Q4 2022 Earnings Conference Call


spk01: Say, ladies and gentlemen, thank you for standing by. Welcome to Joanne's 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 1 on your telephone. Please be advised that today's conference is being recorded. If you require any further assistance, please press star and zero. I would now like to hand the conference over to your speaker, Mr. A.J. James, Head of Investor Relations. Please go ahead, A.J.
spk04: Thank you, Sherry, and good afternoon. I'd like to remind everyone that comments made today may include poor-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 Joanne's website. at On the call today from Julian are Wade Michelon, President and Chief Executive Officer, and Matt Sues, a Financial Officer. I will now turn the call over to Wade Michelon.
spk05: Good afternoon. Before I begin my prepared remarks, I wanted to personally acknowledge the horrifying situation in the Ukraine and the 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 the Ukraine. To that end, Joanne has partnered with the Red Cross to provide direct assistance during the ongoing humanitarian crisis. Through this program, we will match all contributions by our team members dollar for dollar. We'll continue to monitor the situation on behalf of our leadership team. We offer 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 have achieved at 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 continued the expansion of our omni-channel business, which has more than doubled based on a two-year comparison, including the launch of new payment methods with Karna and Apple Pay, making it easier for customers to purchase with us. We enjoyed a successful first year 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 historic supply chain headwinds and labor shortages to include an industry best performance in curbside pickup where we consistently deliver to the customer in just two minutes. We've 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 multi-purpose distribution center in Columbus, Ohio. This fulfillment center is truly unique. We've 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 handling the seasonal flow of merchandising to our stores. In addition, we believe that the opportunity to improve line fill rates and reduce split shipments is a significant opportunity for Joanne to improve our costs and omni-channel profitability once fully operational. 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, and St. Jude, and we're on the way to record fundraising for 4-H in early fiscal year 23. We took steps to improve our balance sheet through the sale-lease back 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 SVP, or Singer Viking Faf. This new partnership will bring exciting products and services as it revolutionizes the pattern access, design, and the cutting processes for sewers everywhere. Turning the number one SOAS pain point into the most fun part of the process is just the beginning of this journey. The Ditto 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. We continue to add new customers to Joann at a high rate. Through the end of fiscal year 2022, our known customer database grew by 42% over the three years, and it's now in excess of 77 million. Our customer profile continues to evolve with these new additions, becoming younger, more diverse in demographics, and in crafting and selling interests, and also more digitally native. In fact, 85% of the new customers acquired in fiscal year 2022 were acquired through a digital channel. We believe this sets us up for future growth. Another highlight of this past fiscal year was the performance of our top customer segments, those who are true category enthusiasts. We were able to grow sales with these customers by over 2x 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 in our base as well. We see them purchasing at the same rate, but now with higher average unit retails due to pullbacks we've executed with promotions. These category enthusiasts recognize and appreciate our breadth of assortments, quality, value, and most of all, the knowledgeable service we provide in our stores and 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 in 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 Omnicron variant spread. We did see a greater shift to online during the month of January, from shift 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. We estimate that the combined impact of Omnicron, along with some significant weather storms resulting in incremental store closures, was between 100 and 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. 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 merchandise 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 clearly came at a cost to our operating and financial results in Q4. While we previously anticipated that excess freight costs in Q4 would 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 include significantly higher container rates, transloading fees, and additional expenses including retention and demerge fees needed to free 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 JOANN is no different. Over the past few weeks, we have seen a shift in behavior among our non-core customers at JOANN as the war has 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 We'll make relevant adjustments to our business as needed. Heading into fiscal 2023, we have always anticipated that sales comparisons will be unfavorable in Q1 due to our 15% comp last year. We have 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 related consumer behavior on a near daily basis. We are seeing accelerated growth in some critical reopening categories, such as special occasion for weddings, proms, 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 our actions are balanced for the long term. Overall, I'm proud of the combined efforts of our teams in 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. While we believe that these costs have reached an inflection point following our fourth quarter, at this time we still lack complete visibility on the financial impact for fiscal year 23, in part because we have still not completed our annual ocean freight negotiations. While 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 normalize, creating a multi-year tailwind. I previously mentioned that we have more to share in the months ahead in relation to other Blue Ocean initiatives at JOANN. Today I'm excited to announce that we have forged strategic partnership with JDM Growth Group, the premier wholesale and e-commerce consulting company. The leadership at JDM includes members of the Catan family, who have extensive backgrounds in the arts and crafts industry. This partnership will forge new avenues for Joanne in the B2B wholesale 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 WeaveUp. And for those not familiar, WeaveUp is a leader in innovation in digital