JOANN Inc. (NASDAQ:JOAN) Q3 2023 Earnings Call Transcript

JOANN Inc. (NASDAQ:JOAN) Q3 2023 Earnings Call Transcript December 12, 2022

Operator: Welcome to the JOANN Third Quarter Fiscal 2023 Earnings Conference Call. Please note, this event is being recorded. I would now like to turn the conference over to Ajay Jain, Head of Investor Relations. Please go ahead.

Ajay Jain: Thank you, Chad, and good afternoon. I’d like to remind everyone that comments made today may include forward-looking statements. which are subject to significant risks and uncertainties that could cause the company’s actual results to 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, new information or future circumstances. Please review the cautionary statements and risk factors contained in the company’s earnings press release and the 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 posted to the Investor Relations section of JOANN’s Web site at investors.joann.com.

On the call today from JOANN are Wade Miquelon, President and Chief Executive Officer; and Scott Sekella, Chief Financial Officer. During the question-and-answer portion of the call, we’ll also be joined by Chris DiTullio, JOANN’s Executive Vice President and Chief Customer Officer. I will now turn the call over to Wade for his prepared comments.

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Wade Miquelon: Thank you, Ajay. Good afternoon, and welcome to JOANN’s Third Quarter Fiscal 2023 Earnings Call. I’d like to first ask those on the call to join me extending a very warm welcome to our new Chief Financial Officer, Scott Sekella. Scott brings more than 20 years of experience in finance for several multinational brands most recently serving as Vice President, Corporate FP&A, Head at Under Armour. It’s remarkable to me how fast Scott has hit the ground running, and we are very excited to have Scott on board as a senior executive. In the days ahead, I look forward to introducing Scott to many of you in the analyst, investor and lender communities. As we entered the peak of our holiday season, I want to take a minute to thank our more than 21,000 hard-working team members at JOANN for their dedication to our organization’s success.

I also want to acknowledge the continued support of our customers and to express my gratitude to all the loyal selling and crafting enthusiasts who could need to support JOANN despite unique challenges many are experiencing during this difficult economic climate. In the third quarter, while our results showed some internal signs of strengthening, overall, we were disappointed. Our sales comparison versus last year was a decline of 7.9% and versus fiscal year ’20, which was our pre-pandemic year, our sales declined by 1.1%. Gross profit dollars on an adjusted basis were down 9.3% versus last year and increased by 5.5% versus fiscal year ’20. As stated on the Q2 earnings call, our sales comparison have progressively strengthened through the end of Q2 and as we entered into Q3.

However, midway through our third quarter, this trend worsened. This slowing was not incompatible with what our blind data illustrates for the specialty retail industry overall. This slowing was primarily caused by fewer items per basket as opposed to a downturn in customer traffic trends overall. Further, this reduction in items per basket was skewed to both our lower end database customers and our customers not in our database. During the third quarter, we continued to see strength in many large and important parts of our business, such as fashion apparel, special occasions, needle arts and categories. In addition, our Halloween seasonal business grew approximately 8% and related categories performed very well. However, the fall seasonal decor and floral categories underperformed, as customers seem much less inclined to indulge and decorate versus the prior year.

Additionally, consistent with broader industry trends in this category, we experienced a meaningful slowdown in our craft technology business. Our general belief is that the ongoing inflationary environment has continued to pressure our customers’ level of discretionary spending. We’ve talked many times about JOANN’s resiliency through recessionary times. However, what I feel is a bit nuanced of the extreme inflationary factor, which has not been seen in 4 years. Increasingly, we’re seeing that consumers are feeling the sting of inflation, but the recent shift in shopping behavior has skewed much more towards essentials and basics with less emphasis on discretionary purchases. These budget-conscious consumers have been under a prolonged period of stress for many months now, and they are getting more selective with their purchases.

Fortunately, there are some signs that these inflationary trends are beginning to side even as we potentially head into something more typical of a recessionary environment in the short-term. During the quarter, we continued to advance our key strategies, including enhancing our store experience, which, among other things, includes our journey to refresh our current and relocate stores. We had 13 grand openings in the quarter in which all but one was either relocation where we’re able to increase our square footage or enter into a net new market force altogether. On balance, we’re very pleased with the results of these locations as we were able to showcase the full breadth of the JOANN brand in a way which we could not in our previous smaller footprints.

