that means we're taking money largely from other places and also believing that they will return.
In a solid way for us.
The next question will come from such a segment of credit Suisse.
Because the morning, thanks for taking the question.
If you step back and look at what's we'd on comps over the last couple of years I think it's been mostly transactions growth.
Can you help us better understand if that's actual traffic if there's a traffic issue or is it more about conversion and under serving the customer that's coming in and as you look at the progress here, obviously comps improve this quarter through a lot of the changes that you're making where are you seeing that improvement is that that are conversion better traffic and if you could also help us understand that improvement is coming through a store comps or online or both that would be helpful. As well. Thank you.
Yeah, So all started off and mark and jump in with some additional color and so we are not able today to account traffic in our stores, we can only count transactions.
We're hoping to be able to do more on the traffic side as we implement electronic article surveillance in our stores next year, but at this point, it's really transaction.
From everything that we know we have an opportunity in conversion in the store in those transactions. So every customer that comes in from the survey data we have from the customer doesn't mean that they leave with a purchase and so we do see that as an opportunity. When you think about the improvement from the first quarter to the second quarter in the business. Most of that improvement was driven by an improvement in transactions kind of on a sequential basis. So back to some of the things we changed in the first quarter and ramped into the second quarter, we were able to be converting more of those sales with the customer in the store.
And so I think that that's a a big benefit you know both stores and E. commerce, our contributors to to our performance and so we think about them a bit omni channels simply because so much of our E. commerce sales are actually BOPUS sales that come through the store, but over time you. When you think about where the opportunity is the opportunity continues to be improving conversion and transactions in the store.
Okay. So.
Just a little color on that I mean is is a described in the call. We are rolling out a significant selling program actually rolled out this past week to all of our stores and one of the big components within that will be the ability to invest to measure conversion and sent our team to deliver against conversion based on this new scorecard bits and put in place historically, we haven't differentiated that number we haven't been able to measure that number but we're putting tools in place that will enable us to do that this year and then we're putting even better tools in place next year that will enable us to measure that but importantly, we're putting a program behind really driving conversion within our stores by teaching our associates, and then sending them motivating them to convert and sell within our stores.
Okay. Thank you for that.
Just to clarification is on the model. So S.G.N.A. can you guys size up the marketing and performance based comp that shifted out of this quarter and what goes into the back half of the year and then just for the full year guidance to clarify on tariffs.
I want to make sure I have this right there's no incremental impact embedded here from list for is that the right way to think about it.
Yeah, so in reverse order and anything that's tied to tariffs is invested in our forecasts. The weather that is was three or list for all the 2019 is in the forecast as we would know it today.
On your question about the timing shifts for performance based com and for marketing as Mark indicated a bit earlier, we did plan for this year to shift more marketing dollars into the fourth quarter and take those out of the second quarter. So you're going to see those come back in the fourth quarter, where we think we really do have an opportunity, particularly with the shorter selling cycle between Thanksgiving and Christmas to leverage those marketing dollars.
The performance based comp shift will hit both Q3 and Q4 I would comment that in both of these cases. These are not outsized numbers you can think about both of these being you know a couple of million dollars not not bigger shifts than that.
The next question will come from Laura Champion Loop capital.
Thanks for taking my question, it's really a follow on so I I believe last quarter that your guide included a five cent hit from tariffs rescue me if I'm wrong. There has increased and if so by how much and then I totally understand that most of the impact of list for would impact 2000.
20 could you tell us just give us a perspective sense of how much of an impact that could have given all you know about your mitigation efforts as as well as you know.
Sourcing cost increases of a 400 500 million, which laid out earlier in this call.
Yep.
So first the 2019, a guy just to to reiterate yeah, we've not changed the impact of tariffs in our guidance from the last call to this call. So our impact from the list. Three we believe is consistent with what we had before and just because of the timing in our inventory turns while list for his news since the last call. It will not impact us with any materiality in in 20, a 19. When you looked at 2020, you looked to what's going on with the list for terrorists. You know I mentioned, it was $400 million to $500 million of potential.
P.O. cost exposure from what we buy from China that would be on the list for you know when we think about and I will.
