Earnings Call Transcript - SCVL Q1 2023

Operator, Operator

Good morning, and welcome to Shoe Carnival, Inc. Fiscal Year 2023 First Quarter Earnings Call. Today's conference is being recorded. It is also being broadcast via webcast. Any reproduction or rebroadcast of any portion of this call is expressly prohibited. Management's remarks may contain forward-looking statements that involve a number of risk factors. These risk factors could cause the company's actual results to be materially different from those projected in such statements. Forward-looking statements should also be considered in conjunction with the discussion of risk factors included in the company's SEC filings and today's earnings press release. Investors are cautioned not to place undue reliance on these forward-looking statements, which speak only as of today's date. The company disclaims any obligation to update any of the risk factors or to publicly announce any revisions to the forward-looking statements discussed on today's conference call or contained in today's press release to reflect future events or developments. I'll now turn the conference over to Mr. Mark Worden, President and CEO of Shoe Carnival for opening remarks. Mr. Worden, you may begin.

Mark Worden, President and CEO

Good morning, everyone, and thank you for joining us today for Shoe Carnival's First Quarter 2023 Earnings Conference Call. Joining me on today's call are Carl Scibetta, Chief Merchandising Officer; and Erik Gast, our new Chief Financial Officer. Erik joined the company a few weeks ago, and we are excited to have him on the team and to engage with the investment community ahead. Let me start out today by saying that Q1 was a challenging quarter. While we continue to make significant progress against our long-term strategies and achieved many important milestones, we saw softer-than-expected consumer trends develop in March and April and unseasonable weather conditions persist throughout the quarter. The biggest headwinds our customers faced in Q1 were persistent inflation across everyday expenses they needed to spend on, interest rates continuing to climb and unexpectedly, federal tax refunds ending the quarter with a nearly 10% reduction versus the prior year. Historically, our traffic and sales surge when our customers receive their annual tax refund. This year, the reduced tax refund amounts did not generate traffic levels of the prior year. These headwinds resulted in store traffic declining approximately 10% versus the prior year. What we saw was a segment of customers from lower-income households with stretched disposable income who delayed their shopping trips for footwear, apparel, and accessories. Furthermore, spring weather did not improve in the second half of the quarter as unseasonably cold, wet conditions persisted across most of our markets. This resulted in a sandal season that did not meaningfully start during March or April. All combined, Q1 sales and earnings finished at the low end of our annual expectations. We see a pathway to deliver the low end of our original annual guidance if economic conditions improve this summer. However, we do not have clear visibility into when the economic landscape will turn positive. As such, we are reducing our annual sales and profit guidance to reflect the short-term economic uncertainty. Despite the challenging economic backdrop, I am incredibly thankful for our nearly 6,000 team members who are committed to delivering the preferred footwear shopping experience. Their focus on advancing our long-term strategies led to many wins and have put us in a strong financial and operational position to accelerate profitable growth as soon as we have visibility to improvements in the economic landscape. I'll now provide an overview of the company's key strategic progress and results of the quarter. First, the team and I are most energized about how fast we grew our loyal customer base this quarter. Customer memberships surged to a record 32.7 million at quarter-end, showing growth of 12% versus the prior year. This is the fastest expansion of members in any quarter over the last 3 years. Although a segment of customers are currently not in a strong buying position, they are still actively engaging with retailers they love and making decisions on where they will shop for their footwear when economic conditions improve. Simply put, more customers are picking us every day. Our CRM platform has now reached significant scale and has advanced capabilities to engage with American footwear shoppers wherever and whenever they choose. We now engage ongoing with approximately 1 out of every 8 American adults, which is up nearly 65% from just 5 years ago. Our commitment is to provide this group the preferred family footwear shopping experience as customers are rapidly choosing to become part of our Shoe Perks customer loyalty program. With this large-scale customer reach, 70% of our sales now come from our loyalty members at a very efficient cost to engage. We continue to see this as a core advantage of our company and are confident we will keep growing our customer base this year and in the years ahead. Second, we continue to deliver gross profit margins of over 35% for the ninth consecutive quarter. Over the last few years, we have sustainably transformed our margins from among the lowest tier in our industry to the top tier. We've done so by leveraging our deep