The Michaels Companies Inc (MIK) Q3 2019 Earnings Call Transcript

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The Michaels Companies Inc (NASDAQ: MIK)
Q3 2019 Earnings Call
Dec 5, 2019, 9:00 a.m. ET


  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:


Good morning. My name is Anita, and I will be your conference operator today. At this time, I’d like to welcome everyone to The Michaels Companies Third Quarter Earnings Conference Call. [Operator Instructions] Thank you.

And now I would like to turn the call over to your host, Jim Mathias, Director of Investor Relations. Mr. Mathias, you may begin the conference.

Jim MathiasDirector, Investor Relations

Thank you, Anita, and good morning, everyone. I’d like to welcome you to our fiscal 2019 third quarter financial results conference call.

With me this morning are Mark Cosby, our CEO; and Denise Paulonis, our CFO.

Before we begin our discussion, let me remind you that the comments made on this call as well as supplemental information provided on our website may constitute forward-looking statements and are made pursuant to and within the meaning of the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995 as amended.

These forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from those anticipated by these statements. Information about these risks is noted in our earnings press release and the risk factors in our latest Annual Report on Form 10-K filed with the SEC, as well as in our other SEC filings. These forward-looking statements are only as of today, December 5, 2019, and the company assumes no obligation to update these statements except as required by law. Investors are cautioned not to place undue reliance on these forward-looking statements.

Also, please note that we will reference non-GAAP financial measures on today’s call. The reconciliation of these measures to the corresponding GAAP measures are detailed in today’s earnings release.

I’d now like to turn the call over to our CEO, Mark Cosby. Mark?

Mark CosbyChief Executive Officer & Director

Thank you, Jim, and good morning, everyone.

Let me start by sharing how pleased I am to be here at Michaels as the permanent CEO. Michaels is a beloved brand with passionate customers. We also have industry-leading scale with over 1,270 stores, a thriving and growing e-commerce business in a profitable business model supported by a strong balance sheet and substantial cash flow generation.

That said, while we are working from a great foundation, we know we must address the challenges that we face as a business and return the company to sustainable long-term growth. This is precisely why we have embarked on our recently announced strategy centered on makers. While I am confident, we will do just that as the strategy gains traction in 2020 and beyond.

In the third quarter, we faced several challenges that led to results that did not meet our expectations. We posted sales at $1.22 billion, a 2.2% comp store sales decline and $0.40 in adjusted diluted earnings per share. There were two main factors that we believe drove the decline in comp store sales. First, we estimate that about half of the decline reflects the underlying business trend that our new maker strategy is designed to address. The other half were specific challenges that we faced in the quarter that we are addressing head on with concrete actions. These challenges include mixed performance from events with some not generating the anticipated response, a seasonal transition that was not as smooth as it needed to be and underperformance in a few specific categories. We went deep on each of these factors, and I am confident that we have the course corrected to better position ourselves into year-end.

Let me share some additional detail on each. First, events. It is clear that the strongest events were those where we effectively deployed all of our key assets, including digital marketing, social media, PR, and our store teams, where we did not performance lagged our expectations. Looking to the fourth quarter, we will deploy the full suite. We did so with Black Friday, and the results were solid in advance of the weather challenges later in the weekend. We are now looking to do the same with Cyber Week, the last 10 days and the January Clearance event. And we expect improved execution to benefit our fourth quarter results.

Second, seasonal transitions. We did not complete new sets in our stores as quickly as necessary. We have tightened the time frame going forward with clearly defined daily script for each week of the fourth quarter, and we expect this will deliver a much improved distribution center to shelf process, going forward for seasonal transitions for the remainder of the year and beyond. We implemented the same process for Black Friday working closely with our stores and the transitions proved to be much smoother than expected contributing to the success of the event.

Finally, category action plans. Categories including kids, food crafting, ready-made frames, and stickers were among those that saw weaker trends in the third quarter. Some of these categories were planned to reduce space for more productive categories aligned with our maker strategy, but these categories were also negatively impacted from a lack of newness. We conducted a thorough review and are using it to develop a management process that will help us define rigorous action plans for each of these categories in 2020. We are implementing these changes and expect the benefits to build over 2020, with the majority coming in the second half of the year. Expected sales gains in these categories will be one factor as we work to drive sustainable comp store sales growth.

Now, let me add some color to the recent A.C. Moore news. A.C. Moore is exiting the retail business. As part of their exit, we will acquire certain assets including up to 40 store leases. Some of these stores will be net new to us that we will convert to Michaels stores early in 2020, and others, we will use for relocations. This is a strategic and opportunistic transaction, and we are working with the A.C. Moore team to ensure that a high percentage of sales from the closed A.C. Moore stores transfer to our stores in 2020. We are building a comprehensive sales transfer program to maximize retention of the A.C. Moore customer base, capitalizing on the fact that over 80% of the closing stores are within 5 miles of one of our stores.

So with regards to the fourth quarter, we expect to see benefits from the actions we have taken to address the aforementioned challenges that impacted third quarter results. However, the top holiday calendar with six fewer days and the expected negative impact of the A.C. Moore close down process were more than offset the gains from these improvements. As a result, we expect fourth quarter comp store sales performance to be similar to the third quarter despite the significant progress we are making with our strategic and operational initiatives.