We have four additional stores opening in the fourth quarter to complete this year’s projects. Our second core strategy is to enhance our multichannel proposition. Our omni-channel efforts yielded an additional bright spot in the quarter with sales representing over 11% penetration of JOANN’s sales, plus 40 basis points to last year and over 600 basis points to fiscal year ’20. Omni revenue continued to outpace total sales for the quarter with a moderate 4% decline compared to last year. Backing out the challenged technology business, which penetrates higher online, sales were flat for the quarter. We’ve been able to maintain much of our COVID lift to our online business as Q3 sales increased 126% as compared to fiscal year ’20. Importantly, over the past few days, we have worked hard to improve our omni profitability.

The past few years — sorry about that, our profitability and that trend continues with respect to both our gross and our net omni margin. To further enable our omni efforts in October, we officially began filling orders out of our multipurpose distribution center in West Jefferson, Ohio. This distribution center will enable us to reduce split shipments, improve line fill rates and expand our assortment tail. We are ramping up the production capability as we speak. And the impact of this holiday season will be nominal. However, we anticipate that the impact on value creation will grow substantially and meaningfully over time. Also related to our online business and online selling competitors shut down near the end of Q3, and we are very encouraged by the sales increases that we are seeing thus far.

Now let me shift to what we are seeing as we are in and moving through Q4. We remain cautiously optimistic about our fourth quarter, which we call is our largest and most important quarter due to the seasonality of our business. We typically provide more inter-quarter color for Q4 on this earnings call than we do for other quarters, simply given how material it is to our annual results. As we are now in the midst of the holiday season and less than 2 weeks from Christmas, I have a high-level of conviction that we have been doing the right things right with respect to what we can control in order to win the day with our customers. Our assortments are relevant. Our in-stocks are strong and our promotional offers are competitive. Based on the voice of the customer and our Net Promoter Scores, our operating metrics, including our customer service remain at all-time high comparison levels at JOANN, even despite the labor pressures that JOANN and most service lead companies are experiencing.

November started slower than we anticipated, and indeed, there seems to have been some cycling of last year’s fear of missing out from clogged supply chains, leading to an early consumer holiday shopping spree. Having said that, our pace has picked up with our Black Friday and Cyber Monday events and continued momentum into December. We anticipate finishing the fourth quarter with solid sales momentum as we move out of this fiscal year into next. Now let me shift to a few of our major focus areas moving forward. There is no denying the fact that the current inflationary environment has driven massive annual cost increases and has taken a significant toll on both our cash flow as well as our operating earnings. Fortunately, we are seeing stabilization across our cost structure and deflationary opportunities are now arising based on healing supply chain, stabilized commodity prices and the strength of the dollar.

To be successful, we are rethinking and taking fresh eyes to all costs and are working to root out anything that is not adding imminent value. I can assure you we will leave no stone unturned in order to strengthen our balance sheet and return to the company to double-digit EBITDA margins as soon as possible, while maintaining our focus on a strong customer experience. In that vein, in October, we launched a program that we have coined as focus, simplify and grow, which is targeting approximately $200 million in annual cost reductions to be fully delivered by early fiscal 2025. We anticipate that 50% of these savings will be supply chain related, 30% will be from COGS improvements and the balance will be from reductions to overhead costs. We also expect additional cash savings from other adjustments we are making to the business in areas such as capital expenditures and working capital.

Of note, we anticipate the majority of supply chain savings to come from reductions in ocean freight costs and the majority of these savings will offset the phase out of the ocean freight adjustment, which we have been making over the past five quarters in which we anticipate will be fully eliminated in the first half of fiscal year ’24. While we are off to a good start, it’s still early in the process, and therefore, we will be providing updates on this effort in future quarters. I also want to comment briefly on our dividend. As announced in our earnings release, we made the decision to pause our quarterly cash dividend payments. As a public company, our dividend has been an important part of our capital allocation strategy. This decision was not made lightly.

However, we find ourselves in a period of record inflation, rapidly rising interest rates and a more likely than not recession. No priority can be more important in working to ensure that we can successfully weather any storm, while not compromising on the most critical business investments. Business investments that are critical to winning with our customers and also creating significant shareholder value long-term. We fundamentally remain committed to returning capital to shareholders and being responsive to the needs of all of our key stakeholders and this pause does not preclude us from resuming our dividend at a later date. I would like to close out with some very exciting words regarding two of our Blue Ocean initiatives, the first of which is the SINGER DITTO, our 50-50 joint venture with SINGER, Viking and PFAFF.