customer relationship management capabilities and analytics to engage profitably with our customers, providing the freshest in-demand products at the right value, and delivering a preferred shopping experience. As a benchmark, the 35% gross profit achieved this quarter is growth of over 500 basis points from just 4 years ago. Our customer sales conversion climbed this quarter to the highest level in nearly 2 years. The customer who is ready to make a footwear shopping trip in this challenging economy is finding the brand and shopping experience they love at Shoe Carnival and Shoe Station stores. Our compelling assortments at the right value for our target customers generated not only strong margins and conversion growth but resulted in yet another quarter of market share growth for our company. Given the current economic landscape, we have prioritized reducing our inventory levels, sustaining healthy margins, and building an even stronger financial position for future growth while also providing our customers with the freshest products for the remainder of 2023. Progress is encouraging on all fronts, and Carl and Erik will elaborate more shortly, but here are the headlines. We ended 2022 with inventory up $105 million versus the prior year, and we have plans in place with our vendor partners to right-size this level rapidly toward 2023. I'm so pleased with the progress made already as we ended Q1 with approximately $45 million more inventory versus the prior year, having chipped away about $60 million during the quarter. Importantly, we are not reducing inventory levels by dumping products in the market or drastically eroding margins. The hard work on this inventory reduction topic is complete. Receipts and inventory flows are updated. We continue to have our inventory fresh with no material aged inventory concerns. I can share we remain confidently on track for inventory to be below prior year levels after back-to-school and on track to deliver our annual guidance to be approximately $40 million below prior year inventory by year-end. Our merchant team has done an excellent job managing the balance of freshness, margin delivery, and inventory levels. As always, demonstrating they, along with our partners, are best in class. Carl will elaborate on inventory in a moment. Our athletic inventory position has also materially improved versus last year. As you will recall, vendor supply chain issues disrupted our on-hand inventory for back-to-school 2022, and we disappointed some of our athletic shoppers last year. This year, we have the athletic brand assortment, depth, and freshness in hand that we did not have last year. While I'm not implying that customer economic issues driving soft traffic will be solved in Q2, I do think we are in a position to continue to grab athletic market share this year, convert at very high levels, and maintain our healthy gross profits in this declining market environment we face. Our store development plans continue to advance with success. The Shoe Carnival fleet modernization continues to roll out rapidly and is on track for approximately 60% of the chain to be completed by fiscal year-end. We see this as a key contributor to our sales conversion and a differentiator to our customers who are rewarding us with continued market share growth. New Shoe Station store growth continues to meet our expectations. One of our significant wins has been the market entry into Birmingham, Alabama, with the grand opening of 2 stores over the past 6 months. These stores are projected to be among the strongest in the Shoe Station fleet and in the top tier of stores across the entire corporation. We are seeing great success as we bring our new Shoe Station prototype store to customers in adjacent markets. These expansion wins give us confidence to advance methodically on our roadmap to reach 100 stores for Shoe Station and over 500 stores for the corporation by 2028. We are observing our Shoe Station banners showing positive signs over the past weeks. With Shoe Station's more fluid customer base, the addition of our CRM platform and the launch of the online platform, Shoe Station is outperforming the overall company. Sales for quarter 1 declined in the single digits compared to Shoe Carnival's low double digits. However, over the past few weeks, the Shoe Station banner has been building momentum and growing mid- to high singles. We continue to see Shoe Station capable of growing in the quarters ahead despite the economic headwinds discussed. The bottom line for the quarter is that customer traffic was disappointing due to unfavorable near-term macro conditions and unseasonable weather. Yet our foundations were stronger than ever. Customer growth accelerated to a record level. Gross margin sustained at very high levels. Customer conversion surged on fresh products, great value, and experiences. Inventory levels are progressing well, and our athletic inventory is where we want it for the back-to-school season ahead. We're focused on executing our winning strategic plans on the path to become a multibillion-dollar retailer in 2028 and providing our shareholders with top-tier returns in our sector. I am confident in the resilience of the American consumer and in our economy returning to health ahead. When it does, we are ready to rapidly accelerate growth. I would now like to ask Carl to provide further color on the quarter and the year ahead. Carl?

