J.C. Penney's (NYSE:JCP) second-quarter earnings report raised a lot of questions about whether the company can survive in the long-term. The retailer did see a 0.3% increase in comparable store sales, but it also saw its adjusted net loss jump to $120 million ($0.38 per share) from $23 million ($0.07 per share) in the year-ago period.
The company also reported that its cost of goods sold rose to 66.3% of sales, up from 64.7% in Q2 2017. That's largely due to the company offering "slow-moving seasonal inventory" at lower prices "due to lower than planned sales," according to the company's earnings release.
Management, which is being led by an "office of the CEO" since former chief Marvin Ellison left the company, tried to explain its issues in the earnings release and on a call with investors. The leadership group -- consisting of Chief Financial Officer Jeff Davis, Chief Digital Officer Therace Risch, and Executive Vice President of Supply Chain Mike Robbins -- remained upbeat, but admitted that some changes are needed.
Inventory was a problem
J.C. Penney has been struggling with what it should stock for a long time. It has made major changes to its product mix -- specifically in apparel -- but it still has more work to do. Davis tried to explain the problem in his remarks in the earnings release. He stated:
This quarter we adjusted our approach to inventory management from 'buying to store capacity' to 'buying and chasing' into demonstrated sales trends. Inventory receipts continued to outpace total sales performance this quarter due to prior purchase commitments. As such, we took necessary actions to markdown and clear excessive inventory positions across many of our categories, which encompasses more than just seasonal product or fashion misses.
The CFO acknowledged that further clearance activity would be needed to "right-size" inventory. As a result, J.C. Penney reduced its guidance for 2018. It now projects that full-year same-store sales will be flat, compared to its original forecast of 0% to 2% growth. It also expects a full-year adjusted loss of $0.80 to $1.00 per share, far worse than its previous guidance for earnings between a $0.07 per share loss and a $0.13 per share gain.
The company has cash available
Trent Kruse, J.C. Penney's head of investor relations, spoke during the earnings call to provide details on the company's balance sheet, capital structure, and liquidity position. He noted that J.C. Penney had ended the quarter with $177 million in outstanding borrowings on its credit facility, a number that was actually down $174 million from the end of the previous quarter. He continued:
As such, our liquidity position at the end of the second quarter was approximately $2.2 billion. We expect to have liquidity in excess of $1.5 billion at our trough in November and over $2.2 billion in liquidity at year-end. Cash and cash equivalents at the end of the second quarter were $182 million. In addition, capital expenditures net of landlord allowances for the quarter were $114 million. Free cash flow was a use of $235 million for the six months of the year and an improvement of $186 million since the end of the first quarter of 2018.
This was basically the portion of the call designed to reassure investors that the company isn't in imminent danger of bankruptcy.
There is a plan
The company does plan to hire a new CEO, but only a brief update on the search was offered. Essentially, the company acknowledged that the board was interviewing candidates, and that quality people were interested in the job.
Despite the lack of a CEO, turnaround efforts are ongoing. Kruse pointed out that the retailer has opportunities to more effectively manage planned receipts, improve gross margin levels, and optimize its working capital to increase free cash flow. He said that the company expects gross margin pressure to continue, but believed that it would be possible to at least partially offset the pressure by improving other areas.
These include "driving sales improvement across higher margin apparel categories particularly women's, continue leveraging our capabilities within our private brand and sourcing operations, and further expand and emphasize our pricing analytics efforts," he said.
Doing it right?
J.C. Penney has struggled, but it's not for lack of trying. The company has embraced opportunity, adding appliance sections as Sears exited some markets and adding toy and baby departments to attempt to fill the need created by Toys R Us' demise.
Going forward, the company has to continue to evolve and build on its successes. This was a troubling quarter, but it could turn out to be a speed bump (admittedly one of many) on the road to eventual success.