DITTO is a revolutionary product and platform for sewers and craft enthusiasts everywhere. We have been working on this initiative for over 4 years and now nearing launch during New York’s Fashion Week in February. Units are in production and being shipped as we speak and we will be launching in the United States in mid Q1 of the next fiscal year. As I’ve said many times, traditional sewing patterns are both the heart of selling projects as well as the most painful part of the process, as the format is literally not changed since the 1800s, in fact, since the days of Abraham Lincoln. Our patented DITTO system will allow customers to turn patterning into the most fun part of the sewing process using an AI platform integrated with a digital laser projector system that will enable a multitude of designs and permutations and literally take so is from ideation to sewing in minutes versus hours.

Of note, DITTO receives one of the highest ever purchase intent scores by our external design partner, a partner who has over 1,300 commercialized patents. There are about 30 million households in the U.S. alone that actively sew in a much greater number in the 180 plus countries SINGER, Viking and PFAFF and their respective dealers operate in. We believe that many of these sewing households would like to have access a DITTO. In fact, DITTO has been vetted with expert , design students and beginner sewers and crafters and the like and acceptance excitement across the various constituents is universal. In the coming months, we are working on a way to bring the best brand to life to DITTO for all of our stakeholders so that you can see it in action firsthand and get a better idea as to why this is so revolutionary.

The second Blue Ocean, I will briefly mention today is our wholesale initiative, which is in the early innings, but exceeding our internal expectations based on revenue contribution. We signed up over 200 new B2B customers in the third quarter and we have significant momentum with additional customers as well. The commercial website for our marketplace platform is scheduled to launch over the next 2 months. This website will provide greater operating efficiencies with added checkout capabilities for our B2B wholesale customers. So let me just close by thanking all of you for listening today. While we have faced a series of challenges over the past few years, including Section 301 tariffs, record inflation and rapidly rising interest rates, we have also had many reasons to be optimistic.

JOANN, starting with our stores, has a highly resonant and differentiated customer proposition that is very hard to replicate. Our omni business continues to gain momentum and is prime for significant profitable growth. Input costs, including supply chain costs, have reached an inflection point from highly inflationary to deflationary and we are organizing to capitalize on the reversing trend and capture significant value. And lastly, our Blue Ocean growth initiatives are now coming to fruition and hold the promise to create significant value. DITTO specifically has potential to take an entire sewing industry to an entirely new level of technology, engagement and fun. These initiatives, combined with our recent business momentum give me optimism that we are on the right path as we transition from fiscal 2023 into fiscal 2024.

And with that, I’ll turn it over to you, Scott.

Scott Sekella: Good afternoon, and thank you Wade for the introduction and a warm welcome. I’m very excited to join the JOANN team and eager to meet many of you joining us on the call today. JOANN’s leadership position in the sewing and crafting industry is certainly well documented. Although I joined the organization recently, I’ve been particularly impressed by JOANN’s strong cultural foundation, and I look forward to the opportunity to contribute to JOANN’s continued success. As an organization, JOANN has experienced significant external cost pressures over several years now. More recently, we’ve also seen a noticeable shift in spending patterns by consumers who are prioritizing consumer staples and essentials over discretionary items.

In what is now an increasingly uncertain economic environment, we are taking the opportunity to reset our cost structure simplify and streamline our operations and refocus our efforts for growth opportunities in areas that will maximize our long-term profitability. We also intend to capitalize on the stronger dollar in our sourcing efforts and take advantage of easing supply chain costs to generate greater operational efficiencies. We firmly believe that recent challenges provide us with the unique opportunity to carefully reassess our existing operations and nothing is off limits. As Wade mentioned, we launched our focus Simplified Grow initiative and are targeting approximately $200 million of annualized cost savings by the early portion of fiscal 2025.

I’m excited to see how the organization has embraced this challenge and tackled it head on. These initiatives are intended to combat inflationary pressures we have experienced and create financial flexibility during these uncertain times. I would now like to recap our third quarter results and then provide some additional color about our near-term outlook. As Wade touched on earlier, we experienced some deceleration in our sales trends during Q3 as the quarter progressed, particularly towards the end of the quarter. Net sales for our third quarter totaled $562.8 million, a decline of 7.9% compared to last year with total comp sales decreasing by 8%. Relative to pre-pandemic levels in the third quarter of fiscal 2020, our total comp sales were slightly negative, declining by 1.1% over the corresponding period.

While Halloween was a significant bright spot in Q3, we experienced some pullback in demand for fall seasonal categories as well as continued softness in our craft technology business. Our average ticket increased by 1% in the third quarter over last year, driven by price increases and partially offset by fewer items per basket. Our e-commerce or omni-channel business declined by 4.4% versus last year. Our omni business continues to outpace our overall sales performance and has more than doubled relative to pre-pandemic levels. Going forward, our new multipurpose distribution center remains the cornerstone of our online strategy, and we are focused on bringing it to full capability. Over the long-term, it will drive significant operational efficiencies, improve fill rates and reduce split orders.