Carl Scibetta, Chief Merchandising Officer

Thank you, Mark. As highlighted, today's first quarter performance was below our expectations. Persistent inflation and the large reduction in tax refunds were major factors that affected Q1. In addition, the cool weather we mentioned continued throughout the remainder of the quarter. We anticipated that the weather would normalize in the back half of the quarter, but unfortunately, that never materialized. As a result, sales in seasonal categories did not meet our expectations and contributed to the shortfall. With that said, we continue to focus on driving our strategic objectives, which include connecting with our consumers using our CRM program to maximize sales, reducing our inventory throughout the year, and continuing to deliver our transformational product margin. By categories, first quarter comp sales in women's nonathletic footwear were down low double digits, with dress and boots being down over 20%. Sales in women’s sandals were negatively affected by the late arrival of spring, and comp sales were down high teens in the category. Sport and casuals were the bright spot, with sports down low single digits and casuals increasing mid-single digits. Men's nonathletic comps were also down low double digits, with casuals down mid-singles, men's dress down low double digits, and boots down high teens. Children's comp sales were down high singles, with nonathletic flat and athletic down low teens. Comp sales in adult athletic footwear were down low teens. Due to the late start of new seasonal selling and enhanced promotional activity in the marketplace, merchandise margins were down; however, they remained up 750 basis points over pre-pandemic levels. This further demonstrates the transformation of our promotional strategy. Our outstanding team of merchants continues to collaborate closely with our vendor partners, ensuring the appropriate flow of products to our stores. Our best-in-class vendor relationships are enabling us to adjust to consumer demand. The result will see inventories reducing as we move through the year. We entered the first quarter with inventory up 36.9% versus the previous year. First quarter ending inventory was up 13% versus 2022. We expect as we end the third quarter, inventory levels will be below 2022 levels, and we anticipate we will finish the year at the previously stated level of approximately $40 million below fiscal 2022 ending inventory. Currently, our inventory content is clean, and we still see no reason to aggressively promote distressed inventory to achieve our goals. As we move into the back-to-school time frame, we will be in a much better inventory position versus 2022 with the most desirable key athletic brands. This will position us to maximize the sales opportunities during this critical selling season. Diligently managing our inventory flow will ensure our stores are stocked with the most desired product offerings that are timely as we move through the second quarter and the balance of fiscal 2023. This reduction will further support our store modernization as well as our aggressive store growth plans. Our best-in-class CRM program continues to drive loyal customer growth. We have seen success in engaging with our loyal consumers through targeted offers. This program continues to drive sales and plays a key role in maximizing margins while reducing inventory levels. Using this data enables us to communicate with our over 32 million consumers and maximize sales opportunities without reducing margins below expectations. With that, I will turn the call over to Erik for a review of our financials. Erik?