Now, let me shift gears to the notable progress we are making in advance — advancing our maker strategy. I also wanted to note that we are very pleased to have hired Vidya Jwala to the newly created position of Chief Customer Officer. Vidya has a solid track record of leading customer experience in omnichannel transformations across some iconic retailers. This move reflects our commitment to enhancing our internal capabilities and our talent to deliver against our maker strategy, and I look forward to Vidya’s contributions to the new team. He will be instrumental in leading the implementation of our customer-centric omnichannel strategy across our brand touch points.

We’re here for the makers is our purpose, and keeping these makers at the center of our strategy is our focus. By doing so, we are confident that we can grow our share within this community and deliver the growth objectives of our maker strategy. Importantly, the core maker community represents over 60% of the $36 billion spent in the arts and crafts industry annually. So, the opportunity is significant and well within our reach. While we are only a few months into implementing our new strategy, we are encouraged by the early results. We know our progress will not be linear with the early results bode well as we look forward.

Let me review each of the building blocks of the maker strategy and share some of the exciting proof points that we are seeing. Build the business better, leverage digital and data and reposition the business. These are the building blocks and drivers of our strategy.

Build the business better is comprised of four initiatives designed to move the business forward quickly. Build the store selling culture, create a customer-centric assortment, optimize pricing and promotions, and maximize marketing productivity. We launched our store selling initiative in August with a focus on shifting our store culture from tasks to serving our customers and selling. The scorecards that we provided to each of our stores last quarter have already led to key metric improvements, including a 1% improvement in our overall shopping experience measure and a 1% improvement in customer conversion.

Importantly, this is also helping to drive more consistency across our stores. Our assortment shift toward maker categories including technology, craft storage and fine art was very successful, as all three categories were up significantly in the third quarter. We doubled the size of our technology department enabling us to feature strong performing products from Cricut and Caesar. We also significantly improved our card assortment and product presentation. Finally, the August fine art expansion added over a 1,000 news items in drawing and paint, helping drive strong third quarter category level performance.

As we look to next year, as I mentioned earlier, we will further enhance our assortment through our new category management strategy and approach using data and analytics to optimize key product categories for our makers across all of our stores and online. This focus on maker categories will translate into shifts in some of our core assortments with categories aligned with maker demand such as art, tools and technology and jewelry becoming more important to us.

We will also make sure the mix within each category is appropriate and aligned with the needs of our makers, and that we have injected newness across all of our categories. This year though our work in the technology, craft storage and fine art reproved that we can drive meaningful sales results when we add newness and get the assortment right. All three of these categories saw significant sales growth with two of three up high double digits. These results give us confidence that our category management initiative will contribute significantly to our future growth.

Adding to this growth potential, we implemented a pricing and promotion optimization solution in the third quarter that are designed to allow us to use quantitative data to optimize discounting and improve our customers’ perception of the value that Michaels offers through discounts, coupons and other promotional activities.

The early results are promising as we replaced lower productivity promotions with higher productivity promotions. We believe this capability will further improve our value perception and help drive profitable growth into 2020. We also made notable progress in the third quarter on our maximize marketing productivity initiatives. We completed a media mix model that is helping us effectively adjust our fourth quarter spending. As a result, we are shifting to higher productivity and media options such as digital and addressable TV, without increasing our spend and we will continue to leverage this model to manage our marketing spend going forward. And finally, we have entered into a new creative agency partnerships that are designed to align our marketing message to our focus on our core maker customers.

Moving to how we are leveraging digital and data, this includes two initiatives: enhanced customer relationship management and profitable e-commerce growth. The enhanced CRM initiative is focused on increasing our customer engagement through personalization of all of our customer messaging. We are leveraging our extensive customer data in our rewards program including 31 million active email addresses and 37 million customers. Early efforts are driving measurable results.

In June, only 1% of our emails were personalized and we are on track to reach a rate of 15% personalized emails by the end of December, with plans to increase that number throughout 2020. This is significant as we have found that personalized emails have click rates almost three times that of our typical mass email. This enhanced customer engagement is helping generate incremental trips to our stores and website in driving bigger baskets.

We have also expanded our CRM efforts to our website. This month, we launched the first phase of our personalized website, where each identified customer will see a different website configuration based on their spending history with us. While this enhancement is in its early stages, the results reflect a 20% conversion improvement. As an extension of the CRM initiative, we launched an enhanced rewards program in two test markets in September. Although early and based on a small sample size, we have increased sales and a 20% increase in customer sign-ups. We plan to launch this enhanced loyalty program naturally in the first half of 2020, should our test continue to deliver positive results.

Our profitable e-commerce growth initiative made very solid progress in the quarter. The goal of this initiative has been to take our already profitable e-commerce platform and maintain rapid sales growth, while further enhancing the profitability of the business. We have a number of initiatives under way to continue our growth by optimizing our digital spending, enhancing our web capabilities and personalizing our website for our customers.

We have also implemented order logic enhancements designed to reduce our shipping costs through reduced splits shipments and improved shipping efficiency. Our holistic maker experience approach is also reflected in continued favorable response to Buy Online Pick-up In Store, or BOPIS. With no shipping costs, this is an important and supporting profitable growth. In the third quarter, BOPIS accounted for 45% of online sales and nearly two-thirds of online orders. We continued to use technology to facilitate BOPIS orders, including near real-time inventory tracking to improve BOPIS fulfillment percentages.