textile printing and related solutions. Our strategic partnership with WeaveUp began in 2018. This relationship expanded further following a subsequent round of financing led by Joanne. Since that time, we've tightened our proposition to create value, and by coming fully together, we believe we can accelerate that journey. WeaveUp is led by Flint Davis and is truly a unique software company that empowers digital textile solutions for the consumer, commercial applications, and hospitality markets. This will allow us to create the highest quality of a spoke consumer and designer fabric and other offerings, streamline our product development and sourcing processes, enable both digital and rotary mills to be more efficient. The evolution of our relationship with WEVA 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 a part regarding the legality of Section 301 tariffs with China that went into effect in 2018. A three-judge panel has heard the case and has the ability to either dismiss the case, overturn the tariffs, which could include back tariff refunds and penalties, or move the case to a trial. We understand that the decision should be forthcoming in the coming weeks or months. Further, the Administration is conducting a required review of U.S. trade policy related to Section 301 tariffs. The current tariffs are set to expire four years after they were initially implemented unless the Administration makes the case for their necessity moving forward. Our forecasts and projections continue to assume that 301 tariffs will continue into the foreseeable future. With 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 disruptions head-on. From over 20,000 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 ally to our customers and to each other, and I am very excited about the journey ahead. with more to come in fiscal 23 and beyond. And with that, I will turn the call over to Matt for a more detailed review of our financials. Matt. Thank you, Wade.
spk06: 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 $0.32. 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 sales increased by 6% in the fourth quarter. 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 will 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 and the two-year comp decelerated to 6% for the month of January. Our omni-channel business continued to be a significant growth driver for Joanne. Omni-channel penetration represented 14% of our fourth quarter sales, 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 gap basis gross profit declined by 1% in the fourth quarter on a two-year basis, driven by expected but escalating increases in excess freight and related supply chain costs. We fully absorbed around $42 million year-over-year of higher ocean freight costs 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 pandemic. 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 leverage 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 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 9.4% 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 costs to handle later arriving goods, increases in strategic and technology development costs, and higher incentive compensation than two years ago. 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 costs based on more favorable pricing terms. This follows the previous refinancing of our term loan during FY, 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 7.9% to $2.4 billion and comparable sales grew by 8.3%. 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 50.2% in fiscal 2022 compared to fiscal 2020. Adjusted for excess ocean freight and related supply chain costs, gross margin rate improved by 280 basis points from two years ago, or fiscal 2020, to 52.1%. For the full year, adjusted EBITDA was $242.5 million, an increase of 58% on a two-year basis compared to fiscal 2020. 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 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 costs, which represent $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 910,120 shares of our common stock at a total cost of $9.2 million. Combined with previously reported share repurchases, for the full year, we repurchased 1,889,050 shares at a total cost of the full $20 million provided under our board authorization. At the end of fiscal 2022, our trailing 12-month credit facility adjusted EBITDA was $251.3 million, resulting in a leverage ratio for net debt less cash to adjusted EBITDA of 3.1 times. Our longer-term leverage target of approximately 2.0 times remains unchanged, 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 10 cents per share was paid on December 29 to shareholders of record as of December 15, 2021. Our board of directors recently authorized a quarterly dividend increase of 10% to 11 cents per share to be paid on April 8 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 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 decline by approximately 5%. Data we use 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 related shutdowns in China, we are managing the business to a more conservative outlook. And so we have more certainty around the length and 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 two quarters that we expect will enable modest growth and adjusted gross margin rate. That growth and adjusted gross margin rate is expected to be offset by what we see as prolonged, but still temporary, excessive international supply chain costs. As you 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 that U.S. ports will continue to be congested, we see these excess costs affecting our results for all four quarters of this year before normalizing. 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 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 general inflation. For fiscal 2023, capital expenditures, net of landlord contributions, will be approximately $70 to $75 million, primarily to fund our new point-of-sale system rollout, completion of our multipurpose distribution center near Columbus, Ohio, and the grand open 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 to $17 million. Depreciation and amortization is expected to be between $81 million and $83 million, a slight increase to this past year driven by the capital investments I just mentioned. We have reduced the planned number of store refresh projects for this year from our earlier provided range of 50 to 60 due to current challenges in 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 of project completion once they do. We estimate annual interest expense of $47 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 an ability to garner new customers and market share during this past year that will support our future growth. I also share Wade's 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 will announce as they mature. With that, we'd be happy to take your questions.