Erik Gast, Chief Financial Officer

Thank you, Carl, and good morning, everyone. First, I joined Shoe Carnival in late April, and I appreciate the collective team and how they have supported me in the transition from Kerry Jackson, the previous CFO. Kerry, as you know, was here for 35 years and recently retired. I am looking forward to continuing the excellent work he started and collaborating with the Shoe Carnival team. Having worked over 30 years of most of that time in retail, I look forward to sharing experiences and collaborating with the Shoe Carnival team. The company has long-term plans to grow to over 500 stores and become a multibillion-dollar retailer by 2028, and I am excited to be part of it. Now moving to the financial results. In my remarks, I will compare our first quarter results with the first quarter of 2022, noting comparison to 2019 if needed for context. Starting with revenues, our net sales in Q1 were $281.2 million. This is down 11.4% on a comp decline of 11.9% versus the prior year. To offer some perspective, while representing a larger-than-expected decline, the sales were the third highest first quarter in the company's history. The comp decline was driven by an approximately 10% reduction in traffic. Our consumers are being negatively impacted by inflation and lower tax refunds. Lack of normal seasonal weather shifts, driven by cooler weather patterns, was also a contributing negative factor, resulting in spring seasonal products down by over 20% compared to the prior year. Shoe Station banner sales came in with a mid-single-digit decline, whereas Shoe Carnival banner sales saw a low double-digit decline. Q1 gross profit margin was 35%, reflecting the ninth consecutive quarter at or exceeding 35%. The margin reflects continued advancement in our CRM capabilities, resulting in high customer conversion and increased loyalty members, as Mark discussed. The gross margin represents an increase of over 500 basis points compared to pre-CRM implementation and pre-pandemic in 2019. Compared to the prior year, merchandise margins decreased 30 basis points, reflecting our promotional intensity. Buying, distribution, and occupancy costs declined, however, we are deleveraging by 20 basis points as a result of the sales decline. The buying, distribution, and occupancy expense reductions were primarily the result of the absence of the high distribution costs experienced in the prior year with a return to more normal levels this year. SG&A expense in Q1 was $77.6 million. While essentially flat in cost to the prior year, it was deleveraging to 27.6% due to the sales decline. Overall, SG&A expenses were under plan, with increases in depreciation associated with our store modernization program and healthier costs, offset by reduced selling costs when compared to the prior year. Q1 operating income was $20.9 million or 7.4% of sales. This is at the low end of our expectations. Net income for the first quarter of 2023 was $16.5 million or $0.60 in diluted earnings per share. Although this was our third highest Q1 diluted EPS with only 2022 and 2021 being higher, this was at the low end of our expectations. We closed out the quarter with inventory of $389 million, which was up approximately $45 million compared to the prior year or 12.3% on a per store basis. The increased inventory reflects an improved athletic merchandise assortment for back-to-school shopping this year. The increase of $45 million compares to $105 million higher than the prior year just 3 months ago. After back-to-school shopping, we do expect inventory to be lower than last year and be approximately $40 million lower by year-end 2023 compared to year-end 2022. We continue to have ample liquidity to fund our growth initiatives. At the end of Q1, we had total cash, cash equivalents, and marketable securities of $44 million and no outstanding debt. As of the end of 2022, the company has maintained no debt for the 18th consecutive year and continued funding its operations without debt through the first quarter. During the quarter, there were no share repurchases. We currently have the full amount of $50 million available for the share repurchase program. Given the Q1 results driven by traffic declines and consumer trends, we now are updating our sales guidance for fiscal 2023 to decline by 3% to 6% compared to the prior range of down 2% to up 2%. We are expecting gross profit margin to be between 36% and 37% versus prior guidance of approximately 37% for the year, including the extra week. We are lowering our diluted EPS guidance to $3.60 to $3.85 from previous expectations of $3.96 to $4.20. In closing, allow me to share some initial observations about the company. There are headwinds facing the industry. We highlighted the macroeconomic conditions, promotional intensity, and higher inventory. However, I am encouraged about the company. We have no debt. We are producing products and gross margins that are up meaningfully in a transformative way versus the pre-pandemic period. Plans are underway to reduce the inventory, and they are being implemented as evidenced by the current quarter reduction. The business has solid financial fundamentals to build and grow upon that can outlast any economic downturn. There is an ample growth opportunity for the business. I am glad to be here and look forward to working with the team and all of you. This concludes our financial review. Now I would like to open the call up for questions.

Operator, Operator

Your first question comes from the line of Mitch Kummetz with Seaport Research.

Mitchel Kummetz, Analyst

I'd like to welcome Erik. Let me start with the guidance. Can you update us on SG&A in either operating margin or EBIT for the year? There was nothing in the release, and I didn't hear anything in your comments, but I think you previously had given guidance on those line items.