We hit a major milestone this quarter with the launch of e-commerce in Canada. Early results have been very encouraging from both the customer satisfaction and the sales perspective. Not only have Canadian e-comm sales accelerated every week since launch, the vast majority of these sales will be of BOPIS. We expect the e-commerce sales in Canada, while still modest, should be a sales driver for us in the fourth quarter and have a more meaningful contribution in 2020.

The third and final building block of our maker strategy is to reposition the business. This building block is focused on initiatives that will set us up for growth over the longer term. Today, we are focused on two initiatives: a Michaels community and a maker-centered store experience. Community is very important to our maker customers. They want to share and learn with other makers and we are focusing on ways to build a community with our customers both in stores and online. This will include taking our existing and highly successful community classroom to the next level and creating an online community for our makers.

We made strides on this initiative in the third quarter. For example, we held a Cricut week in our stores in October and the results clearly demonstrated the appetite for community. More than 650 stores scheduled classes during this week supported by a targeted social media push to drive maker interest. We also held our first ever Facebook live from the maker space in one of our stores. Maker response was exceptional across our stores with nearly 9,000 people signing up for these classes.

Building from here, we are launching a new online calendar feature in December that will significantly scale our classroom capabilities, enabling makers to schedule classes, meet ups and even birthday parties in real time. And we believe that all of this should increase store traffic and drive increased customer engagement. We have also made progress developing our digital community platform which we plan to launch on our website in the middle of next year. This platform is designed to allow customers to engage with each other and with us in far more compelling ways.

The final component of repositioning the business is our maker-centered store experience. We opened our prototype lab store in Dallas on November 14. We believe this lab store features an easier shopping experience, a curated assortment and enhanced service experience, full omni-channel capabilities, and it will bring the community experience to life. As part of the test, we plan to open a few of these stores in 2020 and identify and expand best practices in a low cost way across the system. This is an exciting initiative and we look forward to visiting us in our prototype stores in the near future.

In summary, we are laser focused on executing our maker strategy to address the challenges that we face as a business and return the company to sustainable long-term growth. Our path to achieving our objectives will not be linear as evidenced by our third quarter results, but we will move to course correct quickly and drive our business forward. I am confident that our actions will lead to sales growth in 2020 and beyond as our strategy gains traction.

With that, I would like to turn the call over to Denise.

Denise A. PaulonisExecutive Vice President & Chief Financial Officer

Thank you, Mark. Our third quarter sales were $1.22 billion compared to $1.27 billion last year. The decrease in net sales for the quarter was primarily due to a 2.2% decrease in comparable store sales, the closure of our Pat Catan stores and a decrease in wholesale revenue. This was partially offset by sales from 18 additional Michaels stores net of closures since the end of the third quarter of fiscal 2018.

In the third quarter, the company opened 13 new Michaels stores, 11 of which were former Pat Catan stores converted to the Michaels brand. We also closed one Michaels store and relocated five others. The decline in comparable store sales was driven by a decrease in customer transactions, partially offset by an increase in average ticket, primarily from continued momentum in technology and craft storage.

Sales from were up nicely again this quarter driven by increased traffic and higher conversion rates, with 45% of e-commerce sales and 65% of e-commerce orders fulfilled through our Buy Online Pick-up In Store or BOPIS initiative.

From a category perspective, tools and technology, craft storage and fine art supplies performed very well in the quarter. We saw solid growth in Halloween, driven by the decor and party. However, as Mark mentioned, our fall assortment was impacted by seasonal transition challenges. We also saw softness in yarn, kids, kids crafts and ready-made frames.

Gross profit dollars for the quarter were $441.6 million compared to $479 million in the year ago quarter. As a percentage of sales, gross margin for the quarter was 36.1% versus 37.6% last year.

Gross margin as a percent of sales came in slightly lower than our original expectations due to higher than anticipated seasonal discounting and the deleverage of occupancy and distribution costs given lower than expected sales in the quarter. The decline versus last year in gross margin was also driven by the impact of tariffs on inventory we purchase from China and changes in sales mix.

As I mentioned earlier, we saw solid growth in categories such as technology and craft storage that are lower margin than the box overall. These declines were partially offset by benefits from our ongoing pricing and sourcing initiatives, and a decrease in inventory reserves.

Total store rent expense for the quarter was virtually flat and $99.1 million versus $98.6 million in the year ago quarter. Third quarter SG&A expense, including store pre-opening costs was $324.2 million or 26.5% of sales compared to $341.8 million or 26.8% of sales in the year ago quarter. The decline was primarily due to a decrease in payroll related costs including performance based compensation and expenses associated with the closure of the Pat Catan’s stores. The decrease in performance based compensation reflects the lower than target expected payout as our performance metrics are below our target performance.

Restructuring and impairment charges were $41.4 million in the third quarter, primarily related to a pre-tax $40.1 million non-cash charge related to goodwill and other impairment charges associated with the Darice wholesale business. Typically, in the fourth quarter, we perform impairment tests on goodwill, intangible assets and other long-lived assets. Given our softness in our wholesale business over the last few quarters, we performed interim impairment tests on Darice’s goodwill, indefinite and definite-lived intangible assets and other long-lived assets in the third quarter of 2019. And as a result of the work incurred a non-cash impairment charge in the quarter.

GAAP operating income in the quarter was $76 million compared to $137.2 million in the year ago quarter. On an adjusted basis, excluding the restructure and impairment charge, adjusted operating income was $117.4 million.