Lead in by saying you know, we don't have an exact estimate of the puts and takes of what will be able to do for mitigation versus the cost of those duties coming through.
But I think the key message I want folks to take away is the list of options, we have and what we're aggressively working to do to mitigate.
Those costs coming through so I mentioned them a bit in my script, but you know it kind of happy to walk through them again, so annually, we've been able to be generating sourcing savings in our business of upwards of $40 million.
We do have an anticipation that will continue into 2020 as well so one key starting block in things that we can do to mitigate.
Off of our list three tariffs, which we originally said we had about 400 million of exposure, we have already been able to shift about $75 million of that P.O. cost outside of China, and it's really early in the process of working through that it takes factories time to ramp up it takes time to actually work through the sourcing process. So we're quite pleased with being able to have made that shift and then you look at all the other lovers. The core cost savings work that we're doing that really allowed us that while we were lowering comps a bit in the back half of the here to hold our operating income this year something we want to continue on as we look to the new year.
The broader set of sourcing alternatives, where we can leverage our negotiation power.
Manage against currency fluctuations as well and then re engineer product or all additional levers beyond just moving product out of China. Today, and then you know wall. While we do this with with very cautious approach you know implementing price increases where we believe they make sense and were given that we have a low average ticket would have minimal impact to the customer are out there and play for us as well. So a really long list of things that we can do to go up against the headwind that the tariff could provide you know assuming that tariff stays in effect as we as we continue through the months of the year here.
Got it thank you.
In our last question today will become from Elizabeth.
Bank of America.
Great. Thank you for for squeezing me and I was just hoping uses <unk> quantify the positives and negatives the gross margin in the quarter I know sourcing initiative to a positive occupancy costs from the higher comp was was positive and then I was kinda offset by terrorists and mixing promotional activity can you could you quantify each of those buckets.
Yeah. So we don't we don't typically quantify the details of the puts and takes you know.
Well I would just tell you is is is the things that were on the positive as you already mentioned was the sourcing benefit pricing benefit.
Some benefit from occupancy leverage off setting that would be the flow through of some duties coming through.
Sales mix, and then a bit more of a promotional.
Impact, which had a little impacts from our Clarence event, but also had some impact as we've moved away from E.D.V. coming out of the first quarter. You know they were all kind of material impact, hence why we call them out, but you know I think the important note to me is that the net out to pretty much a flat gross margin slightly positive gross margin versus last year.
Okay, and then you know you talked about how one of the options you have for mitigating taxes to increase you know some of your pricing on those low ticket items have you tested out at the L.S.S.D. of demand for some of those products that that you're importing just to determine you know if if there is any push back from the consumer when you raise price there.
Yeah, you know, we we take pricing on some items every year. So history tells us a bit about where there's more or less electricity and we certainly take that into account. When we think about the pricing opportunity. We have to date on any pricing increases. We've taken this year. There has been no surprises about that elasticities, yeah, we're really focused on managing to a more positive gross margin dollar outcome.
Against the opportunity that we have when we take the price.
And and we've generally seen the results that we expected to see clearly low ticket private brand items, you know provide us with a bit more opportunity than more visibly priced higher ticket items.
On the good thing is we put in more science around our ability to measure.
The impact of our pricing changes.
We build the team to enable us to do that and I think also importantly, we've enhanced our ability to monitor our competitive pricing scenarios. So that you know, we know where we stand from a price perspective versus our competition better than we would have a few months back so.
We we are in a position to be able to make smart choices around pricing.
And this concludes our question and answer session I would like to have the conference back over to Mark Cosby interim Chief Executive officer for any closing remarks.
Well. Thank you for joining us. This morning, we are pleased with our trend improvement in Q2, and we believe that we have the right priorities in place to continue the improvement in the back half of this year.
We're also confident that our focus on the customer b. or a new maker strategy will set us up to deliver growth in 2020 and be on thank you again.
Thank you Sir Conference has now concluded. Thank you all for attending today's presentation. You may now disconnect her lines have a great day.
[noise].
Mm.
Mm.
[noise].