Erik Gast, Chief Financial Officer

Sure, Mitch, and thank you for the warm welcome. SG&A, as we mentioned in our previous guidance, is approximately 25.6%. As we look ahead for the remainder of the year, we are continuing to focus on cost management. Our operating income reflects this continued management in our EPS. Therefore, we expect our percentages to align with what we initially provided. There may be some changes in basis points, likely in the range of 30 to 50 basis points. Regarding operating income, we previously discussed a guidance of 11.4%. We are now anticipating an impact on operating income in the range of 40 to 100 basis points due to the sales decline.

Mitchel Kummetz, Analyst

Got it. All right and then just looking at the revised sales guidance. Obviously, it came down for the year, but it looks like, at least I can kind of back into growth that's sort of flat to maybe up low single digits over the balance of the year on a year-over-year basis, which is obviously better than what you achieved in the quarter. Can you just elaborate on why that is? Is that just that we're past tax refunds? Do you expect the weather to be more normal? I'm just kind of curious about your assumptions around the consumer to kind of get to those numbers. And also if there's any color you can kind of provide by quarter? I would guess that you're maybe most optimistic around Q3 just given what you said around back-to-school and better athletic inventory, but maybe some more color there would be helpful.

Mark Worden, President and CEO

Mitch, it's Mark. Thanks for joining today. Yes, you got it right with those key elements. We see back-to-school significantly improved compared to last year. As I shared on the call, our athletic inventory positions are in hand, it’s fresh, and it’s far superior to the supply chain disruptions we faced during back-to-school last year. We think it’s going to come in Q3, Mitch. We're still seeing the macro headwinds in Q2. However, we believe our Q3 position is ready to go for back-to-school and will moderate as the year continues on as inflation gets more in control. The second thing you mentioned that is encouraging is the weather has turned, our Shoe Station business is gaining momentum along with the new stores. At Shoe Station, the dotcom going live and CRM going live. We’re growing nicely as we progress into Q2, and we see that continuing to accelerate as the year goes on. So, we’re really highlighting that we think the segment of our customers that are affected by inflation is a small portion of our total customer base. That's the variability that we’re just not sure yet of when that customer will be healthier and which quarter that will occur in. As soon as it does, we are in great shape to start accelerating growth.

Mitchel Kummetz, Analyst

Got it. And then Carl, on sandals, I know they were challenged in the quarter. I believe that Q2 is by far your largest sandal quarter. What are you thinking there? Do you think there's pent-up demand for the category? And how do you feel about your sandal inventory and your ability to kind of work through that in Q2?

Carl Scibetta, Chief Merchandising Officer

We are not certain when that customer will improve and which quarter that will happen. However, as soon as it does, we are well-positioned to begin accelerating growth. Mitchel Kummetz, Analyst, asked about sandals, acknowledging they faced challenges this quarter. He noted that Q2 is typically the biggest quarter for sandals and inquired about potential pent-up demand in this category, as well as our current sandal inventory and our capacity to manage it in Q2.

Operator, Operator

I'm sorry, this is the operator. Could you start again? The line is coming in broken.

Mitchel Kummetz, Analyst

Hopefully, you can hear me better now. My question is about sandals. I was asking Carl about their performance last quarter, which was not strong. With Q2 being your largest quarter for sandals, do you think there is pent-up demand? How do you expect that to unfold, and what are your plans for managing your sandal inventory in the second quarter?

Carl Scibetta, Chief Merchandising Officer

Sure, Mitch. Thanks. We do believe we're starting to see some movement in the sandal business as we have consistent warm weather that has hit a part of most of the Midwest. So we're encouraged by some very recent sandal business in the Shoe Carnival operations. Shoe Station, in fact, got off to an earlier start due to the geographic nature of that business and the higher-income consumer that tends to shop earlier. Regarding the inventory, we have made the necessary adjustments to our sandal positioning based on the fourth quarter results, and we anticipate ending the season in a better inventory position than we did last year. So we're confident we’ve got that business under control.

Operator, Operator

And there are no further questions at this time. I will turn the call back to, oh, sorry, we do have a follow-up from Mitch Kummetz.