Interest expense in the third quarter totaled $38.8 million, up approximately $1 million versus the year ago quarter. The change in interest expense was due primarily to the higher interest rate on our 2027 senior notes, partially offset by a decrease related to reduced borrowing on our revolving credit facility.

On August 30, 2019, we extended the maturity of our amended revolving credit facility to August of 2024. Between our solid cash flow and our undrawn revolver, our liquidity is strong totaling $886 million, comprised of $118 million in cash and our $850 million undrawn revolver, net of $82 million in outstanding letters of credit.

From a maturity perspective, our nearest term maturity is 2023 for our term loan. Our effective tax rate for the quarter was 22.5% compared to 15.8% in the year ago quarter. It was higher due primarily to the absence of tax benefits recognized in the third quarter of fiscal 2018, associated with the enactment of the Tax Act of 2017.

On a GAAP basis, net income was $28.7 million or $0.19 per diluted share. Adjusted net income was $60.1 million or $0.40 per diluted share. Adjusted third quarter EPS excludes $31.4 million of restructure and impairment charges, net of taxes, primarily related to the non-cash impairment charge, I just discussed.

During the third quarter of 2019, we purchased 8.6 million shares for an aggregate of $80 million under our share repurchase authorization. The total remaining authorization of our repurchase program is approximately $294 million. Our repurchase authorization does not have an expiration date, and the timing and number of shares repurchased under the program depend upon changing market conditions, corporate considerations, as well as debt agreements and regulatory requirements.

Total merchandise inventory decreased 1.2% to $1.42 billion compared to $1.44 billion as of the end of last year’s third quarter. The decline in inventory was primarily due to the closing of Pat Catan’s stores.

Average inventory per Michaels store, including inventory for e-commerce, inventory in the distribution centers and inventory in transit was $1,069,000 or 2.9% higher than the third quarter of last year. The increase reflects the impact of tariffs and softer sales in the quarter than our original expectation. We feel good about the quality and quantity of our inventory available to serve our makers in the fourth quarter.

Total debt at the end of the third quarter was $2.7 billion. On a trailing 12-month basis, our total debt to adjusted EBITDA was 3.4 times and interest coverage was 4 times. For the third quarter, capital expenditures totaled $32 million and were primarily comprised of ongoing investments in technology projects including costs associated with launching e-commerce in Canada and the cost of installing electronic surveillance in some of our stores. On a year-to-date basis, investments in capex through the first three quarters have totaled $90 million. For the full fiscal 2019, we now expect to invest approximately $125 million in capital expenditures with the timing of some projects moving into the beginning of 2020.

Subsequent to the end of the quarter, Nicole Crafts announced the closure of A.C. Moore retail operations. As part of this closure, Michaels entered into asset purchase agreement with A.C. Moore. As part of this agreement, we purchased intellectual property and the right to leases on up to 40 store locations for a cash consideration of $58 million. In connection with the acquisition, we also leased a distribution facility located in New Jersey, previously owned by A.C. Moore . The store locations are expected to be reopened under the Michaels brand name in fiscal 2020 and will include the relocation of certain existing Michaels stores.

We believe this opportunistic transaction should enable us to enhance our position as the largest specialty arts and crafts retailer in North America as we seek to capture additional sales from both new stores and sales transfer, as well as the benefit of having a distribution center closer to our stores and a large portion of our customers. We are currently working through integration plans and we’ll share the expected financial impact when we communicate our plans for 2020 on our fourth quarter earnings call.

Moving now to our business outlook for the fourth quarter and the full year 2019. Our guidance excludes the impact of restructuring charges related to the Pat Catan’s store closures. Expenses associated with the transition of our company’s former CEO, a write-off of an investment in a liquidated business, non-cash impairment charges associated with the Darice wholesale business, costs related to debt refinancing activities and tax related adjustments.

For the fiscal fourth quarter, we expect comp store sales will be down 2% to 3%. This reflects improved execution from the third quarter, which we expect will be more than offset by current business trends and a shorter holiday selling season in the fourth quarter. We also anticipate some near-term sales headwinds as the existing A.C. Moore retail stores are liquidated, and we’ve reflected our best assessment of the impact in our guidance.

We expect adjusted operating income for the fourth quarter between $271 million and $281 million. This reflects our updated view of sales for the quarter and our expectation for heightened competitive activity given six fewer shopping days between Thanksgiving and Christmas, partially offset by continued cost savings activities.

We expect adjusted diluted earnings per share to be in the range of $1.21 to $1.27 for the fourth quarter, assuming a diluted weighted average share count of 147 million shares.

Our fourth quarter guidance translate to the following expectations for the full year. Total sales between $5.06 billion and $5.08 billion with comp store sales down approximately 2%; adjusted operating income in the range of $565 million to $575 million; interest expense of approximately $152 million with no anticipated changes to rates and adjusted diluted earnings per share in the range of $2.07 to $2.12 on a diluted weighted average share count of about 153 million shares, and effective tax rate between 23% and 24%.

In closing, we’re encouraged by the early progress and positive indicators of our maker strategy. Our path will not necessarily be a linear one. However, backed by our strong balance sheet and solid cash flow generation, we expect our initiatives return Michaels to long-term sustainable growth as we move into 2020 and beyond.

Operator, let’s go ahead and open the call for questions.

Questions and Answers:


We will now begin the question-and-answer session. [Operator Instructions] The first question today comes from Christopher Horvers with JP Morgan. Please go ahead.