spk01: Thank you. As a reminder, to ask a question, you will need to press star 1 on your telephone. We ask that you please limit yourself to one question and one follow-up question. You may then return to the queue. To withdraw your question, please press the pound key. Please stand by while we compile the Q&A roster. Our first question will come from Liz Suzuki with Bank of America. Please go ahead.
spk02: Great. Thank you. So you mentioned that your core enthusiast customer comp positively in the fourth quarter. Can you talk about what percentage of sales they represent and then how many of your newer customers that you gained during COVID have essentially disengaged from the category or have shopped less with you?
spk05: Yeah. I mean, our top 3 million, we've always said are about 30% and then our kind of our next part of our cores are three to 6 million, which I think that rounds out to slightly below 50. That's all been strong. You know, it's, And actually, through the quarter, it was all reasonably strong. I think it's really kind of the last three weeks that was saying that that far down in database has been less engaged since the war, really. And it's across all categories for 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, the same kind of pattern in the short term, so it's not new to us. But it's really been the last three weeks that we've seen that. Our top customers have been growing at a faster rate than our lower customers, which is, you know, if you had to pick one, that's what you'd want to see.
spk02: Right, right. And then, you know, I just wanted to clarify a statement that was made about, you know, the original expectation of the first quarter being down low to mid-single digits. Now you expect that to 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.
spk05: I'd say it's kind of day by day, right? You know, even by day you'll see a much stronger day than a day that pops back to what we've been talking about. So it's hard to say. But I would say that that's probably, you know, if this current trend continues, that's probably reasonable.
spk02: Okay. All right. Thank you.
spk05: Again, we're cycling a 15 comp last year, so you have to also keep that in mind, I think, as your model.
spk01: Yep. Thank you. Our next question will come from Stephen Forbes with Guggenheim. Please go ahead.
spk10: Good evening. Maybe just to start with the 40 projects that are planned for 2022 later, Matt, can you just provide a little more detail about how you would classify them between the three types of projects that we discussed during the IPO process and any color sort of on the cadence of those projects?
spk06: Yeah, I can take that one, Steve. This is Matt. So, as I mentioned in my prepared comments, slightly over half of those are relocation. We'll have 23 of those that are currently planned. Then we'll have about another, and these scale and scope on these do morph a little bit over time, but in general we'll have about five to ten of the more higher-end remodels, and then the balance of those will be the work that are primarily to reestablish the most efficient macro layouts for the stores. 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 projects 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.
spk05: You know, across the whole portfolio of our projects, when you put them together in aggregate, we are actually, you know, outperforming our pro forma, both in sales and in but what we're also seeing right now in the short term is in some of our projects and markets, we're seeing contractors trying to take significant increases. We're seeing some of the things like fixtures, significant delays. So as we've redone the plan from about 55 to 40, we've really been able to prioritize the ones that make sense and where we're not going to have kind of the short-term inflation burdening what we think is the appropriate long-term investment, more or less.
