Despite Dismal Q2 Report, Johnson Says JCPenney “On Track

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New jeans shops, including Levi’s, premiered this month and CEO Ron Johnson says they are performing well.

Plano, TX—Despite reporting that JCPenney swung into a second quarter loss with a 23% dive in sales, CEO Ron Johnson said the store’s transformation begun six months ago is “on track.”

“Our rock solid balance sheet will support the execution of our transformation and position us for growth beginning in 2013,” Johnson added.

When the retailer began its controversial “Fair and Square” strategy, the company warned investors in its annual reports that its everyday low price strategy “could result in a prolonged decline in sales.”

So far, that caution has proven true. In its first quarter reported in April, JCPenney swung into a loss of $163 million with sales plummeting 20% and comparable store sales sinking 18.9%.

For its second quarter ended July 28, the department store reported an equally dismal report: it swung into a net loss of $147 million, or 67 cents a share, compared with a year-earlier profit of $14 million, or 7 cents. Excluding one-time items, the company lost 37 cents a share, even worse than the 25-cent-a-share loss that analysts’ expected.

Reduction in Marketing Activities Hurt Sales

Sales plunged 22.6% to $3.02 billion with comparable store sales falling 21.7% while online sales dropped 32.6%.

“Sales were adversely impacted by the company’s decision to significantly reduce its marketing activities during the latter half of the quarter, as it reconsidered its approach to pricing and marketing in time for back to school, the company said, a veiled reference to Michael Francis, the president who was in charge of marketing who left suddenly in June.

Gross margin narrowed to 33.2% from 38.3% due to “lower than expected sales in the quarter and approximately $102 million of markdowns taken to clear discontinued inventory in preparation for new product arriving in the fall of 2012. Excluding these transitional markdowns, adjusted gross margin was 36.6%.”

Johnson once again reiterated the company will stay the course.

“We have now completed the first six months of our transformation and while business continues to be softer than anticipated, we are confident the transformation of JCPenney is on track,” Johnson said. “The transition from a highly promotional business model to one based on everyday value will take time and we will stay the course.”

He added that “this month we simplified our pricing, launched the first of our new shops, and accelerated our marketing efforts to focus on brands, products and value. Early response to these efforts has been very encouraging…We continue to learn and adjust, and fully expect that our unique, specialty department store experience will drive JCPenney’s long term success.”

On a more positive note, JCPenney reported that its selling, general and administrative expenses fell 15.5%, and it continues to expect savings to accelerate and exceed an approximately $900 million at the end of the year, based upon “aggressive” management of expenses.

The company ended the second quarter with approximately $888 million in cash and cash equivalents, and expects to end the fiscal year with in excess of $1 billion of cash. Seeking to reassure investors, Ken Hannah, its chief financial officer, said JCPenney also has a $1.5 billion asset-backed line of bank credit that it doesn’t plan to tap into this year and may sell non-core assets to boost its cash position.

“I want you to understand how strong our balance sheet is,” Hannah said. “Our liquidity allows us to fund this transformation out of our current operations.”

However, JCPenney no longer expects to achieve its fiscal 2012 earnings target of $2.16 a share and didn’t supply an updated estimate. Analysts’ estimates expected earnings of $1.26 a share.

Rating Services Downgrade the Company

As part of its back to school marketing, JCPenney is offering free haircuts to kids

Last month, Standard & Poor’s Rating Services described JCPenney’s business risk profile as “weak” and its financial risk profile as “highly leveraged.” Moody’s Investors Service last Friday lowered its rating on the company’s debt two notches to Ba3 from Ba1, citing the retailer’s double-digit sales declines and gross margin pressure.

But some analysts today were even more skeptical that JCPenney’s transformation will be successful.

“I am very skeptical as to whether he understands that the JCPenney customer is looking for value and perceives value only with couponing. As long as Macy’s Inc. keeps banging away, I don’t think he has a ghost of chance,” said Walter Loeb of Loeb Associates, a retail management consultancy.

Brian Sozzi, chief analyst at NBG Productions, a research firm, said: “This is worse on top of whatever I thought was going to be a bad story. I am losing faith in the pricing switch.”

“JCPenney’s is losing its battle on two fronts. First, in its competition with other bricks-and-mortar retailers like Target Corp. and Kohl’s Corp., the company’s no-promotion strategy is by now a proven loser. Sale prices and gimmicks are what drive traffic and sales in retail,” said Paul Ausick, analyst at 24/7 Wall St. “Second, its e-commerce business competes with Inc. as well with its traditional competitors’ websites, and JCPenney’s is not making a compelling offer there either.”

Nonetheless, Johnson called the transformation “a marathon, not a sprint”–a notion backed up by William Ackman, JCPenney’s largest shareholder.

So far this month, when the store added its first shops-within-the-store concept, Johnson said there’s already been success.

“We’re thrilled with their performance,” he said, noting in particular Levi’s sales, which are up 25% at the new shops compared with the previous format.