Christopher HorversJP Morgan — Analyst

Thanks. Good morning. The first question, if you look at the first half comp down 1.3% and then based on the commentary around some of the mis-execution versus the strategy issues that you’re trying to address that would suggest that the underlying comp was sort of in a similar range in the third quarter. Do you agree with that? And then thinking about the fourth quarter guide of down 2% to 3%, are you essentially assuming that same underlying sort of core business trends that will get fixed over time and the other half of it is basically to six fewer days in the A.C Moore liquidation pressure?

Denise A. PaulonisExecutive Vice President & Chief Financial Officer

Hey, Chris. Let me try to take that question for you. So when we think about the comp and what we’ve had and we isolated in Q3, two underlying factors driving the comp performance. The first was the underlying just trend of the business, which we said was about half of the decline, and so we will take 100 basis points. The other half in Q3 were execution opportunities that we saw across events and transitions and some of the softer categories.

When we’re transitioning into the fourth quarter guidance and how we described it, we believe that underlying trend remains that underlying trend. So think about that as a 100 basis points of challenge. I think offsetting that, we do believe that we’ve course corrected against the events and transition issues that we did have in the third quarter, which was good news. Over time though, what we do believe is that with the A.C. Moore liquidation that’s going to put some pressure as they liquidate through the fourth quarter, and we believe into the early part of the first quarter, and we wanted to reflect that in the guidance that we provided.

I think if you step back and say, what we’re really trying to do that underlying business trend of 100 basis points down or so is what our maker strategy is really geared to course correct against, right, being able to be more relevant to the core makers, who spend the most in the arts and crafts space and being able to really build upon that as we focus on what they need and how they want to be served. The other pieces of the challenges we feel are a bit more transitory in nature, and as I mentioned, believe that we’re course correcting through those, but just need to get past the A.C. Moore liquidation.

Christopher HorversJP Morgan — Analyst

Got it. And then on the A.C. Moore front, you had a chance to look at the portfolio. How do these 40 stores compare to the $3.3 million per store in revenues that A.C. Moore did in 2010, which was the last time they filed the K? And how are you thinking about the share capture of the remainder of the stores that you weren’t liquidating? Do you sort of discount the sales on those because probably not the best locations, and say you can capture say low double-digit percentage of those store sales, which is say your market share? Or is there some real estate factors that would make that higher or lower?

Mark CosbyChief Executive Officer & Director

Well, I’ll just first step back for a second talk about why we did the A.C. Moore thing. I would categorize it is opportunistic certainly in nature and made sense because of where the stores are located in the Northeast, which is an important geography for us. It did come with up to 40 leases that we’re evaluating and we will obviously choose those based on the location, based on the strength of their performance and also some work we will do to get the leases into a better shape.

We picked up at DC, which is important to us. Also as we went through our modeling, we determined that within the next year or two, we were going to have a problem from a DC perspective, from a capacity side, both for our stores, but even more so from the e-comm business and we needed one in the Northeast. And the beauty here would be is, this is located in a good place and we were able to get it at a compelling lease cost.

For us the biggest benefit though, beyond those things, was the fact that we were be able to transfer the stores sales that close to our existing stores. And the reason we feel confident that we’ll be able to do a meaningful percentage of the sales is that over 80% of the stores were within 5 miles of one of our stores.

The other reason we feel good is it will be able to control the sales transferred from a certain perspective because we also acquired the customer file and their website, and we will be able to leverage those things both within their stores and outside of their stores to transfer as much of the sales as is possible. Most of the lift, as we said, will happen in 2020. There will be a little bit of a drag this year because as they close their sales — or stores down and they go into clearance mode that will impact us for a short period of time, but as we go into 2020, we believe that there’ll be a nice impact.

A secondary benefit, but an important one also, is the talent side of the equation. We will work with A.C. Moore to pickup the great people working in their stores, but we will also talk to their folks in the support center. They could also have an impact on our business. So again, we see it as an opportunistic way to enter the Northeast and to add some sales growth and really buy us time for our strategy and our initiatives to really come into full play as we move into 2020.


The next question comes from Simeon Gutman with Morgan Stanley. Please go ahead.

Josh KambojMorgan Stanley — Analyst

Hi. This is Josh Kamboj on for Simeon Gutman. Thanks for taking my question, and congratulations Mark on the CEO appointment. Could you please estimate what your comp might have been in very rough terms for maker customers versus the non-maker customers in the quarter? And if possible the year-over-year benefit you might have gotten in Q3 from the shift back to high level promotions?

Denise A. PaulonisExecutive Vice President & Chief Financial Officer

Yes. So we don’t typically break out that comp difference between maker customers and maybe our more casual customers. I think the way that I’d frame it for you in the third quarter in terms of the categories that performed well versus where we saw more softness, categories that performed well were categories very much tied to our core makers. So tools and technology, craft storage, specifically craft storage for our makers, and our fine arts business. So we feel good that those things are resonating with the core customers into the store.

Where we indicated we had some softness in core categories with those makers are categories where we know we owe them newness and we owe them some change. And I think as Mark indicated, that is in our plans with our new category management strategy and what we will bring to bear as we move into 2020, but that will take a little time to transition that product.

On the more seasonal side of the business, we saw strong performance in the Halloween side of the business, but did see some softness in fall. Both our core maker and our more casual customer participate in the seasonal business, and we think that our misstep there was more about executing the transitions in the way that we really needed to fall to have the right merchandise on the floor when the customer was coming into the stores.