spk06: And a lot more certainty around delivering them on time.
spk05: Right.
spk10: And just a quick follow-up. At a high level, if we think about gross margin, obviously you noted the elevated freight cost and the associated impact, but any sort of changes to call out within the sort of other line items within gross product margin, shrink, clearance, are there any sort of changes, both positive or negative, that are worth noting?
spk06: I think we have the same general positive trends on shrinking 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.
spk05: If you do look over our margins over time, I think we've made extraordinary progress considering the inflation we've absorbed, considering the ocean freight, the other transportation issues, and considering tariffs. And I think we feel pretty good about this environment that we can keep, you know, driving margin to make sure we can absorb those. But having said that, you know, gross profit dollar is really our first and foremost focus in driving that. In this environment when it's very, very hard and expensive to get products, you know, making sure that we're putting that in front of the radar makes even more sense. Thank you.
spk01: Thank you. Our next question will come from Paul Kearney with Barclays. Please go ahead.
spk07: Hi, everybody. Thanks. I have a multi-part on the excess freight and then a follow-up. So first, as you pointed out, you expected it to double and it tripled. What drove the variance? What drove it higher from what you would expect it in December? What do you expect it to be for Q1 next year? And then can you just remind us of how this flows through to your inventory and how this impacts gross margin into next year? And then we'll follow up after.
spk06: Sure, I'll try to make sure I capture all that, but 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... costs we incur due to congestion at the port so to the extent we have containers stuck in ports at a certain period of time under our contracts we incur fees for that and at a certain point of time those become pretty material i think this is something we're with more time to plan we're going to be able to 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 containers stuck there, some additional handling costs as well, but those fees were also a significant piece of that.
spk05: I'm sure everybody is dealing with this, but this is part of the issue that's 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 over time, and it's something that really hasn't been seen before, but I think it's much more widespread than us.
spk06: Yeah, on the first quarter expected impact, you know, I would say we're not in a position to give a very specific number on that, but basically what we said is the $35 million approximately 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, you know, it'll be approaching that number, but certainly don't expect it to be 100% equal to that.
spk05: Because the P&L will have a lot of the flow-through from the prior quarters, but our cash spending this quarter on that will actually be pretty good because our volume is lower, our contracts that we have are pretty good, and a much higher percent of our contracts will be honored this quarter because it's a lower quarter in aggregate. So there's receipts and the cash flow versus P&L timing mismatch here.
spk06: Which is kind of your last piece of your question. How does this flow through our inventory and then to our P&L? Basically, this works as we're paying the excess cost for moving the container and then if we're incurring any additional fees and costs either transload or to the extent what unfortunately we do have some containers stuck in ports and we're paying fees related to those. That all, we're able to attach that to specific purchase orders for our inventory and we attach those costs to that inventory. So that's what represents the $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's the adjustment you'll see to our adjusted EBITDA to get from GAAP basis to adjusted gross margin. And then, obviously, on a GAAP basis, it's 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, it runs through our gross margin.
spk07: Okay. My second one is on the Section 301 tariffs, Can you remind us first how much of your product mix is impacted by that? And 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 be to your financials if that reverses? Thanks.
spk05: Yeah, good question. Just to remind people, you know, in 2018, We had the tariffs through when Larry levied in two phases. That was about $85 to $90 million a year of tariff costs levied against us. And I don't know the exact percentage. I want to say it's in the mid to high 20s or something in total. But nevertheless, we've been able to mitigate about half of that over time. If they were repealed 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 paid it directly and then raised it with us, and that would have to be a process of going back to negotiate for the future. We'll see if this happens or not. If they are deemed to be illegal, the best-case scenario is we would get a repayment for it. substantial money. More than $80 million plus interest, I think, would be the number. There's also a scenario where nothing happens, so we'll see. But I think, like I said, in terms of immediate benefit, we probably would get 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.
spk06: Just to emphasize again, although Wade covered this in his remarks, our current expectations and how we're managing the business from a cost perspective and pricing, we're not expecting any relief on tariffs at the moment. All right.