On a GAAP basis, our gross profit in Q3 was $281 million, a decrease of 11.9% from last year and a decline of 1% from pre-pandemic levels in fiscal 2020. We absorbed $18.5 million of excess import costs during the quarter. While this figure reflects a $7.2 million increase over last year, the amount was lower than expected as we continued to benefit from improving conditions in the spot market. After adjusting for excess import freight costs for both corresponding periods, our gross profit of $299.5 million declined by 9.3% from last year. Our core merchandising or POS margin was slightly higher compared to last year in spite of deeper promotional activity that we incurred late in the quarter in relation to fall, seasonal and floral categories.

While up close to 5% from last year, our average unit retail metric moderated slightly in Q3 on a sequential basis due to increased promotional intensity. Concurrently, our average unit cost increased on a sequential basis. However, these costs were anticipated. As we communicated in our previous earnings call, we’ve continued to experience spillover effects from higher inventory costs incurred during the peak period of last year’s supply chain headwinds. It typically takes 6 months or more for inventory costs to work their way through our P&L. Once we complete the process of renegotiating our contracts for next year, we expect the outlook for average unit cost to improve in fiscal 2024. Our gross margin on a GAAP basis was 49.9% in Q3, a decrease of 230 basis points from last year.

In addition to the impact of excess import costs, we experienced higher domestic freight expense as a result of higher carrier rates and fuel costs. Since we are now cycling the impact of extremely high ocean freight costs from the back half of last year, the year-over-year decline in our GAAP gross margin was much more moderate in Q3 and compared to the 730 basis point decline in the prior quarter. After adjusting for excess import freight costs, adjusted gross margin of 53.2% and represents a decrease of 80 basis points from last year, driven by the timing of clearance activity, increased carrier and fuel rates as well as . On a sequential basis, the decline in our adjusted gross margin in Q3 was more moderate compared to the 150 basis point decline in the prior quarter.

As Wade mentioned in his remarks, we are encouraged by the fact that we are finally reaching an inflection point with regards to supply chain costs and cost of goods inflation. Of particular note, excess import freight costs have now effectively transitioned from headwinds to tailwinds and we expect that will be clearly reflected in the fourth quarter from a P&L perspective. That said, we realized $32 million of cash benefit from lower ocean freight rates in Q3. The fourth quarter of fiscal 2023 represents the first of what we expect will be several consecutive quarters of P&L benefit from improving ocean freight rates. In Q4, ocean freight expenses are expected to be around $15 million to $20 million favorable relative to last year from a P&L perspective.

On a cash basis, we also expect to realize $15 million to $20 million of improvement in the fourth quarter from lower ocean freight expenses based on favorable comparisons to last year and ongoing improvements in the spot market. Turning to expenses. Our selling, general and administrative expenses increased by 4.4% from last year. Although we managed to optimize store labor hour successfully during the quarter, our operating expenses were negatively impacted by higher preopening and closing expenses relative to last year and incremental cost for our new multipurpose distribution center in West Jefferson, Ohio. We also cycled a significant reduction to incentive compensation from last year, resulting in unfavorable year-over-year comparisons as well as experienced higher stock-based compensation expenses from a change in our retirement policy.

Our net loss in Q3 was $17.5 million compared to a net income of $22.8 million over the same period last year. Adjusted EBITDA in the third quarter was $40.2 million compared to $72.6 million last year. Moving on to our balance sheet. Our cash and cash equivalents were $27.5 million at the end of the quarter. As of October 29, we had $74.5 million of availability on our revolving credit facility. Our long-term debt net at the end of Q3 was close to $1.1 billion reflecting an increase of $209 million from the same period last year and a leverage ratio of 6.6x is measured by net debt relative to credit facility adjusted EBITDA on a trailing 12-month basis. The majority of this increase in borrowing was driven by higher import freight costs that we’ve absorbed on a cumulative basis over the past year.

Our inventory at the end of the third quarter was nearly flat year-over-year and lower than we anticipated on our last earnings call. We continue to manage our inventory receipts in line with current business trends. The plans that we previously outlined to lower inventory receipts in the back half remain on track. You’ll recall, on last quarter’s call, we indicated that during the back half of fiscal 2023, we would generate a significant amount of cash flow with a particular emphasis on fourth quarter. We still expect the fourth quarter to be cash flow generative, but not to the extent we previously expected. We previously indicated we expected net debt to be in the low to mid $800 million range. We now anticipate around mid $900 million for our year-end net debt.