So overall, encouraged by the core maker and what we are doing there to win her share of wallet and that was seen through some of the core categories where we have been able to make some changes and improvements.

Josh KambojMorgan Stanley — Analyst

Thank you. And then just as a follow-up. So, can you remind us how the drag from maker customers may have been in the last couple of quarters? What line of sight you have into any changes in that trajectory in the near term? And then just, is the source of improvement on that side of the business is going to be your gradual mix shifts away from them and toward makers over time or do you think you have the ability to actually sustainably improve the trends for the non-maker customers with initiatives in your business?

Denise A. PaulonisExecutive Vice President & Chief Financial Officer

You know, overall, when we think about the customer portfolio, we think about we want to welcome everyone into our stores. What the core maker told us who is the higher income, more engaged, bigger basket customer is be sure that we’re there for her. So be sure that we have the depth of the assortment we are offering the community and experience to get her excited to come in and engage in our stores, engage with us online. We don’t believe that that is an exclusion to a more casual or novice customer who might come in. And in fact we see there is real power in the synergy of that core customer who loves to talk about what they’re doing with the more casual customer coming into the store or engaging online and being able to ask questions and learn from that more experienced maker.

So we don’t really see it as an or situation, we see it as an and, but believe that the way to push our market share gains in this space and really win over time and drive consistent comp store sales growth is going to be through over-serving on that core maker and letting everyone else enjoy the fruits of all of those changes that we make along the way.

Josh KambojMorgan Stanley — Analyst

Thank you. And then just lastly, very quickly, is it fair to interpret all the comments you made on the call through to now to mean that you think comps will sort of bottom in the first half of 2020 and improve thereafter, or is that too literal in assumption?

Denise A. PaulonisExecutive Vice President & Chief Financial Officer

I would say it’s a little too early for us to provide guidance on specific quarters for 2020. With the moving parts that we have with the A.C. Moore liquidation and what will be the sales transfer that comes from that business as well as some of the other transitions we’re working on with our strategic initiatives, I think we just be a little over our skis to be commenting specifically on the quarter trajectory at this point.

Josh KambojMorgan Stanley — Analyst

All right. Thank you. That’s fine.


The next question comes from Seth Sigman with Credit Suisse. Please go ahead.

Seth SigmanCredit Suisse — Analyst

Hey guys, good morning. A couple of follow up questions here. So first just in terms of the A.C. Moore liquidations, how we think about the short-term impact from that on your business and how long that actually lasts?

And then related, if you could just speak broadly about what’s happening from a competitive perspective? You still have some other big direct competitors out there. Are you seeing more store closings from competitors? What else are you guys seeing in terms of less traditional players like Amazon moving into the category? Just love to get your perspective on that. Thanks.

Denise A. PaulonisExecutive Vice President & Chief Financial Officer

So I’ll take the first part on A.C. Moore, and then I think Mark will be the right person to comment on the broader industry dynamics. On the A.C. Moore front, we don’t directly control any of the liquidation that’s happening in the stores. But to the best of our understanding, we expect that liquidation will be the fourth quarter and into the first quarter. How far into the first quarter will be meaningful is a little too early to tell. But for us, we’re very focused on what will happen after that, which is as we work through those quarters, working hard and having access to those stores to be able to transfer customers over into the Michaels family and into the Michaels stores and e-commerce websites, but also preparing for and analyzing and making the decision on how many of those potential 40 stores we will take on as new stores or relocations and managing through the calendar of when we’ll be able to take possession and when we will be able to reopen them as Michaels stores.

Our best guess right now, while we won’t narrow down the number of the stores at this point, as you would assume that’s very dependent upon the lease negotiations, and what we’re able to do to reduce rents, and potentially get some TI support from those landlords. And our best guess is that new stores or relocations would really start to open and be part of the business at the very end of the second quarter or into the third quarter. So that’s the way that we’re thinking about the cadence of what could be a little bit of liquidation pain, but really more than offset by the long-term goodness of the sales transfer that we’re going to be able to get and be able to welcome these customers into our stores.

Mark CosbyChief Executive Officer & Director

So just a little commentary on the arts and crafts world in general. First, it’s big at $36 billion, and we don’t really see that it’s changed much. You would kind of categorize it as a low growth category, certainly not a rapid growth category. And it’s a share battle. I think unlike or just like most every other category in the retail world is these days, but it is growing. There are seeing more distribution points as your question alluded to, there are — is a big box competitor that’s still building stores, mass online also getting into the space. Definitely is — online is a competitor for us and it is receiving a tremendous amount of our focus as we go forward.

What I would say is, I do believe we are uniquely positioned to win, both because of our scale, but also because of our omnichannel capabilities. One of the big drivers within the maker strategy is that we’re pushing toward becoming an expert, and we believe that this expertise will differentiate us versus the other players that are in the space today. And the initiatives that sort of support the strategy everything from leveraging digital and data and build the business better and reposition the business and the initiatives underneath it from selling, CRM efforts, loyalty, omnichannel, marketing, productivity, promotion, all of those things are launched, I’d say in their infancy. But all of the results would indicate that we’re heading in the right direction with the strategy.

But as we said in the commentary, it’s going to take time for these initiatives to have a meaningful impact on the results. But as we turn into 2020, we feel much more confident that those initiatives will begin to have a meaningful impact, particularly when you consider the positive benefits that will pick up from the A.C. Moore transition. So that little commentary in the arts and crafts space, we feel good about the space and we feel good about how we’re positioned within the space.