spk07: Thank you. Best of luck. Thank you.
spk01: Thank you. Our next question will come from Peter Keith with Piper Sandler. Please go ahead.
spk09: Hi. Good afternoon. 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 to take many markdowns. What are you now seeing to pick off the year as sales in the industry have weakened? Are promotions starting to pick back up at all?
spk05: I haven't seen that. And the other thing I'll tell you that's very interesting is we have actually taken some pricing on several SKUs, but we've also had holdout markets. And we've really not seen any difference in unit flow, whether it's had pricing or no pricing. So this 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 an inflation and a war shock, really, versus an overall pricing issue.
spk09: Okay. And then next, I just wanted to just break apart the freight costs and the component that's stripped out. So just mathematically, I think you said 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?
spk06: Yeah, for the quarter, yes. That's correct. Okay.
spk09: Okay, so is that a fair way to think about the freight pressure on an adjusted gross margin basis going forward, maybe about 100 basis points of pressure for Q1, Q2 as these costs continue?
spk06: Yeah, I hesitate to give a range because some of this does depend on relative sell-through of products that are impacted by this and mix. You know, I think at a general scale, you're probably in the ballpark. But, again, you know, I would hesitate to give more specific guidance than that.
spk09: Okay. Sorry, one last question just on this topic. So when we look at that 100 basis points that is flowing through adjusted, as your contracts readjust in June, I think most people would agree everyone's contracts will go up, but there will just be less spot market pricing. Okay. Should we expect on an adjusted basis that you'll continue to have freight pressure through the year as your contract rate probably will move higher mid-year?
spk05: Yeah, I mean, what you said is, I think, right, because people will have, you know, hopefully more contracted, not only because they may be contracted more, but because more is honored. So you are, you know, less on the spot market. You know, from everything we're seeing, though, you know, kind of 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 that kind of the new normal will set in the year after that. And that new normal, what we believe is kind of what we're calling our non-adjusted. And from all the benchmark and work and what we're seeing in the indicators, I think that's probably the current best thinking at this time. Okay. I don't know if that answers your question, but you're exactly right about the contract rates being higher, but less on the spot, which, you know, Some of our SPA last year was 10X our, you know, sort of contracts. So.
spk09: Okay. Yep. That helps a lot. So thank you very much.
spk01: Thank you. Our next question will come from Daniel Hoskins with William Blair. Please go ahead.
spk08: Good afternoon. Just I guess one. maybe if you could refresh our memory, one question that we get from a number of investors is just kind of a general approach on the, or the kind of the rationale for the adjusted numbers and, you know, 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? It's just the question we're getting is basically like, Why are these adjustments, you know, especially given that there's so little visibility for the time being on when and what the trajectory is going forward? Just curious, you know, if there's any, if you could kind of just refresh our memory on the thought process behind the adjustments. I think everyone understands that if the environment gets better, you know, the cost structure will improve. But, you know, just help us understand that a little bit.
spk05: Yeah, but I recognize that there's different ways to view this. So, you know, I'm not making anybody wrong if they see it in a different way. I think the way we view it is a couple things. One is that, for starters, it's a very, very big number to the degree that, you know, we're directly or indirectly importing, you know, 90% of what we do and a huge percent of that from where the lanes are, you know, most pressed. And then, you know, the average item that we sell is, you know, $4. So when you look as, you know, If we were importing luxury watches or rubies or something, this wouldn't be an issue, but when you have bulky things that cost a couple bucks and you sell for four bucks, it's a big percent of that. If you combine that with the fact that what we don't want to do is we don't want to overprice for something which we believe in a year or so is going to normalize, because that's going to be a situation that's not great for the long term. We also want to make sure that when we're setting our objectives We're not lowering our threshold for the future at a much lower base because we're assuming these are permanent. When they're not permanent, then we're spending that away or eating that away for value creation. So that's really the philosophy is that they're very big, they're 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.