Mitchel Kummetz, Analyst

I thought there would be other people. One of my other questions was about the BOGOs. You mentioned the gross margin, which was down year-over-year but still significantly higher than four years ago, especially in terms of merchandise margin. I'm intrigued that while you still offer BOGOs, your approach has changed considerably. Can you comment on the margin related to the BOGOs and explain how it differs from four years ago?

Carl Scibetta, Chief Merchandising Officer

Sure, I'll take that. The BOGO promotions that we run, and we only do it a couple of times a week on seasonal products that we have purchased at a very advantageous price. So they are planned on selected items, and the margin on them during BOGO is actually in line with the total company margin. In fact, in some cases, it is margin accretive. So they are limited-time targeted products and merchandise that were bought for that intent.

Mitchel Kummetz, Analyst

And so how does that compare from like 4 years ago when it was more of an all-store BOGO? I assume that those margins were dilutive to the total. But I mean, have you seen like within kind of the BOGO piece, I mean, is like the margin 1,000 bps better than it was 4 years ago? Or is there any way you can again sort of isolate how much that's improved? And how much of that is kind of a story for the overall margin expansion of the business?

Carl Scibetta, Chief Merchandising Officer

Sure, Mitch. That is definitely the story. The BOGOs that we used to run included the entire inventory. They weren't targeted, and the margin was, as you pretty much said, about 1,000 basis points dilutive to the margins we run today on the very selected BOGO products. So that is a major factor in the trend towards the margins we've been producing.

Mitchel Kummetz, Analyst

Got it. One last question for me. Can you, Carl, discuss how much better the athletic inventory is compared to last year? Can you express it in percentage terms? Also, please remind us of the athletic comparison you are using for back-to-school; I assume it's a relatively easy comparison.

Carl Scibetta, Chief Merchandising Officer

Yes. It is. The athletic inventory, if we go back historically, when we look to last year, our athletic inventory was really hampered by supply chain issues. We received quite a few delays with products arriving late, around the end of August into September, which caused us to miss the back-to-school time frame. In addition to that, we had many products that we purchased that we never received. So from an athletic standpoint, I see a major improvement in not only the products but in the quality of the brands and the quality of the products we have. We anticipate our athletic inventory going into the back-to-school timeframe being up in the teens. But it’s really the quality of the inventory and the timing of the delivery that we expect to be much better than last year. We’re actually expecting inventory improvements ending in July in the mid-teens and as we progress through early August around 20%.

Mark Worden, President and CEO

And if I can add, yes, Mitch, I'll give you one point. So if you look at comps from last year, to remind you, Q2 was down 13.8%, and it was really driven by declines between 15% and 20% in June and July during that period where our supply chain was really disrupted. So we see that as an opportunity to claw back and gain market share and have a much more solid Q2 than we did last year.

Mitchel Kummetz, Analyst

Okay. And then, I guess maybe one last question for me. Just on the loyalty program, Mark. I know that Shoe Station is now plugged into Shoe Perks and has access to all of those loyalty members. What have you seen there? Have you seen some of those customers buying products from Shoe Station, especially maybe some brands and some price points that they didn't have access to in the Shoe Carnival stores?

Mark Worden, President and CEO

We do. We have almost 2 million people who have already joined Shoe Perks on the Shoe Station side. I see a fantastic opportunity to grow that rapidly as we're just starting now to engage with them. We're seeing them buy products in different price tiers that they can now cross-shop. We're seeing them engage with different categories that they haven't had before. Importantly, we're seeing the direction where the Shoe Carnival Shoe Perks members are being introduced to new products from the new brand that aren't offered. This is a big opportunity for cross-introduction over the quarters ahead and really fueling growth.

Operator, Operator

There are no further questions at this time. I will turn the call back to Mr. Mark Worden.

Mark Worden, President and CEO

Thank you all for joining us for today's call, and thank you for bearing with us through our technology challenges. We look forward to talking to you all again as we approach the back-to-school season and have the Q2 report.

Operator, Operator

This concludes today's conference call. Thank you for joining us. You may now disconnect your lines.