Seth SigmanCredit Suisse — Analyst

And Mark, it sounds like you guys are focused on the right areas. But how do you think about the right operating margin for the business over the long term? So, sales have obviously been quite volatile over the last couple of years. It seems like you’re underperforming your potential, and there’s some opportunity there, but your margins are also still quite elevated in the low teens when we think about your margin structure versus other retailers. So how we think about the need to reinvest here maybe reset the margins next year to get this company on a stronger course? Thanks.

Denise A. PaulonisExecutive Vice President & Chief Financial Officer

I’ll answer — I’ll start the answer and Mark can jump in here. I think broadly speaking, we’re paying a lot of attention to the value perception that our customers have of us. Our pricing and promotion work that we’ve had under way for quite a while is holistic in its approach, looking at not just where we can cut discounting, but also are we competitively priced and offering what she wants from us in the market.

I think what we’re getting feedback from in regards from our core makers is that our core makers are searching for more than just price. They are searching for a great assortment, a great experience, a great linkage to community, which doesn’t mean that we don’t have to offer a great value, but doesn’t necessarily mean that price is her first choice.

So, I think that when we think about overall where we are with operating margins in the next few quarters, I think there’s going to be many puts and takes, because we’re going to continue to manage against tailwinds like our sourcing benefits, headwinds like tariffs and we’ll see how that naturalizes out over time. But I think the bigger part is, we’re very focused on value perception. I think we’re going to be looking closely at which categories we might need to take some action on. But at this point, we’re looking at really the holistic proposition to what we offer her rather than being focused on just one element of the model in its regards to pricing.

Mark CosbyChief Executive Officer & Director

And just to build on Denise’s piece a little bit, I mean value perception obviously a big priority for us and we do have a team as I mentioned around optimizing promotion and discounting, where we’re looking at the best ways to do that. And we have analytics and tools in place to help us do that. And then looking for places where it makes sense to reinvest back into pricing in a prudent way as I would describe it. But as you know, value is more than just the price. So we are looking at the way we present within our stores, making our isle presentation more compelling, working on our signing package to make it more compelling. We’ve also put a lot more discipline around our competitive price monitoring. So we have tools in place that will tell us where we are priced versus our competition that allow us to be a little more intelligent around both how we promote and discount, but also our regular pricing. So definitely a priority for us, definitely something that we will watch closely as we go into next year.


[Operator Instructions] The next question comes from Kate McShane with Goldman Sachs. Please go ahead.

Kate McShaneGoldman Sachs — Analyst

Hi. Thank you. Good morning. Thanks for taking my question. You had mentioned with regards to the strength in categories versus other categories, lack of newness driving some of the softer results. How is newness something that you can drive going forward and what does the pipeline look like?

Mark CosbyChief Executive Officer & Director

Well, I think, just to broadly answer that because we do believe the newness is a huge priority for us. And as you heard me speak one of our big initiatives is around category management. And back to some of the earlier questions too around what that means. As we go through this category management process, it will mean that categories that are more in line with the core maker will become more important to us like fine art, yarn, technology, jewelry and kids. We were — are working to address those as we speak.

It also means that all other categories will be shifted a little bit, I would say, toward the maker. We won’t abandon categories. So categories that you might think of is more novice in nature, seasonal will still become very important, because those are important to the maker customer. But the belief is that we’re going to put this process in place, we’re going to assess every business and we are going to add newness. If you look at our assortment in general over the last few years, we have not done enough to introduce new products and update the category over time.

Now the good news is, as I mentioned in my commentary, I think we proved this year that when we do touch the categories and really get them right from an assortment perspective and add newness where it’s right that we can drive sales growth, we did that successfully in technology, craft storage and fine art this year. We are now in the process of collecting consumer feedback against seven or eight key categories, and we plan to update those categories in the first half going into the third quarter of next year. But big part of our future growth will be around getting the assortment right for our maker and getting the assortment newer, so to speak, across the board.

Denise A. PaulonisExecutive Vice President & Chief Financial Officer

And Kate, I’ll just add that newness can take many different forms, and it will be very different by category. So newness in some areas could be, do we have the right color palette in something like ready-made frames for what she wants to offer. Newness could be something in tools in the knitting or needle space. Do we have the latest kind of knitting needle sizes and things that she wants. And sometimes it can be fundamentally new product that comes into the market such as the recent years of additions of the technology players. But it really spans a wide variety of definition of newness, but fundamentally, it’s about making the changes in that assortment in the store through resets in the store, which just take a little longer time to bring to fruition, but newness doesn’t always have to mean a new category like technology, it can simply mean a refresh of an existing portfolio.

Kate McShaneGoldman Sachs — Analyst

Thank you.


The next question comes from Laura Champine with Loop Capital. Please go ahead.

Laura ChampineLoop Capital — Analyst

Thanks for taking my question. It’s really about bridging the gap between your comments, Mark, that arts and crafts as the category is growing, and your comments on underlying trends in the business this back half being negative 100 basis points. I presume that means share loss. And if you look at what are Michaels’ biggest detriments to growing at the pace of the industry, would those be value, is it merchandising, is it omnichannel mix? Just if you can help us diagnose the biggest issues that Michaels facing as it looks to catch up with the category?