spk08: Yeah, I think it's maybe the question is a little bit about whether these should be, you know, formal adjustments in the numbers or just sort of discussion points around areas of cost pressure. But I hear what you're saying.
spk05: It's a question. You know, hopefully that we're trying to be as transparent as we can on the number. And then, you know, however people want to funnel it, at least they know, you know, what the aggregate number is.
spk08: Sure. Okay. And then, you know, 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 of the benefit and the comparison last year in March?
spk05: Well, you know, we're modeling that in a little bit. We don't exactly know how much benefactor we are stimulus. We're usually not, not a lot, but I will tell you that, you know, what we kind of call, you know, you know, our technology sales, you know, we are modeling what that spike was last year. Some of that was because you had 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 is, you know, big machine sales, high ticket. So I think we are factoring that in. But like I said, what you could see is to the day when the war hit, a certain kind of customer was just frozen for whatever reason. You know, and we have seen that before. And then we see that customer, you know, ultimately normalize and come back. But, you know, I think the biggest piece we're seeing right now is just that you know, shock that that customer has. And I'm sure... Yeah, I'm sure. I'm sorry, go ahead. Oh, I'm sorry. I didn't mean to cut you off. Obviously, in some of the data we get in terms of, you know, across all discretionary and other spend, it seems to be that this consumer has similar patterns in many other areas. So I think it's something that a lot of others are probably seeing, would be my guess.
spk00: Okay.
spk08: Yep. And then I guess lastly, can you give any added color on kind of category performance, either traditional sewing versus some of the newer arts and crafts businesses that you're underdeveloped in? Is there any way to kind of talk about that before the recent slowdown and what you're seeing more recently?
spk06: Yeah, we don't get, for competitive reasons, too into the weeds on this, but I can say the themes, for one, it's very consistent with the themes we've expressed earlier. We continue to be pleased with our ability to grow our arts and crafts business at a more rapid rate than our overall growth, which, again, we've got more opportunity to take share in that lane. 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 in country. Even with those challenges, we had very solid performance on our seasonal business over the last quarter.
spk05: And on the sewing side, you know, as we've come through the quarter and, you know, come through what I would call the Omnicron, you really saw an Omnicron hit kind of the end of December. You saw kind of, again, that same traffic shock. But we're actually within sewing, as Matt said before. You know, our special occasion, which is tied to, that's an example, tied to, you know, reopening events, proms, weddings, all of that has really started to, you know, explode, which is good. That's been our theory on the reopening. We have a few other businesses like that too, but it's just a certain 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.
spk08: Got it. Okay.
spk05: Thanks.
spk08: Best of luck. Thank you. Thank you.
spk01: Thank you. Our next question will come from Christina Fernandez with Telsey Advisory Group. Please go ahead. Thank you.
spk11: Thank you for taking my question. I wanted to ask on the inventory side, Can you expand about the quality of the inventory you have on hand, perhaps how much is on hand versus in transit, and how do you feel about the ability to get inventory for the key seasonal periods here in the first half of the year?
spk06: Yeah, so I described in my earlier comments about half of the growth on a year-over-year basis is really these excess freight pots. If you look at the balance, we did have – roughly double the amount in transit that we would normally have at the end of the year. As you can imagine, 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 and fabric fashion receipts that are spring-based products or spring-based prints. We're doing a 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 a Halloween and a Christmas would be, typically about twice as long, 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, you know, probably lagging about two to three weeks late on a lot of our receipts. But again, compared to like Halloween being, you know, less than a two-month selling season, typically these, our spring seasons tend to, they're much longer time to sell through those products.
spk11: Thank you for that caller. And my second question is, I wanted to see if you could talk about, you have a number of initiatives that are new, whether it's the thing or JV, the wave of acquisition, you know, the other one you announced today with JVM, you know, in aggregate, this one and also international e-commerce, which launched last year. You know, when could we start seeing more, you know, material contribution from this month? Maybe some color there about, you know, how should, you know, will this contribute to the course of 2022?
