J.C. Penney Q2 Conference Call Highlights: Momentum Expected To Continue

J.C. Penney's JCP Chief Financial Officer Ed Record hosted the company's second quarter conference call. CEO Mike Ullman is recovering from a surgical procedure and was unable to take part in the call.

The quarter in review

During the quarter, comparable store sales rose six percent from a year ago. Total sales rose 5.1 percent from a year ago to $2.799 billion. Online sales through Jcp.com continued to show growth with a 16.7 percent increase over last year.

Store traffic continues to improve, but is still negative for the quarter. Meanwhile, conversion and average transaction size showed an improvement versus last year.

Sephora continues to be a driver of sales growth as the company added 13 new Sephora stores inside J.C. Penney, bringing the total count to over 500. Sephora sales were up over 25 percent year over year and up over 11 percent in stores opened at least one full year.

Related Link: Will J.C. Penney Recreate Last Quarter's Impressive Results?

Gross margin improved to 36 percent of sales from 29.6 percent a year ago. The improvement was positively impacted by better sales performance. Clearance sales were less than 15 percent of total sales for the quarter, in-line with the historical rate.

SG&A for the quarter declined six percent from a year ago to $964 million due to lower store expenses, net advertising and corporate overhead and an improved credit income.

Operating income for the quarter improved by $325 million to a loss of $70 million, while EBITDA improved by $342 million to a positive $90 million.

Cash and cash equivalents at the end of the quarter were $1.036 billion, while operating cash flow for the quarter was a source of $137 million compared to a $708 million use last year. Cash flow from financing activities was a use of $229 million, reflecting a pay-down of borrowings under the previous credit facility.

Free cash flow improved by $1.2 billion in the quarter to a positive $76 million. The uptick was driven by strong inventory management and an improvement in the profitability of the business.

Comparative inventory fell 9.7 percent from a year ago to $2.848 billion.

With the closing of J.C. Penney's credit facility, short-term borrowings are now zero. $500 million of the $650 million previously outstanding shifted into the new term loan and the remaining $150 million was retired with cash on hand. Long-term debt rose to $5.323 billion from $4.850 billion a year ago due to the addition of a $500 million term loan under the new credit facility.

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Looking forward

During the conference call, Record offered the following third quarter guidance:

• Comparable store sales are expected to increase by a mid single-digit.
• Gross margin is expected to be in line with the second quarter.
• SG&A expenses are expected to be slightly above last year.

The following guidance was offered for the full fiscal year:

• Comparable store-sales to increase mid single-digits.
• Gross margin is expected to be positive.
• Liquidity is expected to be approximately $2.1 billion at year-end.
• Capital expenditures are expected to be approximately $250 million.
• Depreciation and amortization are expected to be approximately $640 million.

Notable quotes

Ed Record on private labels: “The restoration of key private brands has been fundamental to our turnaround. Brands like St. John's Bay, JF, J. Ferrar, Ambrielle and Xersion all continued to outperform. We believe private brands like these are key to JCPenney's growth. They not only give customers style at a price that fits their budget but at margins that are 300 to 600 basis points higher than other brands.”

Ed Record on the back to school season: “We're very pleased with our back-to-school performance. I would tell you week 26, which is the last week of the quarter, is the second-largest week of the spring season for us, second only to Easter, and we ended on double-digit comps. So we feel really good as we head into August about the back-to-school. As far as areas of the business, I could tell you, through the weeks that we track as back-to-school which are weeks 23 through 26 in second quarter, all areas that we track for back-to-school were positive. So all areas are performing well and we feel good about back-to-school.”

Ed Record on traffic and competition: “I've spent a fair amount of time looking at our traffic history, and the best I can tell is, traffic is an issue I think in the industry and I think you heard Macy's and Kohl's talk about it, talk about transactions which equates to traffic. I think we're in a little different position because I think if you look at it, our sales dropped more than the traffic dropped last year. And so, as we she traffic more normalize, we're seeing conversion go up. So while traffic is negative, conversion is positive.”

Ed Record on clearance gross margins: “One of the issues we have is the clearance, the margin on clearance continues to improve and improved dramatically over Q1 but is not back to historical levels yet, and as we get into Q3, as we get to the end of the spring lifecycle and liquidating that product, we don't expect to be able to run the margins on that clearance that we did historically.”

After trading higher by around 10 percent immediately following the earnings result on Thursday, shares of J.C. Penney were seen trading lower by 3.3 percent at $9.41.