Mark CosbyChief Executive Officer & Director

I think if you do the math, and what I said, I think, is true. The category is growing slightly, and if we’re down, our underlying business trends are down. That means we are losing share. So it’s definitely something we’re very focused on. And the answer I would give you to what do we need to do about it, it’s all the initiatives that we’re putting in play. I think we were a little bit behind in getting into the whole omnichannel world, and that’s a big place that we’re working to catch up on both in terms of our e-commerce site and how it relates down to our store.

We think we’re uniquely positioned there, because we do have the technology now in place and we do have the store base that we can leverage to really play big in that space. It also plays into things like CRM and personalization and the opportunities there plays into the assortment and how we need to upgrade that over time, not mass shifts in categories, but more taking each category, looking at it through the lens of the maker customer and updating it over time. So I would say it’s more around updating and shifting toward the maker customer, where we believe we have strength today, and we believe there is tremendous growth opportunity down the road.

And as somebody asked earlier, what does that mean to the novice, we believe if we do the maker thing right, the novice will come along. I mean, they come into our stores a couple of times a year. They are coming there for a purpose. They’re going to still come in for the purpose. We need to win with the maker customer, which really drives this category.

Laura ChampineLoop Capital — Analyst

Thank you.


Our last question today comes from Liz Suzuki with Bank of America. Please go ahead.

Elizabeth SuzukiBank of America — Analyst

Great. Thank you for taking my question. So you guys have been running a free shipping promotion for Cyber Week with no order minimums. Is there anything that you can share about the early results of that program and whether those sales are generally profitable or if they’re more about building loyalty with online customers?

Mark CosbyChief Executive Officer & Director

I mean, I’ll give you a quick answer to that is that we did free shipping for one day for Black Friday, so Cyber Monday. And the only reason we did that is you kind of have to do that to play on that day. It’s not a long — ongoing long-term part of our strategy. Our typical strategy is around $49 and above, is free. This is the one day, I think, we’ve done free in the last six months. And the reason we can be successful in that arena is because we have the stores.

As you heard the stats earlier, two-thirds of our transactions, and over 45% of our sales are going through BOPIS today, which we believe is a huge strength for us in this business, people go online, they can shop for what they’re looking for. And if they want to pick it up, today we have 1,270 stores virtually everywhere somebody would be where they can go and pick it up. So we will selectively move the shipping price threshold here and there, but it’s as a promotion, not as an ongoing part of the business.

Elizabeth SuzukiBank of America — Analyst

Okay, great. And then it seemed like the marketing activity also stepped up a bit in the last couple of months or at least it was more noticeable on like live TV than it’s been in the past. I’m curious how advertising impacted the operating margin in the quarter and how it impacts the guidance for the fourth quarter?

Mark CosbyChief Executive Officer & Director

I’ll give you comment on advertising and then Denise can do the financial piece of it. But we are definitely shifting our media mix. As I mentioned earlier, we have a media mix model that we put together over the last three months or four months that’s really educating us on where to spend our money more productively. We’re not spending more money, we’re just spending it in different ways. Like a lot of retailers, we’re moving out of the mass vehicles, which tend to be lower productivity vehicles like newspaper, like direct mail, and really shifting it into more personalized vehicles, certainly email being in that digital marketing addressable TV, which you just referenced, which has been a big win for us, but the more we can personalize, the more we can directly target the maker customer those tend to be the vehicles that are more productive for us.

We’re also working through this event structure that I mentioned earlier to do more public relations, more social media, a lot of work to try to get the word out, more community type activities. But don’t think of it as an incremental investment, we’re just shifting the spend into more productive vehicles.

Denise A. PaulonisExecutive Vice President & Chief Financial Officer

And Liz, sort of adding to the piece that I mentioned is that what we’ve done throughout the year is we actually just rebalanced and advertising across the different quarters. So in the fourth quarter, you will see about a 30 basis point hit to our SG&A rate because of a mix shift of some of our media and some of our advertising into the fourth quarter, and away from the other quarters in the year. But that was intentional as the time that we can really kind of garner that support and garner that interest from our customer base, but you are accurate in the view that there will be a bit of a headwind from a rate perspective, from a little bit of the dollar shift of advertising from other quarters into the fourth quarter.

Elizabeth SuzukiBank of America — Analyst

Okay. Great. Thanks. That’s really helpful.

Mark CosbyChief Executive Officer & Director

So I think that’s the end of our Q&A, and I’ll just close it down here with a few closing comments. First, thank you for joining us this morning. I want to extend my gratitude to our entire team for their hard work and dedication as we work to implement our maker strategy and return Michaels to growth. There is a lot of great work being done by our teams and operational progress is being made in so many areas every single day. I would also like to acknowledge our investors for their interest in and support of Michaels. Our focus is on disciplined execution of our strategic initiatives and we are committed to driving improved results and shareholder value. I look forward to updating you on our progress next quarter. And finally, I would like to wish all of our stakeholders a very happy and creative holiday season. Thank you.


[Operator Closing Remarks]

Duration: 59 minutes

Call participants:

Jim MathiasDirector, Investor Relations

Mark CosbyChief Executive Officer & Director

Denise A. PaulonisExecutive Vice President & Chief Financial Officer

Christopher HorversJP Morgan — Analyst

Josh KambojMorgan Stanley — Analyst

Seth SigmanCredit Suisse — Analyst

Kate McShaneGoldman Sachs — Analyst

Laura ChampineLoop Capital — Analyst

Elizabeth SuzukiBank of America — Analyst

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