Approximately half of the increase is due to lower sales in the back half while the majority of the remaining increase is related to timing of inventory receipts. This timing impact will now positively impact Q1 of fiscal 2024 instead of fiscal 2023 as previously expected. We have also narrowed our capital spending plans to a range of $65 million to $70 million for fiscal year 2023. The total number of store projects remains unchanged for fiscal 2023. Through the end of the third quarter, we completed 30 projects with another four planned for the fourth quarter. Consistent with our intense focus on capital allocation, we will continue to assess the macro environment and adjust our capital spending in fiscal 2024 accordingly. Overall, we remain committed to enhancing the in-store experience and our store refresh program remains a key part of this growth strategy.

As Wade mentioned, we’ve carefully made a decision to pause our dividend at this time to focus on strengthening the balance sheet and improving liquidity. I also want to clarify that the cash impact from the pause in our dividend is incremental to the $200 million of planned cost reduction. The steps we are taking to streamline our operations are intended to both respond to a rapidly evolving consumer backdrop and to offset the wide range of cost pressures we have — that have taken shape for several years now. To recap, we are focused on cash generation and are positioning our business for a significantly improved cash flow outlook in fiscal 2024. It’s also clear that consumers are being more selective and demanding more value in the current economic environment, which is defined by continued uncertainty and by a noticeable pullback in discretionary spending.

These challenges provide us with a fresh opportunity to reset the bar through cost optimization and to better position ourselves for growth once demand and economic conditions begin to normalize. With that, we’d be happy to take your questions. Operator?

Q&A Session

Operator: And the first question will be from William Reuter with Bank of America. Please go ahead.

William Reuter: Hi. Good afternoon. So in terms of your savings, the $200 million program you expect to achieve by early fiscal year 2025, do you have a sense for what you may be able to achieve during fiscal year ’24 at this point?

Wade Miquelon: Yes. We aren’t putting out specific numbers, but I would suspect it would be very substantive. I would hope more than half. I mean we already have a lot of runway on the supply chain savings, as spot rates are normalizing, in particular, that’s a very, very big number. But as we go forward in future calls, we are going to try to provide a little bit more guidance in terms of the cadence of this. But we are actually starting to incur savings on all the three core work streams. Some will take longer than others. But I think supply chain is one that can be most immediately realized. I would also though just warn you that, first, we’re going to see the cash benefit of these then we are going to see the P&L benefit, because some of these things such as ocean freight and COGS, in particular, those two items work their way through our inventory. So there can be a 6-month lag before some time to the cash benefit to the time of the P&L benefit.

Scott Sekella: Yes. Hi, William. It’s Scott. Yes, I just want to reiterate what Wade said there, particularly at the end that we do expect to see this impact on a cash basis first and more significantly than on an EBITDA basis in fiscal 2024, because with both ocean and those product cost savings, which is a good chunk of that $200 million, that’s going to need to roll through the balance sheet. And oftentimes, those costs take 6 months or more to impact from an EBITDA perspective.

William Reuter: Great. That makes sense. And then just a second question for me. It sounds like it’s the more discretionary, I assume higher ticket items, which may be experiencing greater softness. I guess, is that the case and are you seeing divergent trends between arts and crafts versus your core sewing products?

Wade Miquelon: Yes. I’ll say a few things, and maybe Chris can build on it. I think it’s — what we see is one is in kind of the technology sector. I think some of what we see there is I don’t think is a factor as much discretionary spend is the fact that there was just so much — so many sales during the pandemic. So you had a little bit of saturation on the core products that will eventually work its way through. But I think where we are seeing kind of the tightening is actually really in our seasonal product, not the basic so much, but it’s the — in particular, it was the fall decor. We have a strong Halloween with the fall decor where people chose not to spend the money to decorate as well as some of the other seasonal floral items that go with that. But on the core basics, we are seeing actually pretty strong steady demand.

Chris DiTullio: Yes, I’d agree Wade and — hi, William, it’s Chris. One of the things that we are seeing is our core customer is really strong and strengthening, especially the more advanced sewer, the more advanced crafter on both sides of the house. So we are seeing some very good underlying trends in a number of our categories, both in craft and sewing. It’s just that we are also, at the same time, dealing with some headwinds from those pandemic boosted categories over the past couple of years in craft technology and then more cotton-related fabrics, which were the two categories that really had the biggest boost over 2020, 2021 calendar.