spk05: Yeah, I think you're going to see that, you know, all of these and another one we're working on should, you know, start to matter in the second half of the year and, you know, really matter by the end of the year. So this fiscal year that we're in. As we kind of go along, you know, we'll probably give them more color in some of these and what, you know, the size of prize we think is or the momentum. But I would say it's probably, you know, we'll start to get some, you know, meaningful benefit in the last quarter. And then next year, you know, should be the kind of thing that we're, at least what we believe, should be able to kind of add some, you know, meaningful stacks year on year on top of our base business.
spk01: Thank you. Our next question will come from Laura Champagne with Loop Capital. Please go ahead.
spk00: Thanks for taking my question. So on the increased freight costs, it sounds like some you kept in and some you adjusted out, the vast majority you adjusted out. How do you determine what gets adjusted out and what you leave in in terms of freight inflation?
spk06: Yeah, I can walk you to the high level, but 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, 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 is typically anywhere from like 15% to 20% of our volume at typically about a 15% premium to our contract rates. Obviously, as you're aware and everyone is aware, what we're seeing in the spot markets 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 markets. But that's how we arrive at it. But again, we've added a couple paragraphs to our disclosures to be very specific about exactly how that number's arrived at.
spk05: The other thing is at tens of millions of dollars of costs that have never been incurred before because of these congestions at ports, which is this, you know, some of this trans-loading, off-loading, as well as the demurrage and retention. You know, most of that, you know, is one time and will go away, but it's a byproduct of having, you know, 90 ships floating off the coast and needing to, you know, do special things to pull the product out and pay special penalties you've never paid before. So that piece is clearly one time. I hope that, you know, mostly goes away this fiscal year, and certainly the ports can clear up at will, but that's a piece, again, that's in that number on top of just the ocean freight itself.
spk00: Got it. And if I think about the adjustments longer term, the expectation is if that normalizes, then we'll 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?
spk06: I don't know if we'll ever see those disappear fully. We've historically had them, even as a private company, as a reconciling item. I would say they're higher right now than we've historically been because we're engaged in this very significant project to upgrade our point of sale systems. So I would say they're elevated from where we normally are. But any software development and program rollouts we do come with some costs that you're basically paying double maintenance on the software system that you're developing while you're still running the legacy system. We've historically included that as an add-back for adjusted EBITDA and would anticipate doing so in the future, but I agree the level we have in our adjusted EBITDA reconciliation currently is higher than we've historically been and higher than I would expect to see it in the future.
spk00: Got it. Thank you.
spk01: Thank you. Our next question will come from Zach Fatum with Wells Fargo. Please go ahead.
spk10: Hey, this is David Lanson 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 and size some of the other impacts in the quarter.
spk06: Yeah, so you're saying if I'm just looking at the adjusted gross margin, so kind of ignore the excess freight at that point. Yeah, I would say primarily still promotional optimization is the lion's share of that. We did continue to have very favorable results in terms of our shrink and ability to control clearance. But if I was looking at kind of weighting that, well below a quarter of the benefit. Really, the lion's share continues to be promotions and pricing. You have a little bit of error 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 the main, main event in that regard is our pricing and promotions.
spk10: Got it. And then with inflation accelerating, have you seen customers pushing back to price increases or deferring 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?
spk05: You know, 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, you know, we haven't really seen any, you know, 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, new boat, whatever, and then they actually kind of double down in things like what we do to give them kind of mental peace and solace because we're a $30 basket. So we actually feel that we can ride through this, but what we're trying to do, though, is not get too far over our ski tips in terms of pricing. 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 have built market share. And, you know, with the new customers we've had coming in, we believe there's a lot more to gain if we just kind of stay the course.
spk09: Thanks.
spk01: 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.
spk05: Well, look, I want to thank you all for your generous listening today and a lot of great questions. Thanks for all the Joanne team members and all of our stakeholders who share our mission, our purpose, our passion for our customer. I know there's a lot of moving parts out there, but we continue to make great progress at 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.
spk